Recommended Annual Review for Hedge Fund and Other Private Fund Managers

November 17, 2011

2011 ushered in a number of significant changes regarding how managers of hedge funds and other private funds are regulated. Many of the changes introduced in 2010 took effect this year and have had a significant impact on the private fund industry. The following is meant to briefly recap some of the significant changes that occurred in 2011 and to remind you of certain “best practices” that you should consider in preparing for 2012. This summary is general in nature and does not constitute legal advice for any specific situation.

2011 Regulatory Highlights

Implementation of Dodd-Frank Wall Street Reform and Consumer Protection Act Provisions.

On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted final rules and rule amendments under the Investment Advisers Act of 1940 (the “Advisers Act”) to implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) regarding the registration of investment advisers and managers of private funds.1 Effective July 21, 2011, the Dodd-Frank Act repealed the “private adviser” exemption2 from registration under the Advisers Act. As a result, many investment advisers to private funds that previously relied on the “private adviser” exemption from registration with the SEC now are required to be registered with the SEC by March 30, 2012.3 (These advisers may not be required to register if another exemption from registration is available, as discussed below.) 

Private Fund Adviser Exemption. The SEC adopted a rule that exempts from registration under the Advisers Act any adviser that solely advises private funds and manages less than $150 million assets under management in the United States.4 Advisers must use the “regulatory assets under management”5 method to calculate their assets under management. To determine the availability of an exemption from registration, such calculations must be made annually. In certain cases, non-U.S. advisers may rely on the private adviser exemption — see Foreign Private Adviser Exemption below.

Eligibility for SEC Registration for Mid-Sized Advisers. The Dodd-Frank Act creates a new category of advisers that have between $25 million and $100 million of assets under management (referred to as “mid-sized advisers”). A mid-sized adviser generally must register with the SEC if, under the laws of the state in which its principal office and place of business is located, it relies on an exemption from registration as an investment adviser or is excluded from the definition of investment adviser.6 Furthermore, a mid-sized adviser is also required to register with the SEC if the adviser is registered or required to be registered with a state, but not subject to examination as an investment adviser by such state. New York currently does not conduct examinations of investment advisers, and Wyoming does not currently regulate investment advisers. Therefore, advisers located in these states that have at least $25 million in assets under management must register with the SEC, unless an exemption from SEC registration is available.

Under the rule, each adviser registered with the SEC on Jan. 1, 2012, must file an amendment to its Form ADV no later than March 30, 2012, to demonstrate whether it remains eligible for SEC registration or must transition to state registration. Mid-sized advisers registered with the SEC as of July 21, 2011, must remain registered (unless an exemption to registration is available) until Jan. 1, 2012. If a mid-sized adviser that is registered with the SEC is no longer eligible for such registration, the adviser will have until June 28, 2012 to withdraw its registration with the SEC and register with state securities authorities.

Venture Capital Funds Adviser Exemption. The Dodd-Frank Act provides an exemption from Advisers Act registration for advisers that only advise venture capital funds. The SEC defines a “venture capital fund” as a private fund that (i) holds no more than 20 percent of the fund’s bona fide capital commitments in non-qualifying investments (other than short-term holdings); (ii) does not borrow or is not leveraged (other than limited short-term borrowing); (iii) does not offer redemption or similar liquidity rights to investors except under extraordinary circumstances; (iv) represents itself to investors as being a venture capital fund; and (v) is not registered under the 1940 Act and has not elected to be treated as a business development company under the 1940 Act. The definition of venture capital fund also includes a grandfathering provision7 for advisers to funds that have held themselves out as venture capital funds but would not be classified as such under the rules.

Foreign Private Adviser Exemption. The Dodd-Frank Act established a new exemption from Advisers Act registration for “foreign private advisers.” As defined by Section 202(a)(30) of the Advisers Act, a “foreign private adviser” is any investment adviser that (i) has fewer than 15 U.S. clients and U.S. investors in private funds advised by the adviser; (ii) has less than $25 million in aggregate assets under management from U.S. clients and private fund investors; (iii) does not have a place of business in the United States; (iv) does not hold itself out generally to the public in the United States as an investment adviser; and (v) does not advise an investment company registered under the 1940 Act or an entity that has elected to be treated as a business development company under the 1940 Act.

Notwithstanding the foregoing, non-U.S. advisers may qualify for the private fund adviser exemption (as discussed above) if they have non-U.S. clients that are not private funds or if they manage in excess of $150 million for non-U.S. clients, as long as (i) the non-U.S. adviser has no client that is a U.S. person except for private funds and (ii) all assets managed by the adviser from a place of business in the U.S. are attributable solely to private fund assets, the total value of which is less than $150 million. Advisers with a principal office and place of business outside of the United States must count toward the $150 million limit only those private fund assets that are managed from a place of business in the United States. 

Reporting by Exempt Reporting Advisers. Advisers (including non-U.S. advisers) relying on the exemption for venture capital fund advisers or the exemption for private fund advisers are subject to limited reporting requirements as “exempt reporting advisers”. Such exempt reporting advisers are required to provide information under certain questions in Part 1A of Form ADV.

Exempt reporting advisers will be required to file their first reports through the IARD system within 60 days of relying on the exemption from registration. Notwithstanding this requirement, an exempt reporting adviser must file its initial Form ADV no later than March 30, 2012. Exempt reporting advisers, like registered advisers, will be required to file updating amendments to Form ADV at least annually, within 90 days of the end of the adviser’s fiscal year, and more frequently if required by the instructions to Form ADV. Exempt reporting advisers, like registered advisers, also are required to update certain items promptly if they become inaccurate or materially inaccurate. Exempt reporting advisers will be subject to certain recordkeeping requirements under the Dodd-Frank Act, as determined by the SEC.

Family Offices. The Dodd-Frank Act amends the Advisers Act to exclude “family offices” from the definition of investment adviser and grants the SEC the rulemaking authority to define this term.8 The SEC has delayed registration for family offices currently exempt from registration and that do not meet the new family office exclusion until March 30, 2012. Family offices managing charitable or nonprofit organizations that are funded in part by non-family money have until Dec. 31, 2013, to comply with the adopted rules.

Amendments to Form ADV. The SEC adopted amendments to Form ADV that are intended to enhance the SEC’s ability to oversee investment advisers. The amendments require advisers to provide additional information about certain areas of their operations, including (i) basic organizational, operational and investment information about the private funds they manage; (ii) advisory business information and business practices such as the use of affiliated brokers, soft dollar arrangements and compensation for client referrals; (iii) information regarding other business activities; and (iv) information on the adviser’s financial industry affiliations.

The Pay-to-Play Rule. The SEC adopted an amendment to Rule 206(4)-5, or the “Pay-to-Play” rule, which prohibits advisers from engaging in pay-to-play practices. The amendment adds “registered municipal advisers” to the categories of regulated entities exempt from the ban on advisers paying third parties to solicit government entities. The amendment also allows an adviser to pay a registered municipal adviser, in addition to another registered adviser or broker-dealer, to solicit business on behalf of an adviser from a state or local government entity. To qualify for the exemption, the registered municipal adviser will be required to register with the SEC, pursuant to Section 15B of the Securities Exchange Act of 1934 (the “1934 Act”), and be subject to a Municipal Securities Rulemaking Board’s Pay-to-Play rule.

The date by which advisers must comply with the third-party solicitation ban has been extended to June 13, 2012. An overview of the Pay-to-Play rule may be found here. For more information on the amendment to the Pay-to-Play rule, please see our alert on the final rules implementing the Dodd-Frank Act provisions discussed in Additional Information.

Rules Implementing Whistleblower Program. The Dodd-Frank Act established a whistleblower program that requires the SEC to pay an award, subject to certain limitations, to eligible whistleblowers that voluntarily provide the SEC with original information about a violation of the federal securities laws that leads to the successful enforcement of a covered judicial or administrative action, or a related action. The Dodd-Frank Act also prohibits retaliation by employers against whistleblower employees. In May, the SEC adopted final rules implementing the whistleblower program.

Under the whistleblower provisions, the SEC will pay a bounty to an eligible whistleblower that voluntarily provides the SEC with original information concerning a securities law violation that leads to an enforcement action that collects $1 million or more. The bounties would be not less than 10 percent and up to 30 percent of the monetary sanctions awarded. Whistleblowers are protected from retaliation regardless of whether they are eligible for a bounty, and the SEC rules incentivize employees to report known infractions internally before reporting to the government. An overview of the final rules may be read here.

Additional Information. A general outline of the Dodd-Frank Act may be found here and a more detailed overview of the Dodd-Frank Act’s implications for investment advisers may be found here. A detailed explanation of the final rules implementing the Dodd-Frank Act provisions may be found here. Finally, a summary of the proposed Volcker Rule regulations may be found here. We urge you to contact counsel with any questions relating to the Dodd-Frank Act or the related rules and regulations.

FINRA Rule 5131. In May 2011, the SEC approved and the Financial Industry Regulatory Authority (“FINRA”) adopted Rule 5131 relating to the allocation of “new issues.”10 This rule became effective on Sept. 26, 2011. Rule 5131 supplements, but does not replace, Rule 5130, which also relates to the allocation of new issues. Rule 5131(b) (the “anti-spinning rule”) directs FINRA members to establish policies and procedures to prevent the involvement or influence of investment banking personnel in the allocation of new issues. Furthermore, Rule 5131(b) prohibits FINRA members from allocating new issues to certain accounts,11 including any account in which certain covered persons have a beneficial interest in specified instances. Rule 5131(b)(3), however, permits allocations of new issues to an account in which the collective beneficial interests of covered persons from a covered company in the aggregate do not exceed 25 percent of such account.

Advisers that manage hedge funds (or funds of funds) that invest in new issues should make sure that their funds’ offering, subscription and other documents provide the necessary disclosures and elicit the proper information from underlying investors so that the adviser can provide a 5131 certification to broker-dealers upon request or when necessary. More information on Rule 5131 may be found here. Please also see Other Annual Requirements.

Form SLT. In June 2011, the Department of Treasury finalized Form SLT, a new reporting form that is part of the Treasury International Capital (TIC) data reporting system and designed to gather information on cross-border ownership of long-term securities by U.S. and foreign residents for use in forming U.S. international financial and monetary policies.

All U.S. individuals or entities (i) who qualify as U.S.-resident custodians‚ issuers and/or end-investors (e.g.‚ funds), and (ii) whose consolidated long-term reportable securities12 exceed $1 billion as of the last business day of the reporting month‚ will be required to file Form SLT. Where securities reportable on Form SLT are held by a U.S.-resident custodian‚ however, a Form SLT report covering these securities would be due from the custodian and not the beneficial owner of the securities. 

In 2011‚ Form SLT must be filed quarterly, as of the last business day of each quarter starting with Sept. 30‚ 2011. Beginning in 2012, Form SLT must be filed as of the last business day of the month in which the $1 billion threshold is exceeded and monthly thereafter.13 Reporters must submit Form SLT to the Federal Reserve Bank of New York no later than the 23rd calendar day of the month following the applicable reporting date (or the next business day‚ if the filing date falls on a weekend or holiday).

Advisers should be aware that it may take substantial work to determine whether an adviser is required to file Form SLT on behalf of entities it manages and subsequently to complete the form. More information on Form SLT may be found here. Advisers also should be aware that the Departments of Treasury and Commerce (which includes the Bureau of Economic Analysis) may impose additional reporting obligations on investment advisers, including, without limitation, with respect to cross-border transactions involving long-term securities, derivatives, currencies and direct investments. We suggest that you contact outside counsel with any questions relating to Form SLT or such other reporting obligations.

Rule 13h-1 and Form 13H. In July, the SEC adopted new Rule 13h-1 under Section 13(h) of the 1934 Act.14 The rule imposes initial and ongoing filing obligations on “large traders”15 and subjects U.S.-registered broker-dealers that service large traders to certain recordkeeping, monitoring and reporting requirements. A large trader may also voluntarily file Form 13H. The purpose of Rule 13h-1 is to assist the SEC in its efforts to identify the most significant participants in the U.S. securities markets and to gather information quickly on their trading activity.

Large traders must file an initial Form 13H with the SEC by Dec. 1, 2011, and, for those who meet the “large trader” definition after the initial filing deadline, “promptly” after meeting its threshold (within 10 days). Thereafter, a large trader must submit an annual filing on Form 13H within 45 days of the end of the calendar year (by Feb. 14 in 2012) and must submit any amendments promptly after the end of any calendar quarter in which information previously provided becomes inaccurate. Broker-dealers must begin maintaining the required records, monitoring large trader activity and be able to respond to requests from regulators with required information, including with respect to “unidentified large traders,” by April 30, 2012.16 More information on Form 13H may be found here.

Form PF. In October, the SEC and the Commodity Futures Trading Commission (the “CFTC”) jointly adopted final rules requiring certain SEC-registered and dual SEC-CFTC registered investment advisers to report certain information on new Form PF. Data collected from Form PF will assist the Financial Stability Oversight Committee in monitoring systemic risk. Although the SEC and CFTC may use Form PF information in examinations, enforcement actions and for investor protection efforts, information reported on Form PF will otherwise remain confidential.

Newly-adopted Advisers Act Rule 204(b)-1 requires SEC-registered investment advisers that advise one or more private funds and have at least $150 million in private fund assets under management to file Form PF with the SEC. The CFTC also adopted new Rule 4.27, which outlines Form PF reporting obligations for dual SEC-CFTC registered investment advisers.17 

Private fund advisers reporting on Form PF are required disclose certain information regarding their advisory business and the private funds they advise, including their assets under management. Generally, private fund advisers must file Form PF within 120 days after each fiscal year. Private fund advisers that meet the definition of Large Private Fund Advisers (“LPFAs”), however, are required to satisfy additional reporting requirements. The frequency with which LPFAs must report depends on both the type of fund(s) an LPFA advises and the amount of assets of such fund(s), as follows: 

  • LPFAs with at least $1.5 billion in assets under management attributable to hedge funds as of the end of any month in the adviser’s prior fiscal quarter must file Form PF within 60 days after each quarter.


  • LPFAs with at least $2 billion in assets under management attributable to private equity funds as of the last day of the adviser’s most recently completed fiscal year must file Form PF within 120 days after each fiscal year.


  • LPFAs with at least $1 billion in assets under management attributable to liquidity funds and registered money market funds as of the end of any month in the adviser’s prior fiscal quarter must file Form PF within 15 days after each quarter.


The initial filing date for Form PF will be determined as follows: Advisers that have at least $5 billion of assets under management attributable to hedge funds, private equity funds, or liquidity funds and registered money market funds must make an initial filing after the first fiscal year or quarter end (as applicable) occurring after June 15, 2012. All other advisers must make an initial filing after the first fiscal year or quarter-end (as applicable) occurring after Dec. 15, 2012. A more detailed explanation of Form PF may be found here.

“Qualified Client” Threshold. Investment advisers should update the subscription documents of the funds they manage to include the change in the threshold for “qualified clients.” Rule 205-3 under the Advisers Act exempts an investment adviser from the prohibition against charging a client performance fees in certain circumstances, including when the client is a “qualified client.” In July, the SEC raised the thresholds used to determine whether an adviser may charge its clients performance-based fees and now includes any client that has at least $1 million under management with the adviser or that the adviser reasonably believes has a net worth of more than $2 million. The previous thresholds were $750,000 and $1.5 million, respectively.

CFTC Proposal to Rescind or Limit Exemptions. On Jan. 26, 2011, the CFTC proposed rules that would rescind or limit exclusions and exemptions from CPO and CTA registration that often are relied on by operators and advisers of private funds that trade in commodities and futures.18 The rescission of these exemptions could result in mandatory registration and disclosure by many sponsors and advisers to private funds that trade these instruments. The CFTC-proposed rules also would significantly narrow the exclusion under Rule 4.5, on which registered investment companies and their advisers often rely, and would reinstate a filing requirement to claim the exclusion. The proposed rule would also impose additional reporting and disclosure requirements on CPOs and CTAs. We are monitoring CFTC communications closely, and will keep you updated with alerts in the future.

Looking Ahead to 2012

Preparing for Registration with the SEC. Those investment advisers required to be registered by March 30, 2012, will be subject to a number of requirements that entail preparation in advance of registration. Such requirements include adopting and implementing compliance policies and procedures, appointing a chief compliance officer, making and maintaining certain books and records, making and maintaining publicly available filings with the SEC (including Form ADV), submitting to periodic examinations by the SEC, and adopting and enforcing detailed codes of ethics and personal trading rules for certain personnel. We urge our clients to contact counsel to discuss a timeline for registration if they have not already done so.

Compliance Policies and Procedures. Investment advisers that currently maintain written compliance policies and procedures should review them to determine their adequacy and effectiveness. Each SEC-registered investment adviser is required to review its compliance policies and procedures on an annual basis and encouraged to maintain written evidence of the review. The annual review should consider, among other things, any compliance matters that arose during the previous year; any changes in the business activities of the investment adviser; and any changes in the Advisers Act or other regulations that might require changes to the policies and procedures, including, for example, changes to the rules governing recordkeeping as a result of the Pay-to-Play rule, the amended Form ADV Part 2 and, eventually, the SEC rules promulgated under the Dodd-Frank Act.19

In light of the SEC’s recent focus on investment advisers’ controls regarding material non-public information, we have found that it is useful to have outside counsel (together with in-house counsel, if applicable) provide training with respect to the prevention of insider trading to all of the investment adviser’s personnel. If you would like us to provide such training for your personnel, please contact Bingham counsel.

SEC-registered investment advisers, among other things, should also be sure that each of their access persons20, and possibly certain other personnel, provides to the investment adviser’s chief compliance officer a quarterly transactions report and annual holdings report listing such person’s personal security transactions or holdings, as applicable.

SEC-registered investment advisers should also consider their other obligations under the Advisers Act, including, but not limited to, considering the effectiveness of their codes of ethics and conducting any necessary training that may be associated therewith as well as the effectiveness of any disaster recovery contingency plans and systems that they have in place.

Form ADV. Each investment adviser that already is registered with the SEC must update its Form ADV Part 1 and Part 2A and file them with the SEC on an annual basis within 90 days after the end of its fiscal year (by March 30 in 2012). In addition, certain Form ADV information must be amended promptly if it becomes inaccurate or upon any change in the disciplinary history of an investment adviser and/or its personnel. Investment advisers should refer to the Form ADV instructions (which can be found on the SEC's website) or contact counsel to determine whether any of their Form ADV information must be updated promptly.

Parts 2A and 2B of Form ADV must generally be delivered to new and prospective clients before or at the time of entering into an advisory contract. Part 2A must also be delivered to existing clients within 60 days of filing. An update of each of Part 2A and 2B (or a statement summarizing material changes) must generally be delivered to clients upon the disclosure of any additional disciplinary event or upon a material change to the description of any disciplinary event already disclosed. Additionally, Part 2A must generally be delivered to clients within 120 days after the end of an investment adviser’s fiscal year (by April 29 in 2012). Although “clients” under the Advisers Act are technically the funds advised by an investment adviser, rather than the investors in those funds, we suggest that Part 2 be offered to these underlying investors.

The updates to Form ADV Part 1 and Part 2A must be filed on the SEC’s electronic IARD system. Although Part 2B is not filed with the SEC, it is required to be maintained in the investment adviser’s files.

In addition, certain states also require that investment advisers file their Form ADV with state regulatory authorities, and some states require a paper filing. In general, special attention should be paid to the requirements of any state in which the investment adviser has a place of business or more than five non-exempt clients. State-registered investment advisers should also consider any other requirements in the states in which they are registered. Generally, a state-registered investment adviser will need to register in every state in which they do business with non-exempt clients.

Form D and Blue Sky Filings. Form D must be electronically filed with the SEC on its filer management system, EDGAR, within 15 days of the initial sale of securities in an offering. If Form D was filed as of Sept. 15, 2008, or later and it relates to an offering that is still on going, it must be amended annually on or before the first anniversary of the most recent previously filed notice. Form D must also be amended as soon as practicable after a change in information on the previously filed notice or to correct a material mistake of fact or error.

The blue sky laws of many states require that a hard copy of Form D be filed with the relevant state authority within 15 days following the initial sale of interests or shares in that state. In addition, the blue sky laws generally require that filings previously made be updated from time to time to reflect certain changes, and some states require filings on a periodic basis. In considering blue sky filings, investment advisers should pay special attention to: (i) new states where they intend to sell (or recently sold) interests or shares; (ii) states where they have sold interests or shares but did not file a Form D; and (iii) states from which investors have made additional investments. The regulatory penalties for failing to make filings on time can be significant and may also result in a requirement to offer rescission to each investor in a state.

Custody Rule Compliance. SEC-registered investment advisers that maintain custody of client securities or assets21  are subject to Rule 206(4)-2 under the Advisers Act. Unless an investment adviser has account statements delivered to the investors in the funds it manages on a regular quarterly basis from qualified custodians, the rule requires that a copy of each fund’s audited financial statements, prepared in accordance with generally accepted accounting principles, be delivered to fund investors within 120 days (or 180 days for funds of funds) after the end of the fund’s fiscal year.22

Other Regulatory Filings. There are several regulatory filings that investment advisers (whether SEC-registered or not) may be required to make in light of certain activities, which may include:

  • Form 13F. An investment adviser is required to file a Form 13F with the SEC if it exercised investment discretion over $100 million or more in Section 13(f) securities on the last trading day of any month in the prior calendar year. Form 13F must be filed within 45 days after the last day of the calendar year (for the coming year, not later than Feb. 14, 2012) and again within 45 days after the last day of each of the three calendar quarters thereafter.


  • Schedule 13D/13G. If an investment adviser directly or indirectly “beneficially owns” (through fund(s), client account(s) or proprietary account(s)) more than 5 percent of a class of publicly traded securities, the investment adviser (and possibly others) is required to file either a Schedule 13D or Schedule 13G with the SEC. “Beneficial ownership” generally means the direct or indirect power to vote and/or dispose of such securities. Unless qualified to file a Schedule 13G, an investment adviser (and possibly others23) must file a Schedule 13D within 10 days of the acquisition of more than 5 percent of such securities, which must be amended promptly to reflect material changes, including, but not limited to, an acquisition or disposition equal to 1 percent or more of such securities.



    Schedule 13G may generally be filed by a person or entity that beneficially owns less than 20 percent of the outstanding shares of a class of such securities in the ordinary course of business and not for the purpose of changing or controlling the management of the issuer of such securities. A “passive investor” must file Schedule 13G within 10 days of crossing the 5 percent beneficial ownership threshold. Certain eligible institutions (including SEC-registered investment advisers) also are permitted to file on Schedule 13G.24 An SEC-registered investment adviser must file a Schedule 13G within 45 days after the end of the calendar year in which more than 5 percent of such securities was obtained or within 10 days of month end if beneficial ownership exceeds 10 percent at such month end. A non-SEC registered investment adviser must file Schedule 13G within 10 days of the acquisition of more than 5 percent of such securities. Schedule 13G must be amended periodically per rules that vary based on the type of filer. In addition, each registered and non-registered investment adviser that has previously filed a Schedule 13G must file a Schedule 13D within 10 calendar days if its passive investment purpose changes and a non-SEC registered investment adviser that has previously filed a Schedule 13G must file a Schedule 13D within 10 calendar days after acquiring more than 20 percent of the class of such securities. The statutes, rules, and SEC and court interpretations regarding Schedule 13D and Schedule 13G are very complicated, and we urge investment advisers to seek guidance from counsel with respect to compliance with applicable statutes, rules and interpretations.25 Investment advisers should also note that in some cases one may need to consider non-equity investments in evaluating their filing requirements.


  • Forms 3, 4 and 5. An investment adviser (and possibly others) may be required to file certain forms if it directly or indirectly beneficially owns more than 10 percent of any publicly registered class of equity security of an issuer or if it (or an employee acting on behalf of the investment adviser) serves as an officer or director of the issuer. Form 3 must be filed within 10 days after exceeding the 10 percent threshold or becoming an officer or director of the issuer; Form 4 generally must be filed by the end of the second business day after executing a transaction in any equity securities of the issuer; and Form 5 must be filed within 45 days after the end of the issuer’s fiscal year to report exempt and other transactions that were not previously reported. These rules apply to securities that are exchangeable or convertible into the issuer’s equity securities, as well. Securities held by certain specified types of institutions in the ordinary course of business, and not for the purpose of changing or influencing control of an issuer, need not be counted in determining if an investment adviser has reached the 10 percent threshold and, accordingly, certain investment advisers may not be required to file these forms. Investment advisers and others who are required to file these forms are subject to disgorgement of profits (or deemed “profits” calculated in accordance with a rigid formula) resulting from purchases and sales within any six-month period. We suggest that such persons seek guidance from counsel prior to becoming subject to these reporting requirements.


  • Other Forms. In addition to Form SLT, Form 13H and Form PF (discussed above), investment advisers also should consider whether other regulatory filings are required based on their operations and investments, including, but not limited to, annual filings that may be required under federal, state or foreign law, as applicable. For example, as discussed previously, an investment adviser may be required to file a large position report with the Department of the Treasury if it holds or controls a significant amount of certain U.S. Treasury securities. An investment adviser that is considering acquiring a large amount of voting securities of an issuer should consider Hart-Scott-Rodino requirements that may apply, depending on the value of the acquisition and/or the size of the parties involved. Also, investment advisers that invest in securities in foreign jurisdictions should consider the filing requirements in each jurisdiction in which they invest.


CFTC Requirements. In order to engage in the solicitation or accepting of funds for the purpose of trading commodity futures contracts or advising others with respect to trading commodity futures contracts, an investment adviser must generally be registered with the CFTC as a commodity pool operator or a commodity trading adviser. However, CFTC rules provide exemptions from these registrations in various circumstances. Investment advisers that are contemplating engaging in commodity futures trading or management activities should contact counsel to determine whether they qualify for the exemptions from registration or if they should register with the CFTC.

Investment advisers that are registered with the CFTC and/or are members of the National Futures Association (“NFA”) must comply with a number of annual compliance requirements, including completing an annual compliance self-assessment and updating their registration information via the NFA’s online system. Failure to complete the online update within 30 days of the registration renewal date will be deemed as a request to withdraw the investment adviser’s registration. An investment adviser that holds or controls a futures position exceeding a certain threshold may be required to file a Form 40 with the CFTC. The compliance requirements referenced above are only examples and, due to the complicated nature of the CFTC and NFA compliance requirements, investment advisers are urged to consult counsel for further details.

Certain Tax Considerations.

FBAR Reporting Requirements. On March 28, 2011, final Treasury regulations became effective with respect to the reporting of foreign bank, brokerage and other financial accounts (“FBAR”) on Form TD F 90-22.1. These regulations reserved on the reporting requirements for investments in offshore funds. If such forms are required to be filed, the filing due date would be on or before June 30 of each year with respect to any such interest owned during the previous year.

FATCA. On March 18, 2010, President Barack Obama signed into law H.R. 2847, the Hiring Incentives to Restore Employment Act (P.L. 111-147) (the “HIRE Act”), which incorporates the measures of the Foreign Account Tax Compliance Act of 2009 (“FATCA”) designed to stop tax evasion. For taxable years beginning after Dec. 31, 2012, FATCA imposes new reporting and withholding rules designed to induce a “foreign financial institution” (an “FFI”) and other foreign entities to report information to the Internal Revenue Service (the “IRS”) regarding their U.S. accountholders and investors. Under these rules an FFI will have to enter into an agreement (an “FFI Agreement”) with the IRS agreeing to certain covenants, and provide evidence of such agreement to payors of certain income from U.S. sources. Generally, offshore funds, whether treated as corporations or partnerships for U.S. federal income tax purposes, will be treated as FFIs and subject to these rules unless guidance is issued exempting them.

While the FATCA provisions are effective beginning in 2013 under the HIRE Act, the IRS intends to issues regulations providing for a phased implementation of the various FATCA provisions. Pursuant to current IRS guidance, the IRS will begin accepting FFI applications through its electronic submissions process no later than Jan. 1, 2013. An FFI must enter into an FFI Agreement by June 30, 2013, to ensure that it will be identified as a participating FFI in sufficient time to allow U.S. withholding agents to refrain from withholding beginning on Jan. 1, 2014. Furthermore, it is expected that regulations will implement withholding by withholding agents on withholdable payments in two phases. For payments made on or after Jan. 1, 2014, withholding agents (whether domestic or foreign, including participating FFIs) will be obligated to withhold on certain U.S. source payments other than payments of gross proceeds. For payments made on or after Jan. 1, 2015, withholding agents will be obligated to withhold on all withholdable payments (including gross proceeds).

ERISA Considerations.

Avoiding “Plan Asset” Status. Each investment adviser that manages funds that accept investments from employee benefit plans, IRAs and other benefit plan investors, but that does not want the funds it manages to become subject to ERISA, should take the opportunity to confirm that the funds satisfy the requirements of ERISA’s “significant participation” exemption. Under the exemption, a fund is only subject to ERISA and certain prohibited transaction provisions of the Internal Revenue Code if 25 percent or more of any class of the fund’s equity interests is held by “benefit plan investors” (“BPIs”). Only benefit plans subject to ERISA (primarily private domestic employer and union plans) or to the prohibited transaction provisions of the Internal Revenue Code (such as IRAs and Keogh plans), or entities that themselves are treated as holding the “plan assets” of such plans, will count as BPIs for purposes of the 25 percent test. Governmental and foreign benefit plans are not BPIs. The 25 percent test should be conducted each time there is a new investment or any transfer or redemption of interests in the fund. A pro-rata rule applies where a fund (such as a fund of hedge funds) that fails its own 25 percent test and is therefore a BPI invests in a lower-tier fund. The lower-tier fund in which the fund of funds invests will consider the fund of funds to be a BPI only to the extent that the fund of funds’ equity interests are held by BPIs. However, an investing fund that is a common or collective bank trust or an insurance company separately managed account that has any level of BPI investment is generally treated as holding 100 percent BPI money. Each year, a fund should reconfirm the BPI status of its investors, particularly its fund of funds investors, whose BPI status, and the percentage of whose equity interests are held by BPIs, can change over time.

Becoming a Plan Asset Vehicle. As the Dodd-Frank Act now requires many unregistered investment advisers to register with the SEC, currently unregistered investment advisers may wish to reconsider their policy of maintaining benefit plan investment below the 25 percent threshold. Once registered under the Advisers Act, a well-capitalized investment adviser with more than $85 million of assets under management may qualify as a “qualified professional asset manager” or “QPAM,” which will greatly enhance its ability to operate a fund that contains “plan assets” in accordance with the prohibited transaction provisions of ERISA and the Internal Revenue Code. Depending upon the fund’s investor base, trading strategy and geographical area of activity, compliance with these rules may be reasonably practicable. Managers who manage or advise ERISA and other BPI client funds though separately managed accounts will generally be treated as investment fiduciaries under ERISA. Managers who accept ERISA fiduciary status should establish, as part of their written compliance policies and procedures, clear operational guidelines to ensure that employees dealing with plan assets comply with ERISA, including the “prudent expert” standard of care and ERISA’s bonding, disclosure and indicia of ownership rules, and the related party and self-dealing prohibited transaction rules of ERISA and the Internal Revenue Code.

Recent Department of Labor Developments.

  • Schedule C Reporting. ERISA plans are required to file an annual Form 5500 with the Department of Labor (the “DOL”). Starting with the 2009 plan year, the requirements of Schedule C to the Form 5500 were significantly expanded, with the result that ERISA plan fiduciaries now require the managers of funds in which their plans invest — whether or not those plans exceed the 25 percent BPI threshold — to provide detailed information about the services the manager provides to the fund and the compensation paid by the fund for those services. Fund managers should expect their ERISA investors to ask for information about management fees and performance fees or allocations, soft dollar compensation, gifts and entertainment received in connection with plan business, and placement and breakup fees. The necessary information about a fund’s management and performance compensation can generally be provided in the fund’s offering documents.
  • Section 408(b)(2) Regulations. In July 2010, the DOL published a related interim final rule under Section 408(b)(2) of ERISA. Designed to give plan fiduciaries sufficient information to assess whether a service arrangement is “reasonable,” the rule imposes significant new advanced written disclosure obligations on certain service providers to ERISA-covered pension plans, including investment fiduciaries. Covered service providers will have to disclose, among other things, the scope of the services to be provided and the direct and indirect compensation to be received. The DOL is also considering whether a summary disclosure document will be required in the final regulations, which are still to be issued. The manager or general partner of a fund will be covered by the rule only if the fund exceeds the 25 percent BPI threshold and thus holds “plan assets” under ERISA (unlike the Schedule C reporting rules, which cover less than 25 percent funds as well). Some managers are exploring the possibility of including some of the required information as part of the manager’s Form ADV. The failure of a covered service provider to provide the necessary information in a timley fashion may technically result in the service arrangement becoming a “prohibited transaction” under ERISA, with the consequence that the service provider may have to disgorge some or all of its compensation and pay excise taxes to the IRS. The rule’s effective date was recently postponed to April 1, 2012; however, existing arrangements are not “grandfathered” and appropriate disclosure must be provided to existing ERISA plan clients by that date. Managers of ERISA assets should be starting to consider which disclosures beyond those already included in offering memoranda will be needed to meet the new requirements. The advanced disclosure requirement is particularly challenging for some compensation items such as gifts and entertainment or soft dollars, the nature and extent of which are difficult to predict.
  • Expanded Definition of Fiduciary. In October 2010, the DOL proposed a significant expansion of its regulation that describes when a person provides “investment advice” to an ERISA plan or an IRA and thus is treated as a fiduciary of the plan under ERISA and/or the prohibited transaction rules of the Internal Revenue Code. As drafted, the rule would have recharacterized many consultants, broker-dealers and appraisers as fiduciaries. Many industry participants feared that, under the rule as proposed, broker-dealers might no longer be able to recommend affiliated hedge funds, and managers of funds (even those that keep under the 25 percent BPI threshold) might become fiduciaries as a result of providing current net asset valuations to plan investors. The proposed rule was met with considerable opposition, and was withdrawn in September 2011. The DOL has announced that it will repropose the rule, along with expanded and new prohibited transaction exemptions designed to permit certain industry practices to continue, in early 2012.

Deferred Fee and Incentive Compensation Arrangements.

Section 457A. Internal Revenue Code Section 457A effectively prevents investment advisers from deferring the taxation of fee income earned in 2009 and subsequent years from funds established in tax havens. Compensation deferred in 2008 and earlier years may only remain deferred until the end of the 2017 tax year, when it must be “repatriated” and taken into income by the manager. Section 475A does not, however, prevent an offshore hedge fund from issuing options or stock-settled (but not cash-settled) stock appreciation rights to a manager if the exercise price equals or exceeds the fair market value of the fund’s shares on the date of grant. However, managers interested in such an incentive compensation approach should consider the various tax issues, including those relating to passive foreign investment companies or “PFICs,” carefully with counsel. Section 457A also impacts incentive fees (but not incentive allocations from partnerships) on side-pocketed investment assets, payment of which is usually postponed until the asset is realized, becomes liquid or acquires a readily available market value. Such an incentive fee may be considered “deferred” under Section 457A, in which case the manager may be subject to an additional 20 percent penalty tax plus interest when the amount of the incentive fee is finally determinable in the year in which the side pocket is realized or deemed realized. Section 457A may also significantly complicate the design of a multiyear fee — whether structured as a fee or a partnership allocation — if the earnings period exceeds two years. Section 457A does, however, permit very limited short-term deferrals of up to a year following the end of the year in which the compensation is earned. Until further notice, Section 457A will not apply to carried interests in a partnership. Therefore, many investment advisers of funds (particularly those with funds that generate long-term capital gains) have changed the form of their incentive for services performed from a fee to a partnership allocation.

Section 409A. Code Section 409A compliance is still important for hedge funds. Investment advisers that retain a fee (as opposed to a partnership allocation) structure with their offshore fund(s) and wish to defer fees for up to one year, as permitted by Section 457A, must continue to comply with Section 409A, which generally requires deferral elections to be made by the end of the year before the fee income is earned. Investment advisers and funds must also structure their deferred bonus, phantom carry and other incentive compensation arrangements with employees to either avoid or comply with the requirements of Section 409A. Finally, all surviving pre-2009 deferred fee arrangements with offshore funds must be administered in accordance with the final Section 409A regulations until the end of 2017. 

Amendment of Certain Payment Dates by Dec. 31, 2011. Under Section 457A, pre-2009 deferred fees owing by an offshore fund to a manager will be taxable to the manager in the fund’s 2017 tax year, even if payable in a later year under the terms of the deferral arrangement. Section 409A does not generally allow parties to a deferred compensation arrangement to accelerate payment dates once they have been fixed. Consequently, to avoid cash flow and taxable year mismatches, the IRS has issued transition relief which permits pre-2009 arrangements that provide for payment of deferred fees on dates after 2017 to pay out all amounts in 2017 as long as the arrangement is formally amended to this effect by Dec. 31, 2011. Fund managers with pre-2009 deferred fees payable by an offshore fund after 2017 must therefore act by the end of 2011. If a manager has deferred fees due in 2013, 2014, 2015 or 2016, it faces an additional complication. Section 409A permits amounts to be redeferred only for a minimum period of five years; any redeferrals of amounts payable between 2013 and 2016 (and some pre-2009 arrangements provide for automatic redeferrals) will therefore push the payment dates beyond 2017. The IRS has informally taken the view that, if such a redeferral occurs after the end of 2011, the transition relief will no longer be available and payment in 2017 will not be possible. Unless further transition relief is granted, a manager will have two options to deal with payments due between 2013 and 2016 which it wishes to redefer to 2017. It must either make the redeferral election and then “pull back” the payment date to 2017 by the end of 2011, or make the redeferral election after 2011 and terminate the arrangement during 2016 and pay out in 2017 in accordance with the Section 409A regulations.

Offering Document Updates. An investment adviser should review the offering documents (e.g., private placement memoranda, subscription documents, marketing materials, etc.) of the funds it manages to determine whether the investment adviser’s and/or a fund’s business has undergone any material changes (including, but not limited to, changes to investment objectives/strategies, risk factors, conflicts of interest and/or service provider relationships), or if there have been any regulatory changes (including tax and ERISA) since the documents were last updated. If so, the investment adviser should consider updating the offering documents to reflect any such changes or developments. Given the events in the markets during the past few years, investment advisers should pay particular attention to whether or not their stated investment strategies and related risk factors are still accurate. Consideration should be given as to whether any changes require consent from investors or directors.

Electronic Communications and Social Media. The ubiquitous use of electronic communications and social media in the workplace means that advisers should consider establishing policies and procedures that govern their use. Such policies and procedures may regulate, without limitation, email communications and employer-provided electronic devices, prohibited communications using the employer’s electronic facilities, permitted disclosures on social and business media websites, electronic delivery of required disclosures, electronic security, reporting breeches of information security, and electronic monitoring.

Liability Insurance. In light of the increasing number of investor lawsuits in recent years, as well as the increasing review and scrutiny by regulatory and governmental authorities of the hedge fund industry generally, investment advisers may want to consider whether management liability insurance should be obtained, depending on the exposure of their current business. Management liability insurance generally includes coverage for directors’ and officers’ liability, fiduciary liability, errors and omissions liability, and employment practices liability.

Employee Training. In order to encourage a culture of compliance in the work environment, an investment adviser, particularly a recently registered investment adviser, should consider instituting training and/or programs to promote better understanding of the investment adviser’s compliance policies and procedures and employee handbook. An investment adviser’s fiduciary duties and obligations, avoiding potential conflicts of interest, and the prevention of insider trading and employee harassment are just a few topics for training that investment advisers should consider.

Other Annual Requirements. SEC-registered and unregistered investment advisers are subject to several other annual requirements and obligations, including those set forth below. Although these obligations need not be completed immediately, investment advisers should confirm that these activities are on their annual compliance calendar.

  • Privacy Policy. A copy of an investment adviser’s privacy policy must be sent to each of its individual clients once within every 12-month period, even if the privacy policy has not changed. In addition, if an investment adviser’s policies and procedures relating to maintaining privacy of client information have changed and such changes lead to the disclosure of information not described in previous policies or lead to the delivery of information to a third-party not previously disclosed, the privacy policy must be updated.
  • New Issues. If funds managed by an investment adviser invest in “new issues” (whether directly or through an investment in another fund), the investment adviser must obtain an annual representation from all investors in the funds it manages as to their eligibility to participate in profits and losses from new issues. This can be accomplished by requesting that each investor inform the investment adviser of any changes in the investor’s status from its representation in its subscription agreement with the fund. The investment adviser must keep a record of all information relating to whether an investor is eligible to purchase new issues for at least three years.


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This summary is not intended to provide a complete list of an investment adviser’s obligations relating to its compliance with applicable rules and regulations or to serve as legal advice and, accordingly, has not been tailored to the specific needs of a particular investment adviser’s business. Please also note that this summary does not address any non-U.S. or state law requirements. We encourage you to contact us if you would like to discuss whether there are additional items that you should consider or if you have any questions about any of the items covered herein. This summary does not purport to be comprehensive and should be used for information purposes only.

Investment Management Partners:

Marion Giliberti Barish, 617.951.8801

David C. Boch, 617.951.8485

Lea Anne Copenhefer, 617.951.8515

Steven M. Giordano, 617.951.8205

Michael Glazer, 213.680.6646

Anne-Marie Godfrey, +852.3182.1705

Richard A. Goldman, 617.951.8851

Thomas John Holton, 617.951.8587

Barry N. Hurwitz, 617.951.8267

Roger P. Joseph, Practice Group Leader; Co-chair, Financial Services Area, 617.951.8247

Amy Natterson Kroll, 202.373.6118

Michael P. O’Brien, 617.951.8302

Nancy M. Persechino, 202.373.6185

Paul B. Raymond, 617.951.8567

Toby R. Serkin, 617.951.8760

L. Kevin Sheridan Jr., 212.705.7738

Edwin E. Smith, Co-chair, Financial Services Area, 617.951.8615

Joshua B. Sterling, 202.373.6556

Stephen C. Tirrell, 617.951.8833

1See June 22, 2011, SEC Final Rules, Release No. IA-3221, “Rules Implementing Amendments to the Investment Advisers Act of 1940” and Release No. IA-3222, “Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers with Less than $150 Million in Assets Under Management, and Foreign Private Advisers.”
Effective July 21, 2011, “private fund” is defined under Section 202(a)(29) of the Advisers Act as “an issuer that would be an investment company, as defined in Section 3 of the [1940 Act], but for Section 3(c)(1) or 3(c)(7) of that Act.”
2The private adviser exemption was available to an investment adviser if, during the preceding 12 months, such investment adviser advised fewer than 15 clients, and neither held itself out to the public as an investment adviser nor acted as an investment adviser to any investment company registered with the SEC under the Investment Company Act of 1940, as amended (the “1940 Act”), or any entity electing to be treated as a business development company under the 1940 Act.
3The SEC suggests that these investment advisers prepare to submit both Part 1 and Part 2A of Form ADV by Feb. 14, 2012, as it may take up to 45 days for the SEC to process an initial application for registration as an investment adviser.
4Advisers with a principal office and place of business outside of the U.S. may qualify for this exemption, even where they have non-U.S. clients that are not private funds or they manage in excess of $150 million for non-U.S. clients, as long as (i) such adviser has no client that is a U.S. person (generally as defined in Regulation S under the Securities Act of 1933, as amended) except for private funds, and (ii) all assets managed by such adviser from a place of business in the U.S. are attributable solely to private fund assets, the total value of which is less than $150 million.
5To assess whether an adviser is required to register (or whether it qualifies for an exemption from registration), advisers are required to determine assets under management by calculating “the securities portfolios with respect to which an investment adviser provides continuous and regular supervisory or management services,” or its “regulatory assets under management.” Advisers are required to include in their regulatory assets under management: (i) proprietary assets, (ii) assets managed without receiving compensation and (iii) assets of foreignclients. Advisers are not permitted to subtract outstanding indebtedness in determining regulatory assets under management. All advisers are required to use the current market value (or fair value) of private fund assets rather than their cost in determining regulatory assets under management.
The rule also requires an adviser to a private fund to include in its “regulatory assets under management” (i) the value of any private fund it manages regardless of the nature of the assets held by the private fund and (ii) the amount of any uncalled capital commitments made to the fund. The method for calculating regulatory assets under management is set out in Instruction 5.B. to Part 1A of Form ADV.
6Advisers to registered investment companies and business development companies under the 1940 Act should be aware that they are required to register with the SEC even if they otherwise would fall within the category of mid-sized advisers.
7The grandfathering provision would only apply to funds that sold securities to one or more unaffiliated investors prior to Dec. 31, 2010, and do not sell any securities to, or accept any committed capital from, any person after July 21, 2011.
8See June 22, 2011, SEC Final Rule, Release No. IA-3220, “Family Offices.” Under Advisers Act Rule 202(a)(11)(G)-1, a family office is any company that (i) has no clients other than “family clients”; (ii) is wholly owned by family clients and controlled, directly or indirectly, by “family members” and/or “family entities”; and (iii) does not hold itself out to the public as an investment adviser. The rule also contains grandfathering provisions.
9The Volcker Rule prohibits “banking entities” (as defined — broadly) from proprietary trading and from owning, sponsoring or having certain relationships with hedge funds and other private funds, subject to a number of exemptions.
10See November 2010, FINRA Regulatory Notice 10-60, “Approval of New Issue Rule.” The term “new issue” is defined generally by FINRA as an initial public offering of equity securities regardless of whether such securities trade at a premium.
11Accounts described in Rule 5130(c)(1) through (3) and (5) through (10) are excluded from the allocation prohibition.
12Long-term reportable securities include equity securities such as common stock, preferred stock, limited partnership interests, and debt securities. The following are not long-term reportable securities: direct investments, derivatives, currencies, short-term securities (original maturity date of one calendar year or less), loans (directly negotiated between lender and borrower), repos and securities lending arrangements.
13Investment advisers should note that, even if an investment adviser were to cease managing at least $1 billion in aggregated reportable securities at some point after filing Form SLT‚ it nevertheless will be required to submit a report for each remaining reporting date in that calendar year‚ regardless of the total fair market value of the consolidated reportable securities on any such date.
14See July 26, 2011, SEC Final Rule, Release No. 34-64976, “Large Trader Reporting.”
15A “large trader” is a person that “[d]irectly or indirectly, including through other persons controlled by such person, exercises investment discretion over one or more accounts and effects transactions for the purchase or sale of any NMS security for or on behalf of such accounts, by or through one or more registered broker-dealers, in an aggregate amount equal to or greater than the identifying activity level.” “Identifying activity level” is defined as aggregate transactions in NMS securities of at least 2 million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month.
16Upon receiving a large trader’s Form 13H, the SEC will assign the large trader a unique large trader identification number (“LTID”). The large trader will be required to provide its LTID to each of its broker-dealers and identify to the broker-dealers all of its accounts to which the LTID applies. 
17New CFTC Rule 4.27 requires commodity pool operators (“CPOs”) and commodity trading advisers (“CTAs”) that also are registered with the SEC and required to file Form PF under the Advisers Act to file Form PF to satisfy systemic risk reporting requirements proposed, but not yet adopted, by the CFTC. Additionally, CFTC Rule 4.27 permits CPOs and CTAs that are otherwise required to file Form PF to submit Form PF data with respect to commodity pools that are not private funds in lieu of compliance with the proposed CFTC reporting obligations.
18Rule 4.13 makes available exemptions from registration for CPOs, and Rule 4.14 makes available an exemption from registration for CTAs. The most commonly used exemptions are Rules 4.13(a)(3), 4.13(a)(4) and 4.14(a)(8).
19Newly-registered advisers generally have 18 months after the adoption or approval of their compliance policies and procedures to complete the initial review.
20An “access person” is any partner, officer, director (or other person occupying a similar status or performing similar functions), or employee of the investment adviser, or any other person who provides investment advice on behalf of the investment adviser and is subject to the supervision and control of the investment adviser, who has access to nonpublic information regarding any client’s purchase or sale of securities, or nonpublic information regarding the portfolio holdings of any reportable fund, or who is involved in making securities recommendations to clients, or who has access to such recommendations that are nonpublic.
21“Custody” is defined broadly under Rule 206(4)-2 as holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them.
22The custody rule further requires that the auditor performing such annual audit be registered with, and subject to inspection by, the Public Company Accounting Oversight Board.
23The requirement to file Schedule 13D or Schedule 13G is applicable to any beneficial owner of more than 5 percent of a class of publicly-traded securities, not just investment advisers. This means that a fund that such investment advisers may advise or a group of funds that acts in concert may have its own filing obligation.
24This does not mean that a fund or group of funds advised by the investment adviser and that may have an independent requirement to file are permitted to file as eligible institutions.
25Please see our alert summarizing the CSX decision (CSX Corporation v. The Children’s Investment Fund Management (UK) LLP et al. (S.D.N.Y. No. 08 Civ. 2764)) for further details, which may be found here.

This article was originally published by Bingham McCutchen LLP.