2010 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 will take effect in 2011, promising to make 2011 an interesting year. The following is meant to briefly recap some of the significant changes that occurred in 2010, and to remind you of certain “best practices” that you should consider in preparing for 2011. This summary is general in nature and does not constitute legal advice for any specific situation.
2010 Regulatory Highlights.
Dodd-Frank Wall Street Reform and Consumer Protection Act. On July 21, 2010, the Dodd-Frank Act was signed into law, signaling an overhaul of the regulation of financial markets in the United States. Investment managers to private funds will be affected by a number of provisions in the Dodd-Frank Act as well as the rules to be promulgated by the Securities and Exchange Commission (the “SEC”) thereunder.
Pursuant to the Dodd-Frank Act, many investment managers that currently rely on the “private adviser” exemption1 from registration with the SEC will be required to be registered with the SEC by July 21, 2011, (we suggest that these investment managers prepare to submit Form ADV at least 60 days prior to such date). An investment manager with at least $100 million under management will generally be required to register with the SEC under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), unless it falls within one of the exemptions introduced by the Dodd-Frank Act. These exemptions require that an investment manager:
The Dodd-Frank Act does not alter the current requirement that U.S. investment managers must have at least $25 million under management in order to be eligible to register with the SEC. However, if an investment manager (i) has between $25 million and $100 million under management, (ii) is required to be registered as an investment adviser with the state in which it maintains its principal office or place of business, and (iii) by so registering, is subject to examination by that state, then the investment manager is precluded from registering with the SEC, unless it would otherwise be required to register with 15 or more states, or is an adviser to 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. In recently proposed rules, the SEC has indicated that investment managers that are currently registered with the SEC would have to withdraw their federal registration and transition to state registration if they are not eligible to register federally under the Dodd-Frank Act.
In addition to the existing requirements applicable to registered investment advisers, a registered investment adviser that advises Private Funds will also be generally required to maintain records and file reports with the SEC regarding such Private Funds “as necessary or appropriate in the public interest and for the protection of investors” or to provide the Financial Stability Oversight Council (the “Council”) with data necessary to monitor systemic risk issues. The Dodd-Frank Act also sets out specific records that must be kept with respect to Private Funds, including (i) the amount of assets under management and use of leverage (including off-balance sheet leverage), (ii) counterparty credit risk exposure, (iii) investment positions, (iv) valuation policies and practices of each fund, (v) types of assets held, (vi) side letters or arrangements providing favorable terms to certain investors, and (vii) trading practices. Additionally, investment managers that are exempt from SEC registration in reliance on either the exemption available to advisers that have less than $150 million under management and advise exclusively Private Funds, or the exemption available to advisers that advise solely “venture capital funds,” will also be subject to certain recordkeeping and reporting requirements as determined by the SEC.5 Generally, the information reported to the SEC will not be made publicly available; however, the SEC is required to make such information available to the Council. Both the SEC and the Council must comply with requests for information from other U.S. federal departments, agencies or self-regulatory organizations; however, the requesting entities are subject to confidentiality requirements designed to protect proprietary information.
The definitions of “accredited investor” under Regulation D and “qualified client” under the Advisers Act rules are subject to certain changes under the Dodd-Frank Act. With respect to the “accredited investor” definition, the $1 million net worth test applicable to natural persons was updated such that an investor seeking accreditation must exclude the value of his or her primary residence.6 Additionally, the SEC is authorized to revise the standards for accreditation periodically. With respect to the “qualified client” definition, the SEC must periodically adjust certain thresholds contained in the definition for inflation.
The Dodd-Frank Act will also impose certain general limits on the ability of certain banking entities, which are subject to the Bank Holding Company Act of 1956, and nonbank financial companies that are subject to regulation by the Board of Governors of the Federal Reserve System, to invest, sponsor or maintain an interest in hedge funds and private equity funds, or otherwise engage in proprietary trading. As a result, over the next few years, such investors may be forced to divest themselves of any significant interest in private funds and proprietary trading.
For a general outline of the Dodd-Frank Act, please see our summary, and for a more detailed overview of the Dodd-Frank Act’s implications for investment managers, please see our alert U.S. Financial Reform Law: Key Changes for Private Fund Managers Under the U.S. Investment Advisers Act and Changes to Certain Investor Eligibility Qualifications. The Dodd-Frank Act charges the SEC with significant rulemaking authority in implementing the act. While the SEC has released a number of proposed rules (please see our alerts on the proposed rules SEC Proposes Definition of “Family Office” and SEC Proposes Rules Implementing Dodd-Frank Act Provisions on Investment Adviser Registration), much remains to be finalized, and it is expected final rules will be passed in the first quarter of 2011 as many of the provisions applicable to investment managers take effect on July 21, 2011. We are monitoring the rulemaking process closely, and will keep you updated with alerts in the future. In the meantime, we urge you to contact counsel with any questions relating to the Dodd-Frank Act.
The Pay-to-Play Rule. On June 30, 2010, the SEC passed what is commonly referred to as the “Pay-to-Play Rule.” The Pay-to-Play Rule applies to investment managers that are registered with the SEC or exempt from registration pursuant to the private adviser exemption, and that provide investment advice to state or local government entities or to an investment pool7 in which state or local government entities invest.
The Pay-to-Play Rule generally prohibits an investment manager from (i) receiving compensation from a government entity for two years after the investment manager or any of its covered associates makes a political contribution to an official of the governing entity, (ii) soliciting contributions to an official of a government entity that the investment manager is seeking to advise, and making payments to a political party of a state or locality where the investment manager is advising or seeking to advise a government entity, and (iii) paying any person to solicit a government entity unless such person is subject to prohibitions on pay-to-play practices or otherwise an employee or officer of the investment manager.
Much of the Pay-to-Play Rule becomes effective on March 14, 2011, though certain provisions do not become effective until September 13, 2011. For a more detailed discussion of the Pay-to-Play Rule, including an overview of certain exceptions, exemptions and recordkeeping requirements, please see our alert SEC Unanimously Passes “Pay-to-Play” Rule for Investment Advisers. The Pay-to-Play Rule will likely be further amended by SEC rules as a result of implementing the Dodd-Frank Act, especially in light of the fact that the Dodd-Frank Act repeals the private advisers exemption.8 We will keep you up-to-date on any noteworthy changes in future alerts.
Amendments to Form ADV. On July 21, 2010, the SEC adopted amendments to Part 2 of Form ADV. The amendments are aimed at requiring investment managers that are registered with the SEC to provide meaningful disclosure to clients, in plain English.
The new Form ADV Part 2 is divided into two parts, the first of which, Part 2A, deals with a number of items related to the business practices and conflicts of interest of an investment manager. In addition to covering many of the items required in the old Form ADV Part II, Part 2A adds some new disclosure items, including a discussion of material changes since the last annual update. Part 2A also requires disclosure on conflicts of interest created by business practices and how those conflicts are addressed, and includes an appendix for disclosure of wrap fee programs. Part 2A must be filed electronically and will be made publically available on the SEC’s website.
The second part of Form ADV Part 2, Part 2B, requires certain information regarding personnel, including: (i) formal education and business experience, (ii) legal and disciplinary history, (iii) other business activities, (iv) bonuses or other compensation based on sales of securities, and (v) the identity of the person who supervises such personnel, and information on how such personnel is supervised. Part 2B is not required to be filed electronically and will not be made publically available on the SEC’s website.
An investment manager that is currently registered and whose fiscal year ends on or after December 31, 2010, must include the new Form ADV Part 2 as part of the next annual update of Form ADV Part 1. An investment manager that registers with the SEC on or after January 1, 2011, must file the new Part 2 with its application for registration on Form ADV Part 1. In addition to filing Form ADV Part 2 with the SEC, investment managers may be required to deliver Part 2 to certain clients directly. For more detail concerning the amended Form ADV Part 2, please see the discussion of Form ADV below and our alerts Form ADV Part 2 Amended and Available to the Public and SEC Extends Date for Delivery of Brochure Supplements.
It is likely that Form ADV will be further amended by SEC rules under the Dodd-Frank Act.9 We will keep you apprised of any changes in future alerts.
Looking Ahead to 2011.
Preparing for Registration with the SEC. Those investment managers planning to register with the SEC in 2011 (if you are required to be registered under the Dodd-Frank Act, then you must do so no later than July 21, 2011, and we suggest that you submit Form ADV at least 60 days prior to such date) 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 done so already.
Compliance Policies and Procedures. Investment managers that currently maintain written compliance policies and procedures should review them to determine their adequacy and effectiveness. Each SEC-registered investment manager 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 manager, 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.
In light of the SEC’s recent focus on investment managers’ 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 manager’s personnel. SEC-registered investment managers, among other things, should also be sure that each of their access persons,10 and possibly certain other personnel, provides to the investment manager’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 managers 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 SEC-registered investment manager must update its Form ADV Part 1 and Part 2A, and file them with the SEC on an annual basis within ninety (90) days after the end of its fiscal year (typically by March 31, 2011). 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 manager and/or its personnel. Investment managers 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, although the SEC has recently extended the delivery date for Part 2B for certain advisers (see our alert SEC Extends Date for Delivery of Brochure Supplements). Part 2A must also be delivered to existing clients within sixty (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 one hundred twenty (120) days after the end of an investment manager’s fiscal year (typically by April 30, 2011). Although “clients” under the Advisers Act are technically the funds advised by an investment manager, rather than the investors in those funds, we suggest that Part 2 be offered to these underlying investors.
The updates of Form ADV Parts 1 and 2A are done on the SEC’s electronic IARD system, and while Part 2B is not filed with the SEC, it is required to be maintained in the investment manager’s files.
In addition, certain states also require that investment managers 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 manager has a place of business or more than five non-exempt clients. State-registered investment managers should also consider any other requirements in the states in which they are registered. Generally, a state-registered investment manager will need to register in every state in which it does 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 fifteen (15) days of the initial sale of securities in an offering. If Form D was filed as of September 15, 2008, or later, and it relates to an offering that is still on-going, it must be amended, annually, on or before 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 fifteen (15) days following the initial sale of interests or shares in a 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 managers 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 managers that maintain custody of client securities or assets11 are subject to Rule 206(4)-2 under the Advisers Act. Unless an investment manager 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 one hundred twenty (120) days (or one hundred eighty (180) days for funds of funds) after the end of the fund’s fiscal year.12
Other Regulatory Filings. There are several regulatory filings that investment managers (whether SEC-registered or not) may be required to make in light of certain activities, which may include:
Schedule 13G may generally be filed by an investment manager that beneficially owns less than 20% of the outstanding shares of the 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. An SEC-registered investment manager must file a Schedule 13G within forty-five (45) days after the end of the calendar year in which more than 5% of such securities was obtained, or within ten (10) days of month end if beneficial ownership exceeds 10% at such month end. A non-SEC registered investment manager must file Schedule 13G within ten (10) days of the acquisition of more than 5% 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 manager that has previously filed a Schedule 13G must file a Schedule 13D within ten (10) calendar days if its passive investment purpose changes and a non-SEC registered investment manager that has previously filed a Schedule 13G must file a Schedule 13D within ten (10) calendar days after acquiring more than 20% 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 managers to seek guidance from counsel with respect to compliance with applicable statutes, rules and interpretations. Investment managers should also note that in some cases one may need to consider non-equity investments in evaluating your filing requirements.13
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 manager 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 managers 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 managers 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 thirty (30) days of the registration renewal date will be deemed as a request to withdraw the investment manager’s registration. An investment manager 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 managers are urged to consult counsel for further details.
Certain Tax Considerations.
For offshore funds, FATCA will impose a 30% withholding tax on any payment of dividends, interest and certain other categories of income from sources within the United States, or of proceeds from the sale of property that can produce dividends or interest from sources within the United States, unless the offshore fund enters into an agreement with the IRS to obtain and report information with respect to its U.S. investors. The 30% withholding is not an additional tax and, under certain circumstances, a non-U.S. person may be eligible for a refund of such withholding tax.
Ongoing ERISA Compliance. Each investment manager 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 to certain prohibited transaction provisions of the Internal Revenue Code if 25% or more of any class of a 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% test. Governmental and foreign benefit plans are not counted. The 25% 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 will apply where a fund (such as a fund of hedge funds or “FOF”) that fails its own 25% test and therefore becomes a BPI, invests in a lower-tier fund. The lower-tier fund in which the FOF invests will consider the FOF to be a BPI only to the extent that the FOF’s equity interests are held by BPIs. Each year, a fund should reconfirm the BPI status of its investors, particularly its FOF investors, whose BPI status, and the percentage of whose equity interests are held by BPIs, can change over time. As the Dodd-Frank Act now requires many unregistered investment managers to register with the SEC, currently unregistered investment managers may wish to reconsider their policy of maintaining benefit plan investment below the 25% threshold. Once registered under the Advisers Act, a well-capitalized investment manager 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.
Recent Department of Labor Developments.
Schedule C Reporting. ERISA plans are required to file an annual Form 5500 with the Department of Labor (“DOL”). Starting with the 2009 plan year, the requirements of Schedule C to the Form C 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% BPI threshold — to provide detailed information about the services provided to the fund and the compensation paid by the fund for those services. Because of the novelty and complexity of the Schedule C rules, the requests for information fund managers received during 2010 from their ERISA plan investors varied considerably in their scope.
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 advance disclosure obligations on certain service providers to ERISA-covered pension plans relating to, among other things, the scope of the services to be provided and the direct and indirect compensation to be received. The manager or general partner of a fund will be covered by the rule if the fund accepts investments from ERISA pension plans and the fund exceeds the 25% threshold so that it holds “plan assets” under ERISA. The failure of a covered service provider to timely provide the necessary information will 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 will become effective in July 2011, and fund managers must determine before then the extent, if any, to which their offering documents will need to be supplemented to meet the new disclosure requirements.
Expanded Definition of Fiduciary. In October of this year, the DOL proposed a significant expansion of its regulation that describes when a person provides “investment advice” to an ERISA plan or IRA and thus is treated as a fiduciary of the plan under ERISA and the prohibited transaction rules of the Code. As currently drafted, the rule will make many consultants, broker-dealers and appraisers the fiduciaries of their plan clients. As a result, broker-dealers may no longer be able to recommend affiliated hedge funds, and managers of funds (even those that keep under the 25% BPI threshold) may become fiduciaries as a result of providing current net asset valuations to plan investors. The proposed rule has met with considerable opposition, and its final form is uncertain.
Fee Deferral Arrangements.
Deferred Compensation Considerations.
Section 409A. Despite the virtual elimination of fee deferrals starting in 2009, Internal Revenue Code Section 409A compliance is still important for hedge funds. Investment managers who 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 managers and funds must also structure their deferred bonus, phantom carry and other incentive compensation arrangements to either avoid or comply with the requirements of Section 409A. All surviving pre-2009 deferred fee arrangements with offshore funds must also be administered in accordance with the final Section 409A regulations until the end of 2017. In 2010, the IRS for the first time provided a means for parties to a deferred compensation arrangement to correct documentary (and not just operational) violations of Section 409A; those failures corrected by the end of 2010 enjoy special transition relief.
Offering Document Updates. An investment manager 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 manager’s and/or a funds’ 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 manager 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 managers 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.
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 managers may want to consider whether management liability insurance should be obtained, depending on their current business’s exposure. 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 manager, particularly a recently registered investment adviser, should consider instituting training and/or programs to promote better understanding of the investment manager’s compliance policies and procedures and employee handbook. An investment manager’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 managers should consider.
Other Annual Requirements. SEC-registered and unregistered investment managers are subject to several other annual requirements and obligations, including those set forth below. Although these obligations need not be completed immediately, investment managers should confirm that these activities are on their annual compliance calendar.
This summary is not intended to provide a complete list of an investment manager’s obligations relating to its compliance with applicable rules and regulations or serve as legal advice and, accordingly, has not been tailored to the specific needs of a particular investment manager’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.
For assistance, please contact the following lawyers:
Thomas John Holton, Partner, Investment Management
1The private adviser exemption, which is eliminated by the Dodd-Frank Act, was available to an investment manager if, during the preceding 12 months, such investment manager 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.
2Proposed rules released by the SEC on November 19, 2010, would permit investment managers with a principal office and place of business (i.e., the place where the investment manager conducts the management of the assets of the Private Fund(s)) outside of the United States to only count Private Fund assets managed from a place of business in the United States toward the $150 million limit. Foreign investment managers may qualify for this exemption under the proposed rule if they have non-U.S. clients that are not Private Funds, provided: (i) all of their clients that are U.S. Persons (as defined in Regulation S under the Securities Act of 1933), are Private Funds, and (ii) all assets of clients that are not Private Funds are managed from a place of business outside the United States. See SEC Release No. IA-3111 at pp. 64-69. See also our alert SEC Proposes Rules Implementing Dodd-Frank Act Provisions on Investment Adviser Registration.
3Proposed rules released by the SEC on November 19, 2010, would define a “venture capital fund” as a private fund that (i) owns only (a) equity securities issued by one or more qualifying portfolio companies, provided that at least 80% of the equity securities of each portfolio company owned by the fund was acquired directly from the qualifying portfolio company, and (b) cash and cash equivalents and U.S. Treasury securities with a remaining maturity of 60 days or less, (ii) offers or provides a significant degree of managerial assistance to, or otherwise controls, the qualifying portfolio companies, (iii) does not borrow and is not leveraged (other than limited short-term borrowing), (iv) does not offer redemption or similar liquidity rights to investors except under extraordinary circumstances, (v) represents itself to investors as being a venture capital fund, and (vi) is not registered under the 1940 Act and has not elected to be treated as a business development company under the 1940 Act. The proposed rules also include a grandfathering provision. See SEC Release No. IA-3111 at pp. 10-58. See also our alert SEC Proposes Rules Implementing Dodd-Frank Act Provisions on Investment Adviser Registration.
4Proposed rules released by the SEC on October 12, 2010, would define a “family office” as any company that (i) has no clients other than “family clients,” (ii) is wholly owned and controlled, directly or indirectly, by “family members,” and (iii) does not hold itself out to the public as an investment adviser. The proposed rules also include certain grandfathering provisions. See SEC Release No. IA-3098. See also our alert SEC Proposes Definition of “Family Office.”
5Proposed rules released by the SEC on November 19, 2010, would require such “exempt reporting advisers” to complete certain items of Part 1A of a revised Form ADV, specifically including items relating to basic identifying information relating to the investment manager, its owners and affiliates, the basis for the investment manager’s exemption from SEC registration, its form of organization, its other business activities, its financial industry affiliates and the identity of any Private Funds it advises, its control persons, and its disciplinary history. The investment manager’s responses would be made publicly available. See SEC Release No. IA-3110 at pp. 35-46. See also our alert SEC Proposes Rules Implementing Dodd-Frank Act Provisions on Investment Adviser Registration.
6This amendment to the definition of “accredited investor” has already taken effect.
7An “investment pool” under the Pay-to-Play Rule includes any registered investment company under the 1940 Act that is an investment option of a plan or program of a government entity, as well as any company that relies on the exclusion from the definition of investment company provided by Section 3(c)(1), Section 3(c)(7) or Section 3(c)(11) of the 1940 Act.
8 Proposed rules released by the SEC on November 19, 2010, would amend the Pay-to-Play Rule to apply to exempt reporting advisers and foreign private advisers. The proposed rules would also permit an investment manager to pay a “regulated municipal adviser,” which is registered under Section 15B of the Securities Exchange Act of 1934, as amended (the “Securities Exchange Act”) and subject to the Municipal Securities Rulemaking Board’s pay to play rules, to state or local government entities on behalf of such investment manager. See SEC Release No. IA-3110 at pp. 68-73. See also our alert SEC Proposes Rules Implementing Dodd-Frank Act Provisions on Investment Adviser Registration.
9Proposed rules released by the SEC on November 19, 2010, would amend Form ADV to require enhanced disclosure in certain areas, including basic information on private funds advised by the investment manager (e.g., type of fund; size of fund; nature of investors; and the identity of auditors, prime brokers and other service providers), advisory business information (e.g., number of employees, AUM, and the use of affiliate brokers and soft dollar arrangements), information on non-advisory business activities and information on financial industry affiliations. See SEC Release No. IA-3110 at pp. 47-67. See also our alert SEC Proposes Rules Implementing Dodd-Frank Act Provisions on Investment Adviser Registration.
10An “access person” is any partner, officer, director (or other person occupying a similar status or performing similar functions), or employee of the investment manager, or any other person who provides investment advice on behalf of the investment manager and is subject to the supervision and control of the investment manager, 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.
11“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.
12The 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.
13Please see our alert CSX Decision: Empty Relief? 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.
14A “nonqualified entity” is in essence a tax-indifferent entity, and includes not only foreign corporations not subject to U.S. tax or a “comprehensive” foreign tax system, but also any partnerships, including domestic partnerships, in which U.S. tax-exempt organizations (or low-taxed foreign persons) are significant investors.
15The term “new issue” is defined generally by the Financial Industry Regulatory Authority as initial public offerings of equity securities regardless of whether such securities trade at a premium.