International Funds Group

Update on the implementation of the Alternative Investment Fund Managers Directive (AIFMD) in Luxembourg:

2013-01-14T11:16:00.001-05:00

On December 19, 2012, the European Commission published the AIFMD Level 2 Regulation ("the Regulation"). The Regulation is intended to supplement the AIFMD (termed a Level 1 measure), and by extension, the legislation that will eventually be implemented by EU Member States in order to give effect to the AIFMD.

The AIFMD, as an EU Directive, will not take effect of its own accord. Instead, EU Member States must pass implementing legislation to effect it at the national level.

In contrast to the AIFMD, the Regulation does not require implementation at the national level. Instead, when the Regulation enters into force, it will be directly applicable to all EU Member States, without the need for transposition into the national law. The Regulation is subject to a three month scrutiny period by the European Parliament and the EU Council and will enter into force at the end of this three month period if neither co-legislator objects.

On August 24, 2012, bill of law no. 6471 (Bill 6471) was submitted to the Luxembourg Parliament. Bill 6471 is intended to implement the AIFMD at the national level in Luxembourg. It was expected that Bill 6471 would be adopted by year end of 2012, but to date has not yet been voted on by the Luxembourg legislature. As a result, the full scope of the implementing law will not be known until the bill is voted on and published by the Luxembourg legislature.

Very few EU Member States have passed AIFMD implementing legislation, and Luxembourg will in all likelihood be among the first to do so. Currently, it appears that the Netherlands are the only member state to have passed implementing legislation (the Dutch legislature having passed the law in October 2012).

The JOBS Act: SEC Proposes Rules to Permit General Solicitation and General Advertising in Certain Private Placements

2012-09-12T15:10:00.001-04:00

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), a collection of reforms to the U.S. federal securities laws designed to reduce the regulatory burdens on small businesses and facilitate capital formation.¹ The JOBS Act directed the Securities and Exchange Commission (the “SEC”) to amend Rule 506 of Regulation D under the Securities Act of 1933 to permit general solicitation or general advertising in unregistered offerings made under Rule 506, provided that all purchasers are accredited investors. The SEC proposed rules on August 29, 2012 to implement that requirement.

Proposed Amendments to Rule 506
Section 4(a)(2) of the Securities Act exempts from registration the offer and sale of securities by an issuer in a transaction “not involving any public offering.” This exemption has been interpreted to restrict an issuer from using public announcements, advertising or general solicitations when offering and selling securities. Rule 506, which creates a “safe harbor” for issuers seeking to use the Section 4(a)(2) exemption, currently prohibits the issuer, or any person acting on its behalf, from offering or selling securities through any form of general solicitation or general advertising.

To implement the JOBS Act, the SEC proposes to add new Rule 506(c), which would permit the use of general solicitation to offer and sell securities under Rule 506, provided that:

the issuer takes reasonable steps to verify that the purchasers are accredited investors;
all purchasers of securities are accredited investors, either because they fit within one of the categories of persons that qualify as accredited investors or the issuer reasonably believes that they do, at the time of the sale of securities; and
the other requirements of Regulation D (other than the general solicitation prohibition) are satisfied.

The proposed amendments preserve under Rule 506(b) the current exemption that allows issuers to conduct Rule 506 offerings without the use of general solicitation and general advertising. Issuers that choose to rely on Rule 506(b) would not be subject to the new requirement that they take “reasonable steps” to verify a purchaser’s accredited investor status (i.e., they can rely on an investor’s self-certification or a pre-existing substantive relationship with the investor) and they may still sell privately to up to 35 non-accredited investors who meet Rule 506(b)’s sophistication requirements.

Verification of Accredited Investor Status

The SEC noted that the purpose of the verification mandate is to address concerns, and reduce the risk, that the use of general solicitation under Rule 506 may result in sales to non-accredited investors. The SEC noted that under the proposed rule, whether the steps taken by an issuer to verify that all purchasers are accredited investors are “reasonable” would be an objective determination that is based on the facts and circumstances of each transaction. The SEC also noted that amendments to Rule 506 must be flexible to accommodate different types of issuers and different types of accredited investors that may purchase securities in these offerings. The SEC provided a non-exclusive list of factors that an issuer would consider when determining the reasonableness of the steps taken to verify that a purchaser is an accredited investor, including:

the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
the amount and type of information that the issuer has about the purchaser; and
the nature and terms of the offering, including the manner in which the issuer was solicited and whether it requires a high minimum investment amount.

Nature of the Purchaser

The definition of accredited investor in Rule 501(a) of Regulation D identifies several different types of accredited investors including both natural persons and entities. The steps that would be reasonable for an issuer to take to verify whether a purchaser is an accredited investor thus vary depending on the type of accredited investor that the purchaser claims to be. For example, registered broker-dealers are accredited investors. An issuer can easily verify the registered status of a broker-dealer and thereby satisfy the verification requirement. Verification of a natural person investor, on the other hand, presents significant challenges because many investors will be reluctant to provide copies of their tax returns or W-2 Forms. The SEC acknowledges that verification of the accredited investor status of natural persons poses practical difficulties that are exacerbated by privacy concerns about disclosing personal financial information.

Amount and Type of Information about Purchaser

The SEC indicates that the amount and type of information that an issuer has about a purchaser is a significant factor in determining what additional steps would be reasonable to verify accredited investor status. The SEC provides examples of the types of information that issuers could review or rely upon to constitute reasonable steps to verify a purchaser’s accredited investor status, including:

Publicly available information in filings with a federal, state or local regulatory body;
Third-party information that provides reasonably reliable evidence, such as W-2 Forms, tax returns or trade publications; and
Verification of a person’s status by a third party, such as a broker-dealer, attorney or accountant, provided that the issuer has a reasonable basis to rely on such third-party verification.

Nature and Terms of the Offering

Another factor that the SEC instructs issuers to consider when verifying the accredited status of investors is the nature and the terms of the offering. The issuer should consider the means through which the issuer publicly solicits purchasers. According to the SEC, an issuer that solicits new investors through a website accessible to the general public or through a widely disseminated email or social media solicitation would likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party such as a registered broker-dealer. As a result, issuers may begin to utilize the services of broker-dealers who have amassed a large pool of pre-screened accredited investors. In such case, the issuer could presumably rely upon the broker-dealer to verify the accredited status as long as the issuer understands the methods used by the broker-dealer to undertake the pre-screening and the issuer reasonably believes that the broker-dealer is conducting such pre-screening effectively.

Form D Check Box for Rule 506(c)

The proposed rules also would revise Form D to add a separate check box for issuers to indicate whether they used general solicitation or general advertising in a Rule 506 offering.

Specific Issues for Privately Offered Funds

The SEC also confirmed that privately offered funds such as hedge funds, venture funds and private equity funds would be able to utilize general solicitation and general advertising to raise capital under Rule 506(c) without running afoul of restrictions under the Investment Company Act of 1940.

Proposed Amendment to Rule 144A

In addition to mandating changes to Rule 506, the JOBS Act directs the SEC to revise Rule 144A(d)(1) under the Securities Act to provide that securities sold pursuant to Rule 144A may be offered to persons other than QIBs,² including by means of general solicitation or general advertising, provided that securities are sold only to persons that the seller and any person acting on the seller’s behalf reasonably believe is a QIB. As amended the rule would require only that the securities are sold to a QIB or to a purchaser that the seller and any person acting on behalf of the seller reasonably believe is a QIB. Under the amended rule, resales of securities pursuant to Rule 144A could be conducted using general solicitation, so long as the purchasers are similarly limited.

No Integration with Offshore Offerings

The SEC made it clear that its long-standing policy that offshore offerings under Regulation S are not integrated with domestic offerings under Regulation D is unchanged by the JOBS Act and related rule amendments.

Conclusion

There will be a 30-day comment period on the proposed rules from the date the rule proposal is published in the Federal Register. If the Final Rules closely resemble those proposed then Issuers should take a totality of the circumstances approach when developing reasonable accredited investor verification procedures. The type of accredited investor the purchaser claims to be, the type of information available about that purchaser and the nature and terms of the offering should all be examined in their entirety to determine how extensive the verification process should be.

^{1. The text of the JOBS Act, as passed by the House on March 27, 2012, is available at http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf. For a more comprehensive discussion of the changes to U.S. federal securities laws instituted by the JOBS Act, please see our earlier client alert, The U.S. Jumpstart Our Business Startups Act (The JOBS Act), available at http://www.curtis.com/siteFiles/Publicati ons/Public%20Company%20Client%20Alert.pdf.↩}
^{2. QIBs are defined generally as institutions that own and invest at least $100 million in securities on a discretionary basis.↩}

The JOBS Act: Implications for Private Fund Sponsors

2012-04-06T13:37:00.004-04:00

Introduction

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), a collection of reforms to the U.S. federal securities laws designed to reduce the regulatory burdens on small businesses and facilitate capital formation.^[1] Although the JOBS Act is primarily aimed at helping small and emerging businesses grow and create jobs, private fund sponsors will also see significant benefits from the new legislation.^[2] In particular, the JOBS Act (i) raises the threshold for the number of equity holders a private fund can have before it becomes a public company subject to periodic and current reporting under the Securities Exchange Act of 1934 (the “Exchange Act”) and (ii) permits general solicitation or general advertising in connection with offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933 (the “Securities Act”).

Increased Threshold for Exchange Act Reporting

Prior to the JOBS Act, Section 12(g) of the Exchange Act required a company with more than $10 million in total assets and a class of equity security “held of record” by 500 or more persons to register the class of equity security with the SEC. Because Exchange Act registration triggers public company reporting obligations, sponsors of private funds that rely on the exemption from registration under Section 3(c)(7) of the Investment Company Act of 1940 (the “Investment Company Act”) have tended to limit the number of investors in those funds to no more than 499 persons.^[3] Section 501 of the JOBS Act raises the record holder threshold in Section 12(g)(1)(A) of the Exchange Act from 500 persons to either (i) 2,000 persons or (ii) 500 persons who are not “accredited investors.”^[4] In addition, Section 502 of the JOBS Act amends Section 12(g)(5) of the Exchange Act to provide that the definition of “held of record” excludes securities held by persons who received the securities pursuant to an employee compensation plan in a transaction exempt from the registration requirements of Section 5 of the Securities Act. To assist issuers in structuring their employee compensation plans, Section 503 of the JOBS Act directs the SEC to adopt safe harbor provisions that issuers can follow when determining whether an employee security holder meets the exclusion. The JOBS Act amendments to the Section 12(g) record holder provisions take effect immediately; however, no deadline is given for the SEC to adopt safe harbor provisions for the employee security holder exclusion.

Because a private fund relying on the Section 3(c)(7) exemption is limited to investors who are “qualified purchasers”^[5] – each of whom would also qualify as an accredited investor – these changes effectively increase the number of investors the fund can accept for each class of its securities from 499 to 1,999, plus any excluded employee security holders.

Anti-Evasion Rules to be Reconsidered

The 500 record holder limitation in Section 12(g) of the Exchange Act received significant media attention last year when it was revealed that Goldman Sachs had organized a special purpose vehicle (“SPV”) to allow its clients to invest in Facebook.^[6] Under Rule 12g5-1, securities held of record by a single entity such as an SPV will generally be treated as held of record by one person, regardless of how many beneficial owners the SPV has. If Goldman’s clients had invested in Facebook directly, each of them would have counted toward the 500 record holder limit, which could have forced Facebook to become a public company subject to Exchange Act reporting before it was ready to conduct its IPO. To many, the investment by Goldman’s SPV appeared to run afoul of the anti-evasion provision in Rule 12g5-1(b)(3), which provides that if the issuer (e.g., Facebook) “knows or has reason to know that the form of holding securities of record is used primarily to circumvent” the 500 record holder limitation, then “the beneficial owners of such securities shall be deemed to be the record owners thereof.”

The scrutiny of Goldman’s Facebook investment prompted concern in the private fund industry that sponsors of so-called “master funds” may be required to count the beneficial owners of “feeder funds” formed to invest in the master fund as record holders, even in cases where the feeder funds were formed by persons unaffiliated with the master fund’s sponsors. SEC Chairman Mary Schapiro has acknowledged that SPV investments in private companies such as Facebook raise a number of policy questions, including whether SEC rules should count the holders of the SPV as record holders for purposes of Section 12(g) registration, regardless of the purpose for which the SPV was formed.^[7]

In light of the uncertainty surrounding the application of Rule 12g5-1(b)(3), Section 504 of the JOBS Act directs the SEC to examine its authority to enforce Rule 12g5-1, determine if new anti-evasion enforcement tools are needed, and submit its recommendations to Congress within 120 days.

General Solicitation and General Advertising of Private Offerings Under Rule 506 of Regulation D

In addition to increasing the number of potential investors that a private fund can have before becoming a public company, the JOBS Act makes it easier for private fund sponsors to offer interests in their private funds without having to register the offering under the Securities Act. Private funds relying on either the Section 3(c)(1) or 3(c)(7) exclusion from the Investment Company Act registration are prohibited from engaging in a public offering of their securities. Interests in such funds are thus typically offered and sold in private offerings pursuant to Rule 506 of Regulation D under the Securities Act, which prohibits any general advertising or general solicitation in connection with the offering.

Section 201 of the JOBS Act directs the SEC to revise Rule 506 to remove the prohibition against general solicitation or general advertising in connection with Rule 506 offerings where all purchasers of the securities sold in the offering are accredited investors. The SEC’s rules must also require that the issuer take reasonable steps to verify that purchasers of the securities are accredited investors using such methods as will be determined by the SEC. The JOBS Act gives the SEC 90 days following the passage of the Act to make the necessary rule revisions.

Furthermore, Section 201(b)(2) of the JOBS Act clarifies that offers and sales conducted pursuant to Rule 506 “shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation.” Accordingly, subject to the adoption of the SEC’s amendments to Rule 506, private fund sponsors should be able to use general advertising or general solicitation to offer interests in their Section 3(c)(1) or 3(c)(7) funds without jeopardizing their ability to rely on those exemptions from Investment Company Act registration. As a result, we expect that private fund sponsors will expand their use of websites and social media to market private funds under Rule 506.

1 The text of the JOBS Act, as passed by the House on March 27, 2012, is available at http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf.

2 For a more comprehensive discussion of the changes to U.S. federal securities laws instituted by the JOBS Act, please see our earlier client alert, The U.S. Jumpstart Our Business Startups Act (The JOBS Act), available at http://www.curtis.com/siteFiles/Publications/Public%20Company%20Client%20Alert.pdf

3 The 500 record holder threshold is generally not a concern for a private fund relying on the exemption from registration provided by Section 3(c)(1) of the Investment Company Act, as that exemption is only available if the fund has no more than 100 beneficial owners.

4In general, an “accredited investor” includes (i) any entity with assets in excess of $5 million and (ii) any natural person (a) whose net worth, either alone or together with the person’s spouse, exceeds $1 million, excluding the value of the person’s primary residence, or (b) whose income exceeded $200,000 (or $300,000 together with a spouse) in each of the two most recent years and who has a reasonable expectation of the same income level in the current year.

5 In general, a “qualified purchaser” includes (i) an entity that owns and invests at least $25 million on a discretionary basis for its own account or for the accounts of other qualified purchasers and (ii) a natural person who, either alone or together with a spouse, owns at least $5 million in investments.

6See, e.g., Steven M. Davidoff, Facebook and the 500-Person Threshold, New York Times, Jan. 3, 2011, available at http://dealbook.nytimes.com/2011/01/03/facebook-and-the-500-person-threshold/

7Letter from Mary L. Schapiro, Chariman of the SEC, to Hon. Darrell E. Issa, Chairman, Committee on Oversight and Government Reform, U.S. House of Representatives (April 6, 2011) at 20-21, available at http://www.sec.gov/news/press/schapiro-issa-letter-040611.pdf

CFTC Releases Final Rules Amending Registration and Compliance Obligations for CPOs and CTAs

2012-02-15T10:05:00.001-05:00

On February 9, 2012, the U.S. Commodity Futures Trading Commission ("CFTC") released final rules amending the registration and compliance obligations for commodity pool operators ("CPOs") and commodity trading advisors ("CTAs"). Among other amendments, annual exemption renewals are now required to be filed with the National Futures Associates by those persons relying on the exemptions from CPO or CTA registration provided under CFTC rules 4.5, 4.13 or 4.14. Most notably, however, the CFTC is eliminating the exemption from CPO registration set forth in Regulation 4.13(a)(4), which permits a CPO to be exempted from registration with respect to any pool where (i) the interests in the pool are exempt from registration under the Securities Act of 1933, as amended, and such interests are offered and sold without marketing to the public in the U.S. and (ii) (x) each natural person participant is a "qualified eligible person" and (y) each non-natural person participant is a "qualified eligible person" or an "accredited investor". This Regulation is commonly relied upon by commodity fund managers to private investment funds that comply with Section 3(c)(7) of the Investment Company Act of 1933, as amended. For those CPOs relying on this Regulation there is a transition period until December 31, 2012, at which point they will need to register with the CFTC or rely on a different registration exemption.

Link to the Final Rules: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister020912b.pdf

Paris seminar explores impact of new FATCA rules on Investment Funds in Europe

2011-09-19T15:02:00.001-04:00

Around 40 fund managers, hedge funds, trust companies and lawyers attended Curtis's Paris seminar last Tuesday, 13 September. The seminar, entitled “Investment Funds: Recent Tax Developments, Understanding FATCA, FBAR and Key Regulations in Europe” brought the European audience up to date with latest developments in the FATCA rules (some of which had taken place within the previous 48 hours). Many of the audience were in Paris for the International Fiscal Association's annual congress, which took place the same week.

New York partners Alan S. Berlin and William L. Bricker, Jr joined Paris based partner Marco A. Blanco for a panel presentation on recent developments in US international taxation. Frankfurt based partner Christian Fingerhut and Milan based partner Fabrizio Vismara drew out the impact of the new rules on investment funds in the European regulations, particularly in Germany and Italy.

Download the presentation materials: http://www.curtis.com/siteFiles/SitePages/Curtis Presentation on US tax and investment funds.pdf
Download Curtis speakers' profiles and team information: http://www.curtis.com/siteFiles/SitePages/Curtis investment funds and tax seminar - speakers and information.pdf

TIC Form SLT imposes new reporting obligations for cross-border investments that may apply to private funds and private fund managers

2011-09-09T14:00:00.000-04:00

The Department of the Treasury and the Federal Reserve Bank recently implemented new Form SLT, which will be part of the Treasury International Capital (TIC) reporting system designed to provide timely information on international capital movements. Form SLT will be used to collect monthly data on cross-border ownership by U.S. and foreign residents of long-term securities for portfolio investment purposes. The reporting panel for the Form SLT consists of all U.S. persons who are U.S.-resident custodians, U.S.-resident issuers of U.S. securities or U.S.-resident end-investors in foreign securities, where for each reporting entity, the consolidated total of all reportable long-term U.S. and foreign securities on the last business day of the reporting month has a total fair market value equal to or more than the exemption level, which is set at $1 billion. All U.S. persons who are U.S.-resident custodians, U.S.-resident issuers or U.S.-resident end-investors and who meet or exceed the reporting threshold must file the Form SLT. Accordingly, certain private funds and private fund managers may be required to filed Form SLT if they satisfy these conditions.

The obligation to report on Form SLT becomes effective on September 30, 2011 with the first filing due by October 23, 2011. The following filing is due by January 23, 2012. Thereafter, Form SLT is required to be filed on a monthly basis.

Link to the Form SLT: http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/fslt.pdf

Link to the Form SLT Instructions: http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/fslt.pdf

SEC Adopts Final Rules Implementing New Reporting, Recordkeeping and Custody Obligations

2011-07-18T15:57:00.005-04:00

On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted final rules to implement certain provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).¹ Among other things, the final rules (i) amend Form ADV to require additional disclosure by advisors; (ii) modify the definition of “hedge fund” to narrow the use of the term in the categorization of funds; (iii) implement a new uniform method for calculating assets under management (“AUM”); and (iv) amend the custody and disclosure requirements for advisers registered under the Investment Advisers Act of 1940, as amended (the “Advisers Act”).

Title IV of the Dodd-Frank Act (“Title IV”) introduces various new reporting requirements for registered investment advisers. Currently, an investment adviser registered with the SEC must (i) submit registration forms – Form ADV Parts 1 and 2 – with the SEC; (ii) submit to each advisory client and prospective client a written disclosure statement that complies with Form ADV Part 2; (iii) comply with various detailed policies and maintain certain detailed records; and (iv) appoint an individual responsible for administering the adviser’s policies and procedures.

A. Form ADV

Under Title IV, Form ADV has been amended to require additional disclosure by advisers about their advisory and business relationships as well as their portfolios. Of particular note, Item 7.B.(1) of Schedule D requires detailed information about individual funds advised by the investment adviser to be disclosed, which would be made publicly available. The final rules expand the information that advisers must report to the SEC about the funds they advise. An adviser must complete a separate Schedule D for each “private fund” that the adviser manages.² Information an adviser is required to report in Section 7.B.(1) will include (i) the name of the fund; (ii) the state or country in which the fund is organized; (iii) whether the fund is a master fund or a fund of funds; (iv) the regulatory status of the fund, such as exemptions from the Investment Company Act on which the fund relies; (v) the type of investment strategy the fund employs;³ (vi) whether the fund invests in securities of registered investment companies; (vii) the gross asset value of the fund; (viii) the minimum amount that investors are required to invest; (ix) the approximate number of beneficial owners of the fund (including related persons); (x) information about the fund’s gatekeepers, including administrators and auditors; and (xi) the extent to which clients of the adviser are solicited to invest, and have invested, in the fund.

The final rules also make modifications to clarify the definition of the term “hedge fund” in order to narrow the broad use of the term in an effort to more appropriately categorize funds. The definition of “hedge fund” no longer includes funds categorized as “securitized asset funds,” and the definition of “securitized asset fund” is no longer used in reference to “hedge funds.” Clause (a) of the “hedge fund” definition also was modified to relate only to fees or allocations that may be paid to an investment adviser (or its related persons) rather than accrued or allocated to them. Clause (a) was modified further so that hedge funds, in calculating performance fees or allocations, may not take into account unrealized gains solely for the purpose of reducing such fees or allocations to reflect net unrealized gain. Lastly, clause (c) was modified to provide an exception for short selling that hedges currency exposure or manages duration.

The final rules also include a new uniform method for calculating AUM that would be used to determine eligibility for exemptions and registration thresholds. In general, the adopted amendments eliminate adviser discretion that would have enabled advisers to opt in or out of federal or state regulation. Under the new method, advisers must count several classes of assets that currently may be excluded, such as proprietary assets, assets managed without receiving compensation, and assets of foreign clients. As such, Part 1A of Form ADV is amended to refer to an adviser’s AUM as “regulatory AUM.”⁴ Advisers also must include accrued but unpaid liabilities, uncalled capital commitments and the value of any private fund over which continuous and regular supervisory or management services are exercised, regardless of the nature of the assets held by the fund.⁵ Additionally, advisers must value all assets at fair value, rather than on a cost basis.

B. Custody, Recordkeeping, and Disclosure

The final rules amend Item 9 of Form ADV to require each registered adviser to indicate “the total number of persons that act as qualified custodians for the adviser’s clients in connection with the advisory services the adviser provides to its clients” to provide a more complete view of an adviser’s custodial practices. Advisers with custody of client funds must maintain those assets with a qualified custodian, and must know both the identity and number of qualified custodians that maintain said assets. The final rules also correct a drafting error in Item 9.A., which now requires advisers to exclude from Item 9.A., and to report in Item 9.B., client assets for which custody is attributed to the adviser as a result of custody by a related person. The client assets reported in Item 9.A. should only be those over which the adviser has physical, rather than constructive, custody.

Title IV requires the SEC to conduct periodic inspections of records of private funds maintained by registered investment advisers. Furthermore, Title IV grants the SEC broad power to conduct additional examinations at any time and from time to time as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk. Registered investment advisers must make available to the SEC “any copies or extracts from such records as may be prepared without undue effort, expense, or delay, as the [SEC] or its representatives may reasonably request.” The SEC is required to make these documents available to the Financial Stability Oversight Council, and to report annually to Congress on its use of the information collected. The costs incurred by the maintenance and reporting of such documents could prove significant for investment advisers.

Title IV further dilutes the ability of investment advisers to keep client information confidential by amending the disclosure requirements of Section 210 of the Advisers Act. Prior to the Dodd-Frank Act, Section 210(c) stated that no provision of the Advisers Act could be construed to require or authorize the SEC to require an investment adviser to disclose the identity, investments, or affairs of its clients unless such disclosure was “necessary or appropriate in a particular proceeding or investigation having as its object the enforcement of a provision or provisions of [the Advisers Act].” Title IV expands that carve-out to enable the SEC to require disclosure of such information “for the purposes of assessment of potential systemic risk.” Exempt reporting advisers also will be subject to the public disclosure requirements of Section 210.

The full text of the Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, is available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h4173enr.txt.pdf.↑

In the event there are multiple advisers to a single fund, only one adviser must report the information for the fund. Further, an adviser managing a master-feeder arrangement may submit a single Section 7.B.(1) on behalf of the master fund and all feeder funds if each fund would report substantially similar information. ↑

The adviser may select from seven broad categories, including: (i) hedge fund; (ii) liquidity fund; (iii) private equity fund; (iv) real estate fund; (v) securitized asset fund; (vi) venture capital fund; and (vii) other private fund.↑

This amendment is meant to distinguish between Part 1A and Part 2 of Form ADV.↑

Calculating AUM on a gross, rather than a net, basis is designed to prevent advisers from utilizing highly leveraged positions to avoid federal registration and systematic risk reporting.↑

SEC Adopts Final Rules Implementing Certain Provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act

2011-07-12T15:28:00.012-04:00

On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted final rules to implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The final rules, which were adopted substantially as proposed, generally will require advisers to hedge funds and other private funds to register with either the SEC under the Investment Advisers Act of 1940 (the “Advisers Act”) or state securities authorities unless such advisers qualify for one of three new exemptions. Implemented in lieu of the now eliminated “private adviser” exemption of Section 203(b)(3) of the Advisers Act, the new exemptions apply to (i) advisers solely to “venture capital funds”; (ii) advisers solely to private funds with less than $150 million in assets under management (“AUM”) in the United States; and (iii) foreign private advisers. Although all three categories of advisers will be exempt from registration, the SEC will require advisers relying on the first two of these exemptions (“exempt reporting advisers”) to file certain reports with the SEC. Additionally, the final rules exclude “family offices” from the definition of investment adviser, thereby excluding these advisers from the registration requirements under the Advisers Act. The final rules also (i) reallocate regulatory responsibility for certain mid-size advisers from the SEC to the states and (ii) provide for certain new reporting requirements applicable to registered advisers and exempt reporting advisers.

In order to provide those advisers who relied on the “private adviser” exemption and may now be required to register with sufficient time to meet their obligations, the SEC has decided to delay the registration deadline until March 30, 2012.¹

Background

Section 203 of the Advisers Act makes it unlawful to make use of any instrumentality of interstate commerce in connection with the provision of investment advice unless registered as an investment adviser under the Advisers Act or otherwise exempt from registration. Subject to certain specific exclusions, the Advisers Act defines an “investment adviser” broadly to include any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities. Advisers who fall within the scope of the definition of “investment adviser” are not required to register with the SEC if they satisfy an available exemption from registration.

Elimination of “Private Adviser” Exemption

As noted above, advisers to private funds historically have not been required to register with the SEC by virtue of the private adviser exemption, which exempted from registration any adviser that had fewer than 15 clients over the course of the preceding 12 months, did not hold itself out generally to the public as an adviser and did not act as an adviser to a registered investment company or business development company. For purposes of calculating whether an adviser had fewer than 15 clients, the adviser was allowed to count each private fund as a separate client. The Dodd Frank Act defines a “private fund” as any issuer that would be an investment company under the Investment Company Act of 1940 (the “Investment Company Act”) but for the exception provided by either Section 3(c)(1) or 3(c)(7) of the Investment Company Act. These exceptions require a fund to either limit itself to 100 total investors (Section 3(c)(1)) or permit only “qualified purchasers” to invest (Section 3(c)(7)). Most hedge funds, private equity funds, venture capital funds and other alternative investment funds rely on these exceptions to remain unregistered.

Title IV of the Dodd Frank Act (“Title IV”) accomplishes the SEC’s goal of increasing oversight of private fund advisers by eliminating the private adviser exemption entirely. Accordingly, many investment advisers that currently rely on the exemption, including advisers that do not advise private funds, will be required to register with the SEC unless they can meet another available exemption.

New Exemptions and Exclusions

Although Title IV eliminates the private adviser exemption, it includes new exemptions for certain categories of investment advisers.

A. Exempt Reporting Advisers

Advisers relying on new exemptions under either Section 203(l) (the “venture capital exemption”) or Section 203(m) of the Advisers Act (the “private fund adviser exemption”) are referred to as “exempt reporting advisers.” While exempt reporting advisers are exempt from registering with the SEC as investment advisers, they still must file certain portions of Form ADV with the SEC.² An exempt reporting adviser must submit its initial Form ADV electronically through the Investment Adviser Registration Depository (the “IARD”) within 60 days of relying on the exemption from registration under either Section 203(l) or Section 203(m) of the Advisers Act. The filing must be submitted by March 30, 2012. Additionally, such advisers may be required to register with the states in which they perform advisory services. Advisers qualifying for either the venture capital exemption or the private fund adviser exemption may decline to avail themselves of the exemption and instead choose to register with either the SEC or the appropriate state securities authorities depending on eligibility.

i. Advisers that Solely Advise “Venture Capital Funds”

Title IV exempts from SEC registration any investment adviser that advises solely “venture capital funds.” Because of the many similarities between venture capital funds and private equity funds, the SEC has issued a new rule defining venture capital funds narrowly in order to limit the number of advisers that can avail themselves of the venture capital exemption. Unlike advisers relying on the private fund adviser exemption, an adviser relying on the venture capital exemption may have an unlimited amount of AUM without having to register with the SEC.

Under the SEC’s new rules, a venture capital fund is a private fund that: (i) invests in equity securities of private companies in order to provide operating and business expansion capital, with at least 80% of each company’s securities owned by the fund having been acquired directly from the qualifying portfolio company;³ (ii) does not borrow or otherwise incur leverage (other than limited short-term borrowing); (iii) does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances; (iv) represents itself as a venture capital fund to investors; and (v) is not registered under the Investment Company Act and has not elected to be treated as a business development company.

ii. Private Fund Advisers with Less Than $150 Million of U.S. AUM

Any investment adviser that advises solely private funds and has AUM in the United States of less than $150 million is exempt from registration under the Advisers Act. For advisers with a principal office and place of business in the United States, all private fund assets of the adviser are considered to be “in the United States.” For non-U.S. advisers, only private fund assets that the adviser manages from a place of business in the United States⁴will count towards the $150 million threshold.

B. “Foreign Private Advisers”

Another new exemption created by Title IV is an exemption for “foreign private advisers.” Title IV defines a “foreign private adviser” as any investment adviser that (i) has no place of business in the United States; (ii) has, in total, fewer than 15 clients and investors in the United States in private funds advised by the investment adviser; (iii) has aggregate AUM attributable to U.S. clients and U.S. investors in private funds advised by the adviser of less than $25 million; (iv) does not hold itself out generally to the public as an investment adviser; and (v) does not act as a company that has elected to be a business development company or as an investment adviser to an investment company.

Note that in counting the number of “investors” the foreign private adviser has in the United States, Title IV requires the adviser to “look through” any private fund it advises and count the number of individual U.S. investors in any such private fund during the preceding 12 months. While Title IV requires advisers to “look through” for purposes of determining applicability of this exemption, it does not require a foreign private adviser to count investors in private funds managed by the advisor as “clients”⁵ under the Advisers Act.

Exclusion for “Family Offices”

Many family offices took advantage of the private adviser exemption, which is eliminated under the Dodd-Frank Act. Title IV amends the definition of investment adviser under the Advisers Act to exclude any “family office,” thus exempting many such advisers from regulation. Section 202(a)(11)(G)-(1) of the Advisers Act defines an exempt family office as one that (i) provides advice about securities only to family clients of a single family; (ii) is wholly owned and controlled by family members; and (iii) does not hold itself out to the public as an investment adviser. The rule also includes grandfathering provisions intended to cover certain advisers that were not previously required to be registered under the Advisers Act.

Increased State Oversight of “Mid-Sized Advisers”

Title IV generally broadens the number of advisers subject to state regulation to encompass “mid-sized advisers.” Prior to the Dodd-Frank Act, Section 203A of the Advisers Act prohibited an investment adviser regulated by the state in which it maintained its principal office and place of business from registering with the SEC unless the adviser had AUM of at least $25 million or advised a registered investment company. Further, an adviser having between $25 million and $30 million of AUM had the option to register with the SEC, while an adviser with over $30 million of AUM was required to register with the SEC unless it was eligible for an exemption.

Under the Dodd-Frank Act, “mid-sized advisers” with AUM of between $25 million and $100 million would generally be subject to supervision at the state level, rather than with the SEC.⁶ If an investment adviser with AUM of $25 million to $100 million (i) is required to register with a state and (ii) would be subject to examination by the state authorities as a result of such registration,⁷ then the adviser must register in the state(s) in which it operates, although the adviser may register with the SEC if it would otherwise be required to register with 15 or more states. If the adviser is not required to register or is not subject to examination at the state level, the threshold for SEC registration remains $25 million. Thus, many investment advisers that were previously exempt from registration under Section 203(b)(3) now will find themselves categorized as “mid-sized advisers.”

The SEC amended Item 2 of Part 1A on Form ADV to reflect the new $100 million statutory threshold. Item 2.A requires each adviser registered with the SEC (and each applicant for registration) to identify whether it is eligible to register with the SEC because it (i) is a large adviser that has $100 million or more of regulatory AUM (or $90 million or more if an adviser is filing its most recent annual updating amendment and is already registered with the SEC); (ii) is a mid-sized adviser that does not meet the criteria for state registration or is not subject to examination; (iii) has its principal office and place of business in Wyoming (which does not regulate advisors) or outside the United States; (iv) meets the requirements for one or more of the revised exemptive rules under Section 203A of the Advisers Act; (v) is an adviser (or subadviser) to a registered investment company; (vi) is an adviser to a business development company and has at least $25 million of regulatory AUM; or (vii) received an order permitting it to register with the SEC.

Each registered investment adviser will have to file an amended Form ADV using a new uniform method for calculating AUM in order to determine eligibility for federal registration and any potential exemptions. In brief, an adviser’s regulatory AUM is calculated, on a gross basis, as the market value of the “securities portfolios” for which the adviser provides “continuous and regular supervisory or management services.” An adviser that provides these services to a private fund must count all of the private fund’s assets as a securities portfolio, regardless of whether those assets actually qualify as “securities.” This determination must be made within 90 days of filing the amended Form ADV. Each adviser registered with the SEC on January 1, 2012 must file an amendment to its Form ADV no later than March 30, 2011. In addition to being required to file an amended Form ADV no later than March 30, 2012, advisers that are no longer eligible for federal registration will be required to withdraw by filing Form ADV-W and register with the appropriate state(s) within 90 days of filing the amended Form ADV but no later than June 28, 2012.

Exemptions from the Prohibition on Registration with the Commission

Section 203A(c) of the Advisers Act authorizes the SEC to permit advisers to register with the SEC even if they would otherwise be prohibited from doing so. Pursuant to this authority, the SEC issued has permitted six types of investment advisers to register with the SEC under Rule 203A-2: (i) nationally recognized statistical rating organizations (“NRSROs”); (ii) certain pension consultants; (iii) certain investment advisers affiliated with an adviser registered with the Commission; (iv) investment advisers expecting to be eligible for Commission registration within 120 days of filing Form ADV; (v) certain multi-state investment advisers; and (vi) certain internet advisers. The final rules amend these exemptions by removing the exemption for NRSROs (now excluded from the definition of “investment adviser” under the Advisers Act), raising the minimum value of plan assets required to be managed by pension consultants from $50 million to $200 million, and lowering from 30 to 15 the number of states in which a multi-state investment adviser would be required to register before it is eligible to register with the SEC.

Transition Period

While new Rule 203A-5 becomes effective on July 21, 2011, an investment adviser may, at its own discretion, register with the SEC under the Investment Advisers Act prior to that date. Mid-sized advisers applying for registration with the SEC may register either with the SEC or the appropriate state authorities. Mid-sized advisers registered with the SEC as of July 21, 2011 must remain registered with the SEC (unless an exemption is available) until January 1, 2012. Thereafter, the adviser may transition to state registration. After July 21, 2011, newly registering mid-sized advisers must register with the appropriate state authorities. The SEC is only exempting those mid-sized advisers that are already registered with the SEC by July 21, 2011 if they have at least $25 million AUM. Each adviser registered with the SEC on January 1, 2012 must file an amendment to its Form ADV by March 30, 2012. Those mid-sized advisers who are no longer eligible for SEC registration must withdraw their registrations no later than June 28, 2012.

The proposed rule would have allowed for a 90-day transitional period with two “grace periods.” Advisers would have had to first determine by August 20, 2011 whether they were eligible for SEC registration and file an amended Form ADV. Then, advisers would have had to register with state authorities and withdraw registration from the SEC by October 19, 2011. However, under the final rules all investment advisers, including exempt reporting advisers, must submit Form ADV to the SEC by March 30, 2012. ↑

Exempt reporting advisers must complete and file the following items of Part 1A of Form ADV: Items 1 (Identifying Information), 2.B. (SEC Reporting by Exempt Reporting Advisers), 3 (Form of Organization), 6 (Other Business Activities), 7 (Financial Industry Affiliations and Private Fund Reporting), 10 (Control Persons), and 11 (Disclosure Information). Exempt reporting advisers also must complete the corresponding sections of Schedules A, B, C and D.↑

A “qualifying portfolio company” is a company that is not publicly traded, does not incur leverage in connection with the fund’s investment, uses the fund’s capital for operating or business expansion purposes rather than to buy out other investors, and is not itself a fund.↑

A “place of business in the United States” is defined as any office where the investment adviser regularly provides advisory services, solicits, meets with, or otherwise communicates with clients, and any location held out to the public as a place where the adviser conducts any such activities that is located in the United States. To determine if a place of business is “in the United States” or if an investor is a U.S. Person, SEC Rule 202(a)(30)-1 defines the terms generally by incorporating the definitions of a “U.S. person” and “United States” from Regulation S under the Securities Act of 1933.↑

A “client” generally means (i) a natural person, their minor children, family members of the same household and related accounts and (ii) a legal organization, but not its owners.↑

The SEC further increased this threshold to $110 million under Rule 203A-1. The amended rules provide a buffer for mid-sized advisers with AUM close to $100 million to determine whether and when to switch between state and SEC registration. An adviser must register with the SEC once AUM reach the $110 million threshold, but does not need to withdraw registration until it has less than $90 million of AUM. The buffer is intended to prevent constant registering and withdrawing of registration because of fluctuations of AUM above and below the $100 million threshold due to market fluctuation or the departure or addition of clients.↑

New York, Minnesota and Wyoming advised the SEC that they will not subject investment advisers to examination at the state level. Advisers registered with all other states are subject to state examination.↑

Will Private Equity Firms Investing in Africa Be Affected by Violations by Portfolio Companies of the New UK Bribery Act?

2011-07-11T11:08:00.007-04:00

The UK Bribery Act (the “UK Act”) is possibly the broadest internationally relevant anti-bribery law worldwide. The UK Act, which took effect on July 1, makes it unlawful to bribe a person, to accept a bribe, to bribe a foreign public official in his capacity as such and, for commercial organizations, to fail to prevent bribery by associated persons. The UK Act includes no limit on the fines that may be imposed for violations and provides for imprisonment of up to 10 years for individuals. This paper addresses the specific implications for private equity firms, especially those who do business in Africa or have African companies in their investment portfolios.

Associated persons. Section 8 of the UK Act defines an associated person to be an entity or individual who performs services for or on behalf of a commercial organization in any capacity, including as employee, agent, contractor or subsidiary. Thus, an employee of a portfolio company or a joint venture partner may be considered an “associated person” under the UK Act whose actions can create direct liability for a private equity firm. Pursuant to Section 8(4) whether one is an associated person “is to be determined by reference to all the relevant circumstances and not merely by reference to the nature [or title] of the relationship”. Indications are that the degree of involvement the private equity firm has in the management of the portfolio company will be a factor in determining whether the portfolio company actor is an “associated person.”¹ Clearly, a firm member who serves as an officer of a portfolio company or as an executive director is an associated person. However, because of the law’s recent vintage, there are still no test cases, rulings or specific guidance clarifying the precise level of control or management required to cause a portfolio company actor to be considered an associated person. Thus, private equity firms would be well advised to be careful in structuring relationships.

Incentive schemes. One feature of the UK Act that could prove problematic for private e equity firms is its application to the bribery of private actors. Under the UK Act, a payment to a private actor that induces that actor to perform his duties improperly can trigger a violation. Private equity firms are typically very involved in the structuring of management and incentive plans at their portfolio companies. Such plans, if structured improperly or carelessly have the potential to violate the UK Act. For example, placement agent or brokering fees may present a particular risk. While a typical and rational incentive or management plan should not ordinarily be an issue, an overly complex web of corporate and employment or contractor relationships could appear to be a way of making third party bribes. Arrangements should therefore be commercial in nature and rational in structure, and responsibility should be taken by senior fund personnel to ensure that any monies are paid for a proper purpose.

Valuation. Among the most important issues to buyers and sellers is the effect UK Act violations will have on ultimate portfolio company valuation and exit. The diligence conducted by prospective purchasers will certainly be looking at potential UK Act violations. Ongoing warranties may be requested from sellers, and if issues are discovered in diligence, purchase price holdbacks would make sense, if a deal can be had at all in the context of potentially unlimited fines.
Investors. As a result of the issues described above, one can expect that investors in private equity funds may begin to condition investments on the implementation of procedures to ensure compliance with the UK Act and even require firms to agree to invest only in companies that are UK Act and FCPA compliant. The consequences of the later discovery of bribery or corruption issues in that case could seriously damage a fund manager’s business and prospects.

Adequate procedures. The failure to prevent language of the UK Act is one of strict liability. In other words, lack of knowledge of the bribing act is not a defense. The only defense a private equity firm may have in the case of a closely managed portfolio company that is found to have violated the UK Act is that the company had in place adequate procedures designed to prevent associated persons from bribing. Unfortunately, but understandably, however, the UK Act does not include a precise definition for “adequate procedures.” As such, until there are a number of test cases, it will be unclear to companies whether they have satisfied the adequate procedures requirement. The UK government has provided some guidance as to what constitutes ‘adequate procedures.’ The criteria are based on six principals which are:

(1) whether the company has instituted procedures that are “proportionate to the bribery risks it faces and to the nature, scale and complexity of the commercial organization’s activities”;
(2) whether “top-level management are committed to preventing bribery”… and foster an associated culture;
(3) whether the company performs periodic, informed and documented internal and external bribery risk assessments;
(4) whether the company uses appropriate due diligence procedures with respect to associated persons;
(5) whether the company communicates and trains with respect to its bribery policies; and
(6) whether the company “monitors and reviews procedures designed to prevent bribery by persons associated with it and makes improvements where necessary.”

Notwithstanding this guidance, without more specific rules defining adequate procedures, companies will still find themselves guessing whether they are indeed UK Act compliant. In addition, in certain circumstances, adequate procedures may all together preclude doing business in some jurisdictions.²

Jurisdictional reach. One must also bear in mind that the expansive reach of the UK Act could make private equity firms acting or formed outside of the UK liable under the UK Act. Not only is where the bribery act occurred not relevant in the case of an individual or entity with a close connection to the UK, in the case of failing to prevent a bribe, organizations that do any business in the UK can be liable under the UK Act regardless of where the bribe occurred and whether the bribing individual has a close connection with the UK. As a result of this broad reach, it will soon be necessary for private equity firms with any ties to the UK with operations in Africa to ensure they have undertaken appropriate and thorough due diligence in order to ensure that their portfolio companies are UK Act compliant. This will be very important for companies that do or wish to do business in African countries known for so-called “gratuities” and the like. In countries where such payments would be considered necessary and not be prohibited locally, these types of payments will be difficult to prevent, and some firms may thus simply be forced to do business elsewhere and even consider divestitures. Private equity firms who are already doing business in Africa and wish to continue to do so may have to augment their due diligence efforts. Firms considering the African market need to pay special attention to diligence efforts to ensure not only current UK Act compliance, but also that procedures are in place (whether they are adequate is to be determined) to prevent bribery. Where companies do have procedures in place to prevent bribery, they need to make sure that all employees, agents or other associated persons are aware of such procedures and trained accordingly. In addition, companies need pay close attention to how court proceedings play out as the definition of what constitutes adequate procedures becomes clearer.

22 June 2011 speech by Richard Alderman, the director of the UK Serious Fraud Office. See http://www.sfo.gov.uk/about-us/our-views/director's-speeches/speeches-2011/private-equity-and-the-uk-bribery-act,-hosted-by-debevoise--plimpton-llp.aspx.↑

See also, the UK Ministry of Justice, The Bribery Act 2010 – Guidance about procedures which relevant commercial organisations can put into place to prevent persons associated with them from bribing (section 9 of the Bribery Act 2010), March 2011.↑

DaMina Advisors LLP and
Curtis, Mallet-Prevost, Colt & Mosle LLP Research Paper

By: Nicole Elise Kearse, Esq., Deputy Managing Director, DaMina Advisors and
Peter F. Stewart, Esq., Partner, Curtis Mallet Prevost Colt & Mosle LLP

SEC Releases Final Rules Implementing Dodd Frank Provisions Affecting Investment Advisers

2011-06-24T11:22:00.006-04:00

On June 22, 2011, the Securities and Exchange Commission (the "SEC") adopted final rules to implement certain provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The final rules, which were adopted substantially as proposed, will generally require advisers to hedge funds and other private funds to register with the SEC under the Investment Advisers Act of 1940 (the "Advisers Act") unless they qualify for one of three new exemptions. The exemptions apply to (1) advisers solely to "venture capital funds", (2) advisers solely to private funds with less than $150 million in private fund assets under management in the United States, and (3) foreign private advisers. Although all three categories of advisers would be exempt from registration, the SEC will require advisers relying on the first two of these exemptions ("exempt reporting advisers") to file certain reports with the SEC. In addition to these exemptions, the final rules exclude "family offices" from the definition of investment adviser, thereby excluding these advisers from regulation under the Advisers Act. Lastly, the final rules reallocate regulatory responsibility for certain mid-size advisers from the SEC to the states and provide for certain new reporting requirements applicable to registered advisers and exempt reporting advisers. In order to allow those advisers who may now be required to register sufficient time in which to meet their obligations, the SEC has decided to delay their registration deadline until March 30, 2012.

We will be examining in more detail the implementation of the final rules and the various specific exemptions in subsequent client alerts. Please check back for further updates.

For the full text of the final rules, please visit the following hyperlinks:

Implementation Release:
http://sec.gov/rules/final/2011/ia-3221.pdf

Exemptions Release:
http://sec.gov/rules/final/2011/ia-3222.pdf

Family Offices Release:
http://sec.gov/rules/final/2011/ia-3220.pdf

Master Fund Registration Requirement Proposed in Cayman Islands

2011-06-16T13:08:00.006-04:00

On June 10, 2011, Cayman Islands Premier and Finance Minister McKeeva Bush proposed a revenue-generating measure to require certain Cayman-domiciled "master funds" to register with the Cayman Islands Monetary Authority (CIMA). These funds would be required to pay an annual fee of CI$1,500 (~US$1,850). Currently, such funds do not pay any fees and are not regulated by CIMA. Premier Bush's proposal will be subject to consideration by the Cayman Islands legislature. Please check back for further updates.

For the full text of Premier Bush’s speech, please click
here.

Council of the EU Adopts AIFM Directive

2011-05-31T14:01:00.003-04:00

On May 27, 2011, the Council of the EU finally announced [http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ecofin/122250.pdf] its adoption of the text of the AIFM Directive [http://register.consilium.europa.eu/pdf/en/10/pe00/pe00060.en10.pdf], following an agreement reached with the European Parliament at first reading. As previously reported [http://curtis-ifg.blogspot.com/2010/12/aifm-directive.html], the European Parliament adopted the text of the AIFM Directive on November 11, 2010.

The official text of the AIFM Directive will now be published in the Official Journal of the EU and the directive will enter into force on the 20th day following publication. EU Member States will have two years to implement the provisions of the AIFM Directive into national law.

Curtis Client Alert: FINRA Rule 5131 Effective May 27, 2011

2011-04-04T14:10:00.000-04:00

FINRA Rule 5131, which will take effect on May 27, 2011, seeks to prevent certain abuses in the allocation and distribution of new issues. One of the abuses that Rule 5131 targets is the allocation of new issues to executive officers and directors of companies for which the FINRA member provides investment banking services, a practice commonly referred to as "spinning." In this Client Alert, we discuss the requirements and prohibitions under the Rule and applicable exceptions, with a particular focus on the Rule's implication for private investment funds.

SEC Proposes Form PF to Facilitate Increased Private Fund Disclosure

2011-02-11T16:33:00.031-05:00

Introduction
On January 26, 2011, the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) (collectively, the “Commissions”) jointly proposed new rules designed to monitor systemic risk to the financial system.¹ The proposed rules create Form PF, which would require registered investment advisers to private funds² to file information about the advisers’ operations and the private funds they advise, such as the amount of assets under management, use of leverage, counterparty credit risk exposure and trading and investment positions for each private fund advised by the adviser. The amount of information reported and the frequency of reporting would depend upon the size of the private fund advised. This client alert summarizes the reporting requirements and types of disclosure required for proposed Form PF.

Overview of Systemic Risk Monitoring
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). While Dodd-Frank provides for wide-ranging reform of financial regulation, one stated focus of this legislation is to “promote the financial stability of the United States” by, among other measures, establishing better monitoring of emerging risks using a system-wide perspective. Title I of the Dodd-Frank Act establishes the Financial Stability Oversight Council (the “FSOC”), which is comprised of the leaders of various financial regulators (including the Commissions’ Chairmen) and other participants.

To further the monitoring of systemic risk, Sections 404 and 406 of Dodd-Frank amend Sections 204(b) and 211, respectively, of the Investment Advisers Act of 1940, as amended, to require private fund advisers to file reports containing information for the assessment of systemic risk by the FSOC. The records and reports must include a description of certain information about private funds, such as the amount of assets under management, use of leverage, counterparty credit risk exposure and trading and investment positions for each private fund advised by the adviser. Information reported on Form PF would not be available to the public, but Form PF information may be used by the SEC in an enforcement action or by FSOC as a basis for ordering further investigation by the Office of Financial Research.

Reporting Requirements
Beginning December 15, 2011, SEC-registered investment advisers that advise one or more private funds would be required to file Form PF. The form consists of 4 main sections.³ Section 1 must be completed by all private fund advisers. Sections 2-4 relate to private fund advisers of private funds in specific categories meeting certain assets under management thresholds.
Smaller private fund advisers (those advising private funds with total assets under management of less than $1 billion in specific classes)⁴ would be required to complete and file Section 1 of Form PF annually no later than the last day on which the adviser may timely file its updating amendment to Form ADV (currently, 90 days after the end of the adviser’s fiscal year).

Large private fund advisers (those advising private funds with total assets under management of $1 billion or more in specific classes), on the other hand, face more frequent filing obligations and additional reporting requirements. Large private fund advisers would be required to complete and file Form PF quarterly, rather than annually, due no later than 15 days after the end of each calendar quarter. In addition to Section 1, a large private fund adviser with more than $1 billion of hedge fund⁵ assets under management as of the close of business on any of the days during the reporting period would be required to complete Section 2. A large private fund adviser with more than $1 billion of combined liquidity fund⁶ assets and registered money market fund assets under management as of the close of business on any of the days during the reporting period would be required to complete Section 3. Finally, a large private fund adviser with more than $1 billion of private equity fund⁷ assets under management as of the last day of the quarterly reporting period would be required to complete Section 4.

The Commissions expect to implement an electronic filing system for Form PF, but have yet to propose a specific solution⁸. Fees have also not yet been proposed.

Form PF Disclosure Requirements
The specific information requested in each Section of Form PF is outlined in more detail below.

Section 1
Section 1 must be filed by all private fund advisers.

Section 1a seeks information about the adviser, including:

identifying information, such as its name and the name of any of its related persons whose information is also reported on the adviser’s Form PF; and
basic aggregate information about the private funds managed by the adviser, such as total and net assets under management and the amount of those assets that are attributable to certain types of private funds.
Section 1b requests information about each private fund advised by the investment adviser. The adviser would need to complete a separate section 1b for each private fund it advises⁹, covering:
identifying and other basic information about each private fund;
each private fund’s gross and net assets and the aggregate notional value of its derivative positions;
basic information about the fund’s borrowings, including a breakdown based on whether the creditor is a U.S. financial institution, foreign financial institution or non-financial institution as well as the identity of, and amount owed to, each creditor to which the fund owed an amount equal to or greater than 5% of the fund’s net asset value as of the reporting date;
basic information about how concentrated the fund’s investor base is, such as the number of beneficial owners of the fund’s equity and the percentage of the fund’s equity held by the five largest equity holders; and
monthly and quarterly performance data for each fund.

Section 1c would require information about hedge funds managed by the adviser. The adviser would need to complete a separate section 1c for each hedge fund it advised, disclosing: investment strategies;

percentage of the fund’s assets managed using computer-driven trading algorithms;
significant trading counterparty exposures (including identity of counterparties); and detailed trading and clearing practices.

Section 2 Section 2 would apply to private fund advisers advising hedge funds with total assets under management of more than $1 billion. Section 2a seeks information about the adviser’s hedge funds in the aggregate:

exposure / market value of assets invested in different types of securities and commodities (on both short and long bases);
duration of fixed income portfolio holdings;
interest rate sensitivity;
turnover rate of portfolios (to provide an indication of the adviser’s frequency of trading); and
geographic breakdown of investments.

Section 2b relates to each hedge fund advised by the investment adviser with at least $500 million assets under management. The adviser would need to complete section 2b for each such fund, disclosing:

exposure / market value of assets invested in different types of securities and commodities (on both short and long bases);
portfolio liquidity;
concentration of positions;
collateral practices with significant counterparties;
identity of, and clearing relationships with, the three central clearing counterparties to which the fund has the greatest net counterparty credit exposure;
certain hedge fund risk metrics;
financing information;
investor information;
impact on the fund’s portfolio from specified changes to certain identified market factors, (if regularly considered in the funds’ risk management), broken down by long and short components of the portfolio;
monthly breakdowns of secured and unsecured borrowing, derivatives exposures, information about the value of collateral and letters of credit supporting secured borrowing and derivates exposures and the types of creditors;
breakdown of the term of the funds’ committed financing;
investor composition and liquidity, such as side pocket, gating arrangements, and breakdowns of the percentage of the funds’ net asset value that is locked in for different periods of time.

Section 3 Section 3 relates to private fund advisers advising liquidity funds and registered money market funds having combined assets under management of at least $1 billion. Such advisers must disclose:

pricing method for computer net asset value per share;
compliance with Rule 2a-7 of the Investment Company Act of 1940;
information regarding the fund’s portfolio, such as - net asset value; - net asset value per share; - market-based net asset value per share; - weighted average maturity, weighted average life; and - 7-day gross yield, amount of daily and weekly liquid assets, amount of assets with a maturity grater than 397 days;
amount of assets invested in different types of instruments, broken down by maturity, as well as information for each open position that represents 5% or more of the fund’s net asset value;
secured or unsecured borrowing of the fund, broken down by creditor type and maturity profile of that borrowing;
whether the fund has in place a committed liquidity facility;
concentration of the investor base;
gating and redemption policies;
investor liquidity; and
percentage of the fund purchased using securities lending collateral.

Section 4 Section 4 covers private fund advisers advising private equity funds having assets under management of at least $1 billion. Such advisers must disclose:

information about borrowings and guarantees of the fund;
leverage of the portfolio companies in which the fund invests;
weighted average debt-to-equity ratio of controlled portfolio companies in which the fund invests and the range of debt to equity among those portfolio companies;
maturity profile of portfolio companies’ debt;
whether fund or any portfolio companies experienced an event of default;
identity of institutions providing bridge financing; and
breakdown of the funds’ investments by industry and by geography.

1. Release No. IA-3145, Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, available at http://sec.gov/rules/proposed/2011/ia-3145.pdf

2. A “private fund” is an issuer that would be an investment company under the Investment Company Act of 1940 but for the exemptions provided by section 3(c)(1) or 3(c)(7).

3. Section 5 is contemplated, but has not yet been proposed, as a hardship exemption form.

4. For purposes of calculating assets under management, each adviser would have to aggregate all parallel managed accounts and any assets advised by related persons. If the investment adviser’s principal office and place of business is outside the United States, it may disregard for Form PF purposes the assets of any private fund that is neither a U.S. person nor is offered to, or beneficially owned by, a U.S. person during the previous year.

5. Proposed Form PF would define “hedge fund” as any private fund that (1) has a performance fee or allocation calculated by taking into account unrealized gains; (2) may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (3) may sell securities or other assets short.

6. A “liquidity fund” would be defined as any private fund that seeks to generate income by investing in a portfolio of short term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investors. This includes, for example, treasury securities, municipal bonds, unsecured commercial paper, and certificates of deposit.

7. A “private equity fund” would be defined as any private fund that is not a hedge fund, liquidity fund, real estate fund, securitized asset fund or venture capital fund and does not provide investors with redemption rights in the ordinary course.

8. The most likely solution for electronic filings is expansion of the existing IARD system, owing to efficiencies “such as the possible interconnectivity of Form ADV filings and Form PF filings, and possible ease of filing with one password.”

9. Funds that are part of a master-feeder arrangement would be filed together in order to avoid duplicative reporting.

AIFM Directive

2010-12-08T15:06:00.000-05:00

The AIFM Directive – At Last
In April 2009, when EU Commissioner Charlie McCreevy announced the proposal for a Directive on Alternative Investment Fund Managers (the “AIFM Directive”), it was widely viewed as a rushed political response to raging populist anger in France and Germany against alternative investment funds that, due to their perceived excessive leverage and risk-taking, were considered catalysts for the global financial crisis.

The Controversial Debate

The initial draft law, which proposed a broad overhaul of regulation over managers of hedge funds, real estate funds, private equity funds and other collective investment vehicles (save for UCITS¹), was roundly criticized by the alternative asset industries of Europe and the US as (i) not achieving any of its legitimate goals, and (ii) not taking into account substantial differences between the business models and asset classes of various types of alternative investment funds, and thus stifling the interests of investors and managers alike. Nowhere was the draft law more hotly debated than the UK, which is home to more than 80% of European hedge fund managers and where fears of a mass exodus of managers to Switzerland and certain other non-EU financial centres ran rampant.

The Result

Fast-forward 19 months – witness to a record 1,700 proposed amendments to the draft, multiple compromise proposals, impact assessments, and lengthy negotiations – and the mist surrounding alternative investment fund regulation in Europe finally lifted after 11 November 2010, when the European Parliament adopted the AIFM Directive with an overwhelming majority.² Suddenly, the regulatory picture for the industry looks considerably less ominous than initially anticipated.

The adopted text maintains the core features of the original proposal aimed at achieving better investor protection, enhanced transparency, and effective prudential oversight of systemic risks. The related provisions include requirements regarding the managers’ future reporting and disclosure towards regulators and investors, their minimum capitalization, remuneration, risk management, liquidity, use of leverage on the fund level, conflicts of interest, fund control positions in portfolio companies, fund portfolio valuation, and marketing/fundraising.

Notwithstanding the broad regulatory scope of the adopted text, it adopts a substantively less draconian and protectionist stance toward industry regulation than that of certain prior versions. This softening in position is most apparent in the relatively watered-down depositary liability regime and the planned introduction (as of 2015) of a “passport” for the marketing of non-EU funds within the Union. Even before the extension of the passport to non-EU funds, such funds will, subject to certain minimum conditions, be able to access specific EU markets in compliance with their respective existing private placement regimes. The adopted text also stops short of proscribing passive, non-solicited investments by EU investors in non-EU funds.

Market Impact of the AIFM Directive

While stakeholders generally view the AIFM Directive as imposing substantial compliance burdens on the alternative asset universe, the consensus view is that neither a fatal blow to the nearly €2 trillion-strong industry, nor a prompt en masse manager exodus from the EU, is forthcoming. Rather, the expected behavioural consequence of the AIFM Directive is that fund managers will largely self-segregate into one of two groups: those managers with substantial interest in EU-based fund marketing and investment activity, and those focused on fund marketing and investment outside the EU.

Those managers seeking to tap the EU investor base or operate within the EU will need to begin assessing the impending impact of the AIFM Directive on their current and future fund activities and platforms, with a view toward modifying those activities and platforms to ensure compliance. On the other hand, those managers with little or no connection to the EU markets should conduct a cost-benefit analysis as to the perceived advantages and disadvantages of becoming subject to the AIFM Directive and act accordingly.

Exemptions

In addition to the nationality mix of a manager’s investor base, the size of its fund management operation and its investment strategy will also influence the manager’s assessment of the AIFM Directive, as certain exemptions from the manager authorization and ongoing compliance requirements may be available. In particular, the agreed text sets forth a “lighter” supervisory regime for a manager whose fund portfolio does not, on aggregate, exceed (i) €100 million, or (ii) €500 million, provided that the fund platform is unleveraged (with leverage being assessed only at the fund level, not at the portfolio company level) and the investors are “locked-in” for a minimum five-year period.

Managers that are able to avail themselves of one of the foregoing exemptions will still be required to register with their home-state regulator, satisfy certain initial and ongoing disclosure requirements, and comply with any applicable national regulation in their respective Member States. An exempted manager will be able to largely avoid the compliance costs associated with the AIFM Directive but will be restricted in its marketing efforts due to the non-availability of the EU passport. As a result, managers with a broad pool of existing EU investors, or those managers seeking to expand their marketing efforts into multiple EU Member States, may elect to voluntarily opt into the AIFM Directive framework, thereby subjecting themselves to the full gamut of compliance requirements.

Interestingly, as the AIFM Directive is concerned exclusively with managers of “funds”, the Euro-denominated thresholds associated with the foregoing exemptions only take into account the value of fund portfolio assets, without regard to assets associated with managed accounts or other non-collective investment management arrangements. As such, some investment managers will be able to manage large single-investor portfolios without falling under the AIFM Directive umbrella.

UCITS as an Alternative

Another option for the avoidance of future AIFM regulation that may appeal to hedge fund managers with a substantial EU investor base or fund platform is the possibility of migrating to or creating mirror investment vehicles under the UCITS regime. UCITS III-compliant hedge funds (“NewCITS”) represent a trend that has been gaining momentum since the dawn of the financial crisis and may climax with the advent of the AIFM Directive. The UCITS framework offers managers a number of benefits, such as new sales channels (to retail and certain institutional investors), broader geographic reach, economies of scale and a recognized global brand, while not substantially curtailing absolute-performance, long-bias strategies. The “gold-plating”³ associated with the UCITS brand has historically come at a higher compliance cost for managers, but the overall impact of the AIFM Directive, coupled with the added flexibility afforded by the upcoming UCITS IV, may ultimately render this distinction meaningless.

Conclusion

The regulatory implications and consequent market reactions to the advent of the AIFM Directive, together with related developments under the UCITS regime, represent the dawn of a brave new world for the EU alternative asset industry. Managers within and without the EU will be confronted with a sweeping array of regulatory challenges of first impression, challenges which will call into question the fundamentals of how and where the alternative asset industry structures, sells and locates its products. The manner in which other leading (offshore) financial centres position themselves to competitively attract elements of the industry and market players also remains to be seen, as does the overall efficacy of the EU’s regulatory initiatives in the face of future economic turmoil, though assuredly we are now witnessing merely the opening act of a several-act play, with more drama to follow.

The AIFM Directive is due to be transposed into national law by EU Member States by 2013. In 2017, the European Commission is required to review the AIFM Directive’s effectiveness in achieving its regulatory goals and market impact. Immediately after the formal completion of the EU legislative process, the European Commission will begin working with the Committee of European Securities Regulators (“CESR”)⁴ to promulgate technical advice and undertake rulemaking under the AIFM Directive. Finally, in 2018, ESMA is due to review the efficacy of the dual marketing system and potentially end the national private placement regimes.

¹ Gold-plating refers to the practice of national bodies exceeding the terms of European Community directives when implementing them into national law.

² CESR will be replaced by the newly established EU Securities and Markets Authority (“ESMA”), which is due to begin its operations on 1 January 2011.

³ Undertakings for Collective Investment in Transferable Securities (“UCITS”) are pan-European open-ended retail funds organized and operated within the UCITS regulatory regime currently consisting of Directive 85/611/EEC, amended, inter alia, by Directives 2001/107/EC and 2001/108/EC (UCITS III), and recast by Directive 2009/65/EC (UCITS IV).

⁴ The text was approved by 513 votes to 92, with three abstentions. The Council of the European Union is expected to give its formal approval of the adopted text in the coming weeks. However, this is widely expected to be a rubber-stamping exercise.

Ecofin Council Reaches Agreement on AIFM Directive

2010-10-21T17:12:00.000-04:00

At a meeting of the Economic and Financial Affairs Council ("Ecofin") held on October 19, 2010, the Council of the European Union issued a press release setting out its position with a view to concluding negotiations with the European Parliament on the proposed AIFM Directive. The press release indicates the Council's belief that there is a "large degree of convergence" between the Council and the European Parliament, and its hopes to be able to conclude the negotiations in the near future.

In a statement issued following the Ecofin meeting, Michel Barnier, European Commissioner for Internal Markets and Services, stressed the lengthy and difficult negotiations on the subject between Member States, but indicated his belief that a good compromise has been reached. In particular, he highlights that the "essential elements of the initial Commission proposal have been preserved: the broad scope, robust rules, increased transparency, and better protection for the investor."

Neither the Council press release nor Mr. Barnier's statement provides a copy of the text that was agreed at the Ecofin meeting. However, Reuters reports that the agreed text represents a compromise which follows the June 2010 stalemate in negotiations. This compromise is most evident in relation to one of the more contentious aspects of the proposed directive, the so-called "third-country" provisions, which were heavily disputed between France and the UK. While Mr. Barnier's statement confirms that the agreed text does foresee a passport for third-country alternative investment funds and managers, Reuters suggests that in order to reach an agreement, the UK agreed to delay the "start of this new licensing scheme for foreign-based funds until around 2015." It is understood that during the transitional period existing national private placement regimes will co-exist alongside a European passporting scheme.

Andrew Baker, CEO of AIMA, the global representative of the hedge fund industry, indicated that while the agreed text was a "considerable improvement" on the original proposal, “[t]here is still much in the Directive that will be difficult to implement for the industry and there will be a heavy compliance burden that the industry will have to bear. But the impact will be far less severe than if something close to the original proposal had been passed."

The agreed text will now be subject to a trialogue between the Council, the European Parliament and the Commission. If, as expected, it is approved, the agreed text will go to a plenary debate of the European Parliament for approval on November 10, 2010.

The Dodd-Frank Act: Implications for Non-U.S. Investment Advisers

2010-09-04T09:40:00.000-04:00

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act¹ (the “Act”), a comprehensive bill constituting a sweeping overhaul of the regulatory framework of the U.S. financial sector. In this article we analyze the implications of the Act for non-U.S. advisers to investment funds whose clients include U.S. persons, with a particular focus on Title IV of the Act, the “Private Fund Investment Advisers Registration Act of 2010.” For such advisers, the most significant change brought about by the Act is the elimination of the current “private adviser” exemption under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). While the newly enacted Act still provides various exemptions from registration as an investment adviser with the U.S. Securities and Exchange Commission (the “SEC”) under the Advisers Act, including one for certain foreign fund advisers, these exemptions are much more restrictive than the private adviser exemption which is available under current law.

In practice, the Act is likely to require most non-U.S. advisers to private funds who currently have U.S. investors or who intend to raise significant funds in the United States to apply for SEC registration and comply with the substantial regulatory requirements applicable to investment advisers registered under the Advisers Act.

Background

The primary statute regulating the provision of investment advisory services in the United States is the Advisers Act, which requires all investment advisers, unless exempted, to register with the SEC and comply with certain recordkeeping, regulatory reporting and disclosure rules, while also subjecting them to inspection and examination by the SEC staff.

Thus far, non-U.S. advisers have broadly relied upon the so-called “private adviser” exemption, which currently exempts from registration any adviser who:

has had fewer than 15 U.S. clients in the preceding 12 months;
does not hold itself out generally to the public as an investment adviser; and
does not act as an investment adviser to any “investment company,” as defined in the Investment Company Act of 1940, as amended (the “1940 Act”).

When counting the number of U.S. clients for purposes of qualifying under the private adviser exemption, the adviser is generally able to treat each fund that it advises as a separate client and is not required to “look through” the fund and count the number of individual U.S. investors therein as clients.

To date, the private adviser exemption has allowed non-U.S. advisers broad flexibility to accept subscriptions from U.S. investors for their funds without being required to register as investment advisers under the Advisers Act. Once implemented, the provisions of the Act are likely to substantially reduce this flexibility.

New Registration Requirements

The Act eliminates the private adviser exemption by striking Section 203(b)(3) from the Advisers Act. As a result, a large number of private fund advisers who have previously relied on the private adviser exemption will now be required to register as investment advisers with the SEC, unless they qualify for another exemption.

The most relevant exemption for non-U.S. advisers introduced by the Act is the one available to “foreign private advisers.” The term “foreign private adviser” is defined to include any investment adviser who:

has no place of business in the United States;
has, in total, fewer than 15 clients and investors in the United States in private funds advised by the investment adviser;
has aggregate assets under management (“AUM”) attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser of less than $25 million (or a higher amount if the SEC deems appropriate); and
neither holds itself out to the public in the United States as an investment adviser, nor acts as an investment adviser to an investment company or business development company.

The Act defines a “private fund” as an issuer that would be an “investment company” under the 1940 Act but for its reliance on the exemptions provided by Sections 3(c)(1) or 3(c)(7) of the 1940 Act.

The foreign private adviser exemption is non-exclusive, however, and a non-U.S. adviser not falling within its scope may still be able to avail itself of other exemptions available under the Act. These include exemptions for advisers to “venture capital funds” (to be defined by the SEC no later than July 21, 2011), advisers that provide advice solely to private funds and have less than $150 million in aggregate AUM in the United States, advisers that provide advice solely to “small business investment companies”, and commodity trading advisers that manage a private fund and are registered with the Commodity Futures Trading Commission. Finally, the Act exempts “family offices” from the definition of an “investment adviser”. While the term is not defined in the Act (nor does the Act set a date by which the SEC is required to set such definition), the Act provides guidelines for the application of this exemption to bring it in line with the SEC’s existing exemptive policy for family offices.

Discussion

Currently, non-U.S. advisers are generally able to avoid SEC registration as investment advisers by, among other things, limiting the number of their U.S. clients to fewer than 15. Because no look-through provision or AUM test applies to the private adviser exemption, currently a manager can have up to 14 U.S. clients (in addition to non-U.S. clients), and each U.S. “client” can itself be a fund with multiple U.S. investors. Furthermore, AUM attributable to U.S. investors in such funds is not a factor considered by the private adviser exemption, so a non-U.S. manager is able to manage funds with substantial AUM without thereby being subject to SEC oversight.

Notably, a discussion draft of the Private Fund Investment Adviser Registration Act released by House Representative Paul E. Kanjorski in October 2009 (the “2009 Draft”) essentially maintained the private adviser exemption in its current form for non-U.S. investment advisers.² The final version of the legislation, however, sharply limits the availability of exemptive relief for non-U.S. investment advisers, thus signaling a radical departure from historical practice.

The Act departs from the current approach by requiring a non-U.S. adviser seeking to avail itself of the foreign private adviser exemption to limit the aggregate number of its U.S. clients and U.S. investors in private funds advised by the adviser to no more than 14 and the aggregate AUM of those U.S. clients and investors to less than $25 million. In so doing, the Act essentially introduces a “look-through” approach to U.S. investors in private funds which mirrors the client-counting methodology that the SEC previously attempted to adopt by rulemaking but which was overturned by the U.S. Court of Appeals for the District of Columbia Circuit in Goldstein v. SEC.³ Thus, under the new statutory language, investment advisers will be required to look through “private funds” they advise (i.e., funds that rely on the exemptions provided by Sections 3(c)(1) or 3(c)(7) of the 1940 Act) and count U.S. investors therein and their respective AUM against the exemption’s thresholds.

It should also be noted that it is unclear from the language of the Act whether the adviser must count its U.S. clients and investors only during a particular period or whether all its U.S. clients and investors since the beginning of its business must be counted. Although the 2009 Draft followed the current adviser exemption and applied the counting test over a moving 12-month period, the Act does not include any such specification. Therefore, it is possible that instead of considering the number of U.S. clients and investors the non-U.S. adviser has from time to time during any 12-month period, the SEC might consider whether the adviser ever had 15 or more U.S. clients and investors since the inception of its business.

It is also unclear how investors will be counted in the event that a non-U.S. adviser is advising a single investor participating in multiple funds sponsored by the same adviser, a trust with multiple beneficiaries, or an investment made through a joint account.

The Act also leaves largely undefined what it means to have “aggregate assets under management attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser.” Since the fundamental regulatory motivation underlying the Act is the protection of U.S. investors and financial markets, it is likely that the SEC will interpret the expression broadly in order to more closely regulate non-U.S. advisers whose business may have a material impact on U.S. investors or markets.

This and other provisions will likely be clarified through SEC rulemaking required to be completed by July 21, 2011. Because of the broad authority granted to the SEC, the actual impact of the Act will remain uncertain until the underlying rules and regulations are put into place.

However, unless another exemption is available, it is now apparent that a non-U.S. adviser will be required to register with the SEC if it meets any of the following criteria:

it has more than 14 clients and investors in the United States in one or more private funds it manages;
$25 million or more of the assets in the private funds it manages consist of assets attributable to one or more clients and investors in the United States; or
it holds itself out to the U.S. public as an investment adviser or acts as an investment adviser to an investment company or business development company.

In practice, unless the SEC significantly increases the $25 million AUM threshold discussed above, the new foreign private adviser exemption will provide extremely limited relief from SEC registration requirements and will severely limit the ability of non-U.S. advisers to raise significant funds in the United States without first registering as investment advisers with the SEC.

Registration with the SEC⁴

In order to register on a timely basis, a non-U.S. adviser subject to the registration requirement must file Form ADV with the SEC by July 21, 2011, and update the form annually. In addition, as a registered adviser it must, among other things, maintain books and records, implement compliance programs and maintain a code of ethics and insider trading policies and procedures.

Further, if the non-U.S. adviser has custody of client funds or securities, it generally must arrange for an independent public accountant registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board (the “PCAOB”), to perform a “surprise” inspection of the custody property at least once each calendar year, unless the fund it manages is subject to an annual financial statement audit prepared in accordance with generally accepted accounting principles by a PCAOB accountant, and the audited financial statements are distributed to the fund’s investors within 120 days of the fund’s fiscal year-end.⁵

Finally, a registered adviser needs to ensure compliance with the additional reporting requirements introduced by the Act. Section 404 of the Act entitles the SEC to require a registered investment adviser to maintain records and file reports regarding the private funds it advises, including, at a minimum, for each such private fund: (i) the amount of AUM; (ii) the use of leverage (including off-balance-sheet leverage); (iii) counterparty credit risk exposures; (iv) trading and investment positions; (v) valuation policies and practices; (vi) types of assets held; (vii) side arrangements or side letters; (viii) trading practices; and (ix) any other information the SEC determines is necessary and appropriate for the protection of investors or the assessment of systemic risk.

Further information on the Act is available at: http://curtis-ifg.blogspot.com/.

Conclusions

In sum, the Act is expected to have a profound impact on many non-U.S. advisers that advise U.S. or non-U.S. private funds with U.S. investors or raise capital in the United States. Unless such advisers are able to qualify for the narrow foreign private adviser exemption or avail themselves of another exemption, they will be required to register with the SEC as investment advisers and comply with the regulatory requirements of the Advisers Act.

Registration as an investment adviser is likely to result in additional administrative and compliance costs for the adviser which, by some estimates, could exceed several hundred thousand dollars for complex hedge fund structures.

A non-U.S. adviser newly subject to registration with the SEC as an investment adviser under the Advisers Act must comply with the new requirements by July 21, 2011. To achieve registration by the deadline, advisers will likely have to file their applications significantly in advance.

¹The Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, 111th Cong. (2010). Available at: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h4173enr.txt.pdf.

²The Act includes large portions of the 2009 Draft. For further detail, please see: http://curtis-ifg.blogspot.com/2009/10/congressman-proposes-private-fund.html.

³Goldstein v. S.E.C., 451 F.3d 873, Fed. Sec. L. Rep. (CCH) P 93890 (D.C. Cir. 2006). In Goldstein, the D.C. Circuit rejected the SEC’s attempt to treat each investor in a private fund, rather than the fund itself, as an adviser’s “client” for purposes of the Advisers Act.

⁴For a detailed discussion on the procedure for registration as an investment adviser with the SEC and the requirements applicable to registered advisers please contact Carl A. Ruggiero or Victor L. Zimmermann.

⁵For a detailed discussion regarding the current SEC custody rules please see “Amended Custody And Recordkeeping Rules To Become Effective On March 12, 2010” at: http://curtis-ifg.blogspot.com/2010/03/curtis-client-alert-amended-custody-and.html.

Partner Victor Zimmermann to speak at the HedgeWorld Seminar on September 16

2010-08-27T11:17:00.004-04:00

Partner Victor Zimmermann will speak at the HedgeWorld Seminar "Is Your Story Strong Enough?" on September 16 at the Harvard Club in New York.

Mr. Zimmermann will participate in a panel discussion entitled "Compliance: From Product Marketing Collateral to Knowing Who You're Working With." The group will discuss compliance in the post-Madoff world and the due diligence an investor has to perform now to be convinced to invest in any fund.

Visit the event website.

FSA to Expand UK Compensation Rules to Cover Fund Managers

2010-08-09T12:30:00.007-04:00

On July 29, 2010, the United Kingdom Financial Services Authority (the "FSA") announced in a consultation paper its plans to revise its Remuneration Code in accordance with the Financial Services Act 2010 and the amendments (the "CRD 3") to the Capital Requirements Directive (2006/48/EC and 2006/49/EC) approved by the European Parliament on July 7, 2010 following agreement with the Council. The Remuneration Code, which has been in effect since January 1, 2010, is set out in part 19 of the Senior Management Arrangement, Systems and Controls ("SYSC") sourcebook. SYSC is one of 7 sourcebooks comprising the FSA Handbook "High Level Standards" which set out the standards by which FSA authorised firms and approved persons are expected to conduct themselves and the core regulatory obligations that apply to them. The Remuneration Code requires firms to establish, implement and maintain remuneration policies consistent with effective risk management and provides specific rules to ensure compliance with this general requirement.

The FSA consultation paper is relevant to a wide range of FSA-regulated firms and their advisers, as it proposes to substantially expand the scope of the Remuneration Code, which currently applies only to the largest UK banks, building societies and broker dealers. The FSA estimates that bringing the Remuneration Code in line with the CRD 3 will expand its application from a current estimate of about 26 firms to over 2,500 firms with effect from January 1, 2011, including "all banks and building societies, asset managers, hedge fund managers, UCITS investment firms as well as some firms that engage in corporate finance, venture capital, the provision of financial advice and stockbrokers".

The proposed amendments to the Remuneration Code would enhance the existing rules in a number of areas including:

Scope: In light of the expanded scope of the Remuneration Code, the FSA is committed to applying a proportionate approach to its implementation to ensure that "institutions shall comply with the principles in a way and to the extent that is appropriate to their size, internal organisation and the nature, the scope and the complexity of their activities";

Code staff: The Remuneration Code will apply to a specific group of employees within a covered firm including senior management and anyone whose professional activities could have a material impact on a firm’s risk profile ("Code staff"). Firms will be required to submit a list of Code staff which will be subject to review and challenge by the FSA;

Variable Remuneration (Bonuses):
1. Deferral: at least 40% (60% for amounts exceeding £500,000) of all bonuses must be deferred with vesting over a period of at least three years for all Code staff and be correctly aligned with the nature of the business, its risk and the activities of the individual in question. Remuneration payable under deferral arrangements must vest no faster than on a pro-rata basis, with the first vesting no sooner than one year after the award,
2. Cash/Shares: at least 50% of any bonus, taken as a whole, must be made in shares, share-linked instruments, or other equivalent non-cash instruments of the firm, which are subject to deferral or a minimum retention policy,
3. Guaranteed Bonuses: Guaranteed bonuses are exceptional, may only occur when hiring new staff and are limited to the first year of service,
4. Performance Adjustments: After bonuses have been announced and paid, firms will be required to make further adjustments to take account of subsequent crystallized risks and developments of an adverse nature. Such adjustment will be possible only on the deferred unvested portion of the bonus and can be achieved through "malus" or "clawbacks",
Severance Pay: Payments related to the early termination of a contract will be subject to new restrictions to reflect performance over time and prevent the reward of failure;

Pensions: Discretionary pension benefits will be required to take the form of shares or share-like instruments that must be held for at least five years (i) by the firm, in the case of an employee leaving before retirement; and (ii) by the employee, when it reaches retirement.

Remuneration policies similar to the ones included in the CRD 3 and the proposed amendments to the Remuneration Code are also part of the draft EU AIFM directive which will apply to managers of most private investment funds such as hedge funds and private equity funds. However, negotiations on the AIFM directive are continuing, and the current expectation is that it may come into force only towards the end of 2012 or early 2013. In the meantime, certain fund managers will be subject to remuneration restrictions included in the CRD 3 and the Remuneration Code before they come under the remit of the AIFM directive. UCITS are currently not subject to any specific remuneration policies.

The FSA consultation paper is open for comments until October 8, 2010. The FSA intends to publish its policy statement and final rules by mid-November, and the new Handbook text is expected to come in effect on January 1, 2011.

SEC Adopts New "Pay to Play" Rule

2010-07-09T16:47:00.004-04:00

On June 30, 2010, the SEC unanimously approved new Rule 206(4)-5 (the "Rule") under the Investment Advisers Act of 1940, designed to restrict "pay to play" practices by investment advisers.

Pay to play is a practice in which an investment adviser seeks to influence a government official’s award of a potentially lucrative investment advisory contract by making or soliciting political contributions to that official. The motivation behind the Rule, as noted in the SEC press release, is the notion that "selection of investment advisers to manage public plans should be based on the best interests of the plans and their beneficiaries, not kickbacks and favors."

The Rule attempts to diminish pay to play practices through three important prohibitions:

If an investment adviser makes a contribution to a government official or candidate who is or will be able to influence the selection of advisory work for a government entity, that investment adviser may not, within the following two-year period, receive compensation -- either directly or through a pooled fund -- for providing advisory services to that government entity.

An investment adviser may not pay third parties to solicit advisory work from government entities unless the third parties are registered with the SEC as investment advisers or broker-dealers and are subject to similar pay to play restrictions.

An investment adviser and certain executives or employees of an investment adviser may not solicit or coordinate either (i) contributions to an official of a government entity to which the investment adviser is seeking to provide investment advisory services; or (ii) payments to a political party of a state or locality where the investment adviser is providing or seeking to provide investment advisory services to a government entity.

The Rule also prohibits an investment adviser from doing anything indirectly which, if done directly, would violate the Rule. This prohibition attempts to prevent investment advisers and government officials from circumventing the explicit prohibitions of the Rule.

The Rule does contain an exception for de minimis contributions by executives or employees of the investment adviser. This exception allows, per election, contributions of up to $350 to an official or candidate for whom the individual can vote and up to $150 to an official or candidate for whom the individual cannot vote.

The Rule will be effective 60 days after publication in the Federal Register. Investment advisers generally will be required to comply with the Rule within six months of the effective date.

Update: U.S. Financial Reform Progresses

2010-06-28T16:35:00.003-04:00

On Friday, June 25, 2010, a conference of the Senate and House of Representatives reached an agreement on the Financial Reform legislation (the "Bill") previously endorsed by the House and Senate in December 2009 and March 2010, respectively.

As previously reported, the Bill eliminates the "private adviser" exemption from registration with the SEC currently available under the Investment Advisers Act of 1940. The version of the Bill agreed upon at the conference maintains an exemption from registration as an investment adviser for venture capital advisers and small advisers (an adviser to private funds with assets under management in the United States of less than $150,000,000), but the exemption for private equity fund advisers, included in the Senate version of the Bill, has been omitted.

The Bill also maintains a milder version of the so-called Volcker Rule, under which banks and their subsidiaries will only be allowed to invest in or sponsor a hedge fund or private equity fund if their investment in such fund (i) amounts to no more than 3 percent of the total ownership interests of the fund not later than 1 year after the date of establishment of the fund; and (ii) is immaterial (as defined in the Bill) to the banking entity, but in no case may the aggregate of all of the interests of the banking entity in all such funds exceed 3 percent of the Tier 1 capital (core capital) of the banking entity.

One of the co-sponsors of the bill, Senator C. Dodd (D-CT) welcomed the conference as having "produced a strong Wall Street reform bill that will fundamentally change the way our financial services sector is regulated." The version of the Bill agreed upon at the conference must now be approved by both the Senate and the House before it can be signed into law by President Obama.

Update: AIFM Directive Negotiations Stall

2010-06-25T11:13:00.004-04:00

According to Reuters, discussions over the proposed EU Directive on Alternative Investment Fund Managers (the "AIFM Directive") have reached a standstill.

As previously reported here, the ECON Committee of the European Parliament and the Council of European Ministers endorsed diverging versions of the AIFM Directive on May 17 and May 18, 2010, respectively. The Council of Ministers and the European Parliament have since been discussing a compromise version of the AIFM Directive with a view to it being adopted by the European Parliament at a plenary session at first reading in July 2010.

However, on June 24, 2010, Jean-Paul Gauzes, the European Parliament Rapporteur on the AIFM Directive, brought negotiations to a halt after "[t]he Spanish presidency (of the European Union) informed [him] it would not be possible to reach a deal before the end of June." Gauzes indicated his intention to "delay the vote until the second parliamentary session in September".

Update: AIFM Directive Advances

2010-05-18T14:30:00.003-04:00

On May 17, 2010, a revised version of the Directive on Alternative Investment Fund Managers (the "AIFMD"), originally proposed by the Commission in April 2009, passed the Economic and Monetary Affairs Committee of the European Parliament (the "ECON") with a vote of 33 to 11, with 3 abstentions. As stressed in the ECON press release, the main changes proposed by the European Parliament are intended to "increase investor protection and transparency while reducing the potentially protectionist dimension" of the Commission's proposal.

The European Parliament move was followed today, May 18, 2010, by a similar endorsement of the proposed AIFMD by EU finance ministers. As reported by the Financial Times, there are several discrepancies between the Council and the European Parliament versions of the AIFMD, in particular with regard to so called "third-country" provisions regulating the ability of non-European managers to market their funds within the EU.

Before the AIFMD becomes law, the Council of Ministers and the European Parliament must reach an agreement on a compromise version, and negotiations are expected to begin on May 31, ahead of the first-reading vote by the full Parliament, scheduled for July. We will continue to monitor future developments on the subject and report on any progress.

SEC Proposes "Large Trader" Reporting System

2010-04-21T12:06:00.004-04:00

On April 14, 2010, the SEC proposed a new Rule 13h-1 (the "Rule") and Form 13H under Section 13(h) of the U.S. Securities Exchange Act of 1934, which would enable the SEC to identify and obtain certain information about "large traders", i.e. traders that conduct a substantial amount of trading activity, as measured by volume or market value, in the U.S. securities markets.

Under the proposed Rule, any firm or individual whose direct or indirect transactions in "NMS securities" -- i.e. exchange-listed securities, including equities and options -- equal or exceed (i) 2 million shares or $20 million during any calendar day, or (ii) 20 million shares or $200 million during any calendar month (such firm or individual, a "large trader") would be required to identify itself to the SEC and make certain disclosure on proposed Form 13H. The SEC would then issue a unique Large Trader Identification Number (“LTID”) for the large trader, who would be required to disclose its LTID to each of its registered broker-dealers and identify all of the accounts used for its trading.

The proposed Rule would also impose recordkeeping and reporting requirements on registered broker-dealers, and would require registered broker-dealers to provide large trader transaction data to the SEC upon request.

As indicated in the SEC press release, the proposed Rule "is designed to strengthen [SEC] oversight of the markets and protect investors in the process," by giving the SEC "prompt access to trading information from large traders so [it] can better analyze the data and investigate potentially illegal trading activity."

The proposed Rule is subject to a 60-day comment period.

Senator Dodd Unveils Financial Reform Legislation: Implications for Investment Funds

2010-03-17T09:47:00.005-04:00

A revised version of the "Restoring American Financial Stability Act" (the "Bill"), originally presented in November 2009, was unveiled by Senate Banking Committee Chairman Chris Dodd (D-CT) on March 15, 2010. The investment adviser registration provisions of the Bill are essentially unchanged in from the November version of the Bill. As previously reported, the Bill would require advisers to hedge funds and other private funds who manage more than $100 million to register with the SEC and comply with certain reporting requirements that will allow the SEC to assess systemic risk. Advisers that fall beneath this threshold would be subject to State regulation.

In contrast with its House counterpart, the Bill maintains an exemption from registration as an investment adviser with the SEC for both venture capital and private equity fund advisers. Both terms remain to be defined by the SEC for the purposes of the exemption. In addition, the Bill continues to exempt "family offices", as defined by the SEC, from the definition of an "investment adviser" pursuant to Section 202(a)(11) of the Investment Advisers Act of 1940.

An important departure from the November version of the Bill is the inclusion of the so called "Volcker Rule". The rule would prohibit banks and their subsidiaries from engaging in proprietary trading or investing in or sponsoring a hedge fund or private equity fund. The Bill defines the term "sponsoring" in this regard as (i) serving as a general partner, managing member, or trustee of the fund; (ii) in any manner selecting or controlling (or having employees, officers, directors, or agents who constitute) a majority of the directors, trustees, or management of the fund; or (iii) sharing with the fund, for corporate, marketing, promotional, or other purposes, the same name or a variation of the same name.

Finally, the Bill directs the SEC to increase the financial threshold applicable for an investor to be considered "accredited" under the Securities Act of 1933 to reflect the price inflation since the currently applicable figures were determined. The Bill would require the SEC to adjust such figures at least every 5 years, while also requiring the U.S. Comptroller General to conduct a study on the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds.

According to Dodd's statement released ahead of the Bill, a full markup of the Bill should begin in the Banking Committee next week.