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).
Monday, January 14, 2013
Update on the implementation of the Alternative Investment Fund Managers Directive (AIFMD) in Luxembourg:
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.
Wednesday, September 12, 2012
The JOBS Act: SEC Proposes Rules to Permit General Solicitation and General Advertising in Certain Private Placements
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.
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.
- 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.
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.↩
Friday, April 6, 2012
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. 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. 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. 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.” 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” – 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. 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.
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
Wednesday, February 15, 2012
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
Monday, September 19, 2011
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
Friday, September 9, 2011
TIC Form SLT imposes new reporting obligations for cross-border investments that may apply to private funds and private fund managers
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
Monday, July 18, 2011
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.
Tuesday, July 12, 2011
SEC Adopts Final Rules Implementing Certain Provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act
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
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.
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.
Monday, July 11, 2011
Will Private Equity Firms Investing in Africa Be Affected by Violations by Portfolio Companies of the New UK Bribery Act?
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.
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
Friday, June 24, 2011
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:
Family Offices Release: