SEC Issues Concept Releases on Investment Company Derivative Use, Mortgage Securities and Rule 3a-7
Co-authoered by Gregory Xethalis
On August 31, the Securities and Exchange Commission issued three concept releases regarding: (i) the use of derivatives by investment companies (Derivatives Release), (ii) companies engaged in the business of acquiring mortgages and mortgage-related instruments (Mortgage Securities Release), and (iii) the treatment of asset-backed issuers under Rule 3a-7 (Rule 3a-7 Release). In the concept releases, the SEC requests comments from the public on a variety of issues. Comments for all of the concept releases should be received on or before November 7.
SEC Raises "Qualified Client" Thresholds
Co-authored by Sarah E. Connolly
On July 12, the Securities and Exchange Commission issued an order raising the thresholds for determining who is a "qualified client" for purposes of Rule 205-3 under the Investment Advisers Act of 1940. Rule 205-3 exempts an investment adviser from the prohibition against charging a client performance fees in certain circumstances, including when the client is a qualified client. Under the order, a qualified client is one who: (1) has at least $1 million under the management of the adviser immediately after entering into the advisory contract, or (2) the adviser reasonably believes has a net worth of more than $2 million at the time the contract is entered into. These thresholds were raised from $750,000 and $1,500,000, respectively, to adjust for inflation, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC's order becomes effective on September 19.
Continue Reading...GAO Reports on the Feasibility of SRO for Private Fund Advisers
Co-authored by Maxwell Li
On July 11, the U.S. Government Accountability Office (GAO) released a report on the feasibility of forming a self-regulatory organization (SRO) to provide primary oversight of private fund advisers. The report was part of a mandate by the Dodd-Frank Wall Street Reform and Consumer Protection Act to address the potential gap in the regulation of private fund advisers. In preparing the report, GAO reviewed federal securities laws, the recently completed Securities and Exchange Commission study on the investment adviser examination program, past regulatory and legislative proposals to create an SRO for investment advisers, and associated comment letters. GAO believes that the formation of a private fund adviser SRO is feasible but includes challenges such as the passage of new legislation, raising sufficient start-up capital and reaching agreements on fee and governance structures. The report also notes that while a private fund adviser SRO could supplement and help the SEC's oversight of investment advisers, the fragmentation between regulation of private fund advisers and non-private fund advisers could lead to regulatory gaps, duplication and inconsistencies.
Click here to read the GAO report.
Click here to read a summary of the SEC's study on the investment adviser examination program in the January 21 edition of Corporate and Financial Weekly Digest.
Click here to read a summary of industry comments on the desirability of a private fund adviser SRO in the November 12, 2010, edition of Corporate and Financial Weekly Digest.
SEC Approves Proposed Rule Changes to FINRA Rule 5131
Co-authored by Robert Grundstein
The Securities and Exchange Commission has approved the Financial Industry Regulatory Authority's proposed rule changes to Rule 5131 that delete paragraph (b)(1) and delay the implementation date of paragraphs (b) and (d)(4) until September 26. Removal of paragraph (b)(1) of Rule 5131, which would have required members to establish, maintain and enforce policies and procedures reasonably designed to ensure that "investment banking personnel" have no involvement or influence (directly or indirectly) in the members' new issue allocation decisions, simplifies the spinning prohibitions on FINRA members and eliminates potential constraints on certain necessary functions traditionally performed by syndicate personnel. Postponing the implementation date will enable FINRA members to develop a reliable identification process for new issues allocations and to modify existent order handling systems to prevent the acceptance of market orders in new issue shares, thereby promoting effective compliance with Rule 5131 in the future.
Click here to read the SEC's release.
Click here to read a summary of FINRA's proposed changes to Rule 5131 in the May 6 edition of Corporate and Financial Weekly Digest.
SEC Chairman Acknowledges Extension of Investment Adviser Registration Deadlines
Co-authored by Robert Grundstein
Section 403 of the Dodd-Frank Wall Street Reform and Consumer Protection Act repeals, as of July 21, the private adviser exemption in Section 203(b)(3) of the Investment Advisers Act of 1940 and will require advisers relying on that exemption (including advisers to many hedge funds and other private funds) to register with the Securities and Exchange Commission.
Continue Reading...SEC Proposes Adjustments to Advisers Act "Qualified Client" Standard
Co-authored by Christian B. Hennion
The Securities and Exchange Commission has proposed amendments to Rule 205-3 under the Investment Advisers Act of 1940, as amended (the Advisers Act), to revise the definition of "qualified client." Under Rule 205-3, accounts of qualified clients are exempted from the Advisers Act's general prohibition against SEC-registered investment advisers charging performance-based fees to their advisory clients. Currently, a qualified client generally includes any client that has either (1) $750,000 or more under management with the investment adviser or (2) a net worth of at least $1.5 million.
Continue Reading...Form SLT Revised and First Form SLT Filing Date Delayed
The U.S. Department of the Treasury has published a revised version of, and has delayed the first required filing of, the monthly report to the Federal Reserve Bank relating to the aggregate holdings of long-term securities by U.S. and foreign residents (Form SLT). Investment advisers and/or private investment funds that exceed the $1 billion threshold described below must file their first Form SLT report no later than October 23.
Continue Reading...Court Dismisses Case Against Mutual Fund's Distributor and Trustees Concerning 12b-1 Fees
Co-authored by Natalya S. Zelensky
On March 30, in Wiener v. Eaton Vance Distributors, Inc., the U.S. District Court for the District of Massachusetts dismissed an Eaton Vance Municipals Trust shareholder derivative suit involving Eaton Vance Distributors, Inc. and the Trust's nine trustees, alleging that the asset-based Rule 12b-1 fees paid by the Trust to Distributors and selling broker-dealers who distribute Trust mutual fund shares violated the Investment Advisers Act of 1940 since neither Distributors nor the selling broker-dealers were registered under the Advisers Act. The plaintiff sought, among other things, the rescission of the distribution agreement between the Trust and Distributors under Section 47(b) of the Investment Company Act of 1940 (1940 Act).
Section 47(b) creates a private right of action for a party to void a contract that involves a violation of the 1940 Act or any rules thereunder. The plaintiff argued that the alleged violations of the Advisers Act constitute violations of Section 36(a) of the 1940 Act (allowing the Securities and Exchange Commission to bring enforcement actions against, among others, fund trustees and principal underwriters for breaches of fiduciary duties) and SEC Rule 38a-1 (requiring investment companies to establish and maintain adequate compliance policies and procedures) as grounds to rescind the distribution agreement. The court rejected these arguments, stating that Section 47(b) covered violations of the 1940 Act, not of the Advisers Act, and declined to create a private right of action under Section 36(a). The court also stated that the complaint failed to allege a violation of Rule 38a-1 and declined to imply any general duties arising out of the rule.
The Wiener case dismissal follows the October 2010 dismissal of a virtually identical complaint filed in the U.S. District Court for the Northern District of California against Franklin/Templeton Distributors, Inc.
Click here to read the Massachusetts federal court's opinion dismissing the case.
SEC Provides Temporary Relief for Investment Companies Regarding Custody of Collateral to Support Cleared Interest Rate Swaps
In a no-action letter issued on March 16, the Securities and Exchange Commission's Division of Investment Management extended temporary no-action relief under Section 17(f) of the Investment Company Act of 1940 to any registered investment company (Fund) if the Fund or its custodian places and maintains assets in the custody of LCH.Clearnet Limited (LCH), a U.K. derivatives clearing organization, or an LCH clearing member that is a futures commission merchant registered with the Commodity Futures Trading Commission for purposes of meeting LCH's or a clearing member's margin requirements for certain cleared interest rate swap contracts. The SEC relied, among other things, upon the following representations in deciding to flexibly apply the 1940 Act's custody requirements: (1) LCH and clearing members will address each of the requirements of Rule 17f-6 under the 1940 Act; (2) each clearing member will hold Fund assets as part of the over-the-counter derivatives account class; and (3) each clearing member will be required to segregate customer funds and securities from the clearing member's own assets. The SEC's temporary no-action position will expire on July 16, upon the conclusion of a one-year transition period following the effective date of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Click here to read the SEC's no-action letter.
SEC Proposes Rules on Disclosure of Incentive-Based Compensation Arrangements
As required by Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission has announced that it is proposing a rule applicable to broker-dealers and investment advisers with $1 billion or more in assets that would (1) require them to file annual reports with the SEC related to incentive-based compensation; (2) prohibit incentive-based compensation arrangements that encourage inappropriate risk-taking by providing excessive compensation or that could lead to material financial loss to the firm; (3) provide additional requirements for firms with $50 billion or more in assets, including deferral of incentive-based compensation of executive officers and approval of compensation for people whose job functions give them the ability to expose the firm to a substantial amount of risk; and (4) require them to develop policies and procedures that ensure and monitor compliance with requirements related to incentive-based compensation.
When announcing the proposed rule, SEC Chairman Mary Schapiro stated that she is particularly interested in commenters' views on (1) how assets would be calculated for purposes of determining whether institutions fall within either component of the proposed rule; (2) how the proposed rule might affect the broad array of financial firms covered by Section 956, including broker-dealers and advisers—most particularly private fund advisers, given how they often structure their compensation; and (3) the proposal's potential impact on broker-dealer and investment adviser business models and the variety of services they provide to investors.
Public comments on the rule proposal should be received within 45 days after it is published in the Federal Register. The full text of the proposed rule is not yet available.
For a copy of the SEC's press release, see here.
For a copy of SEC Chairman Mary Schapiro's remarks, see here.
SEC Staff Study on Access to Information About Investment Professionals
Co-authored by Natalya S. Zelensky
On January 27, as required by Section 919B of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission released a study conducted by the staff of the Office of Investor Education and Advocacy recommending steps to improve investor access to information about investment advisers and broker-dealers. The staff recommends in the next 18-month period: (1) unifying the search results from BrokerCheck and IAPD (Investment Adviser Public Disclosure)—the online applications through which the public may obtain information regarding broker-dealers and investment advisers, respectively—so that each system searches the other's database and returns results from both; (2) adding a ZIP code search or other indicator of location function to BrokerCheck and IAPD to more easily permit investors to locate and compare nearby financial services providers; and (3) adding educational content to BrokerCheck and IAPD, including links and definitions of terms that may be unfamiliar to individual investors. The staff recommends that subsequent to the next 18-month period, the SEC and Financial Industry Regulatory Authority continue to analyze, including through investor testing, the feasibility and advisability of expanding BrokerCheck to include additional information currently available in CRD (Central Registration Depository)—the database developed by FINRA in consultation with the states from which the information made available through BrokerCheck is derived—including historical information, as well as the method and format of publishing that information. The staff also recommends that the SEC continue to evaluate expanding IAPD content and the method and format of publishing that content, including through investor testing.
To read the study, click here.
To read the SEC's press release, click here.
SEC and CFTC Jointly Propose Private Fund Systemic Risk Reporting Rule
Co-authored by Maxwell Li and Robert Grundstein
The Commodity Futures Trading Commission and Securities Exchange Commission jointly proposed rules that would implement Sections 404 and 406 of the Dodd-Frank Wall Street Reform and Consumer Protection Act by creating a new Form PF, which is designed to gather information regarding the private fund industry that would be useful to the Financial Stability Oversight Council in monitoring systemic risk. Form PF would be required to be filed periodically by any investment adviser registered or required to be registered with the SEC that advises one or more private funds. The proposed CFTC rule would require commodity pool operators (CPOs) and commodity trading advisors (CTAs) registered with the CFTC to file Form PF with the SEC in lieu of proposed CFTC filing requirements, but only if those CPOs and CTAs are also registered with the SEC as investment advisers and advise one or more private funds. Information reported on Form PF would generally remain confidential.
Continue Reading...SEC Releases Study on Investment Adviser Examinations
Co-authored by Maxwell Li
As required by Section 914 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission has released a study conducted by the staff of the Division of Investment Management reviewing and analyzing the need for enhanced examination and enforcement resources for investment advisers. The study finds that the number and frequency of examinations of investment advisers have declined over the past six years. The staff expects that the frequency of examinations could increase following the effective date of amendments to the Advisers Act under the Dodd-Frank Act as a result of a substantial decrease in the number of registered investment advisers, many of whom will transition from federal to state registration. The amount of any potential increase in examinations, however, may be offset by the need to divert examination resources to fulfill new examination obligations that the SEC was given by the Dodd-Frank Act. In addition, the staff expects the number of registered investment advisers and the assets managed by them to grow in subsequent years, and finds that the SEC will face significant capacity challenges in examining registered investment advisers. The staff recommends that Congress consider the following three approaches to strengthen the SEC’s investment adviser examination program: (1) authorize the SEC to impose user fees on SEC-registered investment advisers to fund their examinations; (2) authorize one or more self-regulatory organizations (SROs) to examine, subject to SEC oversight, all SEC-registered investment advisers; or (3) authorize the Financial Industry Regulatory Authority to examine dual registrants for compliance with the Advisers Act.
Continue Reading...SEC to Consider Proposed Rules Applicable to Investment Advisers
Co-authored by Robert Grundstein
In an open meeting scheduled for November 19, the Securities and Exchange Commission will consider proposing rules that would increase the statutory threshold for registration by investment advisers with the SEC, require advisers to hedge funds and other private funds to register with the SEC, and address reporting by certain investment advisers that are exempt from registration. Other proposed rules to be considered would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States, and clarify the meaning of certain terms included in a new exemption for foreign private advisers.
To read the SEC News Digest click here.
FINRA Recommends Establishing Investment Adviser SRO
Section 914 of the Dodd-Frank Wall Street Reform and Consumer Protection Act directs the Securities and Exchange Commission to study the extent to which designating one or more self-regulatory organizations (SROs) to augment its efforts in overseeing investment advisers would improve the frequency of examinations of investment advisers. In a November 2 comment letter to the SEC regarding its study, Richard Ketchum, Chairman and CEO of the Financial Industry Regulatory Authority, advocated establishing one or more investment adviser SROs. Chairman Ketchum wrote that the main problem with the oversight of investment advisers is the lack of examination resources. He pointed out that the SEC, despite its best efforts, is unlikely to successfully oversee investment advisers because of funding limits. He further added that cooperating with one or more SROs in the oversight process would help increase the frequency of examinations and resources devoted to enforcement, and suggested that FINRA would be ready and willing to assist the SEC. If FINRA were to seek authorization as an investment adviser SRO, it would create a separate affiliate, with its own Board of Governors, to ensure that the SRO establishes programs appropriate to the adviser industry.
In separate prior comment letters to the SEC, the Managed Funds Association, the Investment Adviser Association and the Investment Company Institute have each argued against establishing an investment adviser SRO.
To read FINRA’s letter click here.
To read the MFA’s letter click here.
To read the IAA’s letter click here.
To read the ICI’s letter click here.
SEC Proposes Rule to Exclude Family Offices from Regulation as Investment Advisers
Co-authored by Seth M. Messner
The Securities and Exchange Commission has proposed Rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940, as amended (Advisers Act), to define “family offices” that would be excluded from the definition of “investment adviser.” The proposed rule was mandated in Section 409 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Act).
Family offices are established by wealthy families to manage their wealth, plan for their families’ financial future and provide other services to family members. Absent an exclusion, family offices would typically fall under the definition of investment adviser under the Advisers Act.
Many family offices have previously relied on the exemption from registration under the Advisers Act in Section 203(b)(3) for an investment adviser who during the course of the preceding 12 months has had fewer than 15 clients and who neither holds itself out generally to the public as an investment adviser nor acts as an investment adviser to any investment company or business development company. The Act eliminated the exemption contained in Section 203(b)(3), effective July 21, 2011.
Continue Reading...SEC Proposes Revisions for Mutual Fund Asset-Based Fees and Broker Sales Loads
Co-authored by Marybeth Sorady, Kathleen H. Moriarty and Gregory E. Xethalis
On July 21, the Securities and Exchange Commission published a rulemaking proposal that would alter the way mutual funds impose 12b-1 fees and sales loads. The marketing and selling costs involved with running a mutual fund are commonly referred to as a mutual fund’s distribution costs. To cover these costs, mutual funds are permitted to charge fees known as 12b-1 fees that are paid from the mutual fund’s assets. These fees are deducted from a mutual fund to compensate securities professionals for sales efforts and services provided to the mutual fund’s investors. The rule proposal would:
Continue Reading...SEC Adopts Changes to Form ADV to Provide More Effective Disclosure
Co-authored by Joseph Iskowitz
On July 21, the Securities and Exchange Commission voted unanimously to adopt changes to Form ADV, Part 2. Commonly referred to as the “brochure,” Form ADV, Part 2 is the principal disclosure document that SEC registered investment advisers must provide to their clients and prospective clients. Currently, Form ADV, Part 2 consists primarily of a “check-the-box” format, in which investment advisers respond to a series of multiple-choice and fill-in-the-blank questions that are designed to inform investors of advisers’ qualifications, investment strategies, and business practices. Unfortunately, the current format frequently does not correspond well to an adviser’s business.
Under the amended rules, SEC-registered investment advisers are required to prepare a narrative, plain English, brochure, presented in a consistent, uniform manner that will make it easier for clients to compare different advisers’ disclosures. The new brochure will contain enhanced disclosures on those topics the SEC believes are most relevant to clients, including, a description of: the adviser’s business, fees and compensation, performance-based fees and side-by-side management (with an explanation of any conflicts of interest that arise from the simultaneous management of accounts that are charged a performance fee and accounts that are not and how the adviser addresses those conflicts), methods of analysis and investment strategies and the attendant risks of loss, disciplinary information material to a client’s evaluation of the adviser's business and the integrity of its management, the adviser's code of ethics and the nature of its participation or interest in client transactions and personal trading and factors it considers in selecting broker-dealers.
Continue Reading...SEC Adopts "Pay to Play" Rule for Investment Advisers
On July 1, the Securities and Exchange Commission adopted Rule 206(4)-5 under the Investment Advisers Act of 1940 to protect public pension plans and other government investors by deterring advisers from participating in “pay to play” practices. The new rule applies to investment advisers that are registered (or required to be registered) with the SEC or are exempt from registration under Section 203(b)(3) of the Advisers Act, including investment advisers to any “covered investment pool” in which a “government entity” (including public pension plans and other government investors) invests or is solicited to invest. Most, if not all, advisers that provide discretionary management with respect to public pension fund assets would fall under the scope of the new rule. “Covered investment pools” include entities that would be investment companies but for the exceptions provided by Sections 3(c)(1), 3(c)(7) or 3(c)(11) of the Investment Company Act of 1940, and any registered investment company that is an investment option under a government plan or program.
The new SEC rule has three key elements:
- It prohibits an investment adviser from providing investment advisory services for compensation to a government entity within two years after the investment adviser or any of its “covered associates” has made a contribution to an official of the government entity that is in a position to influence the selection of the investment adviser for its advisory services. This prohibition does not apply to certain de minimis contributions made by a covered associate who is a natural person (limited in the aggregate to $150 or $350 per election per candidate depending upon the circumstances).
- It prohibits an investment adviser or any of its covered associates from directly or indirectly paying any person to solicit a government entity for investment advisory services on its behalf, including soliciting investments to a covered investment pool advised by the investment adviser. This prohibition on paying third party marketers does not apply to “regulated persons,” such as registered investment advisers that have met certain preconditions and registered brokers who are subject to similar prohibitions on “pay to play” by the self-regulatory organization overseeing such broker.
- It prohibits an investment adviser or any of its covered associates from coordinating or soliciting any person or political action committee to make any (1) contribution to an official of a government entity to which the investment adviser is providing or seeking to provide investment advisory services, or (2) payment 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 SEC also adopted amendments to the books and records maintenance obligations in Rule 204-2 under the Advisers Act to require registered investment advisers that provide investment advisory services to government entities to make and keep additional records related to political contributions made by such advisers and their covered associates.
Rule 206(4)-5 and the recordkeeping requirements in the amendment to Rule 204-2 become effective 60 days after their publication in the Federal Register, and compliance will generally be required within six months of the effective date. However, the SEC has allowed one year for compliance with the prohibition on paying third-party marketers who do not meet the new requirements and for all of the requirements (under both Rule 206(4)-5 and Rule 204-2) for advisers to registered investment companies that are covered investment pools.
To read the SEC’s press release on Rule 206(4)-5 click here.
To read the Adopting Release click here.
Click here for more information on the Proposing Release in the July 24, 2009, edition of Corporate and Financial Weekly Digest.
