Following our Wednesday Webinar entitled:“Non-US Advisers Under the Dodd-Frank Act: Universal Registration is Here," speakers Mark Berman, ceo of CompliGlobe and Nathan Greene, partner at Shearman & Sterling, offer the following responses to questions posed from the audience during this Web-event.
* Please read the disclaimer at the bottom.
Q: Do we have any ideas as to whether or not the rule-making process will result in any additional exemptions from registration?
A: Doubtful. Exemptions specified by the new law (i.e., the PFIAR provisions under the Dodd-Frank Act) are the only “new” exemptions firms should be counting on. These are the Foreign Private Advisers (FPA) exemption, the $150m AUM exemption for advisers that advise only private funds, the exemption for advisers that advise only venture capital funds and the exemption for “family offices.” Other longstanding exemptions, like those for certain banks, also might be available and should be considered.
Q: For reporting requirements, can a manager rely on fund administrator and prime broker records or does a manager need its OWN books and records (e.g., its own investment accounting system)? And what about separate accounts (w/ no fund administrator)?
A. We’re not sure, because we need to see the rule-making. We expect that this will be proposed for comment in September. For now, it would suffice to rely on records of third parties, but the adviser must ensure that it verifies these and also, as a practical matter, should maintain contractual rights of access for itself and its regulators, protections against unauthorized destruction or alteration of the records, and the like. In addition, some categories of records traditionally have been required to be "on-site," which allows for electronic storage but implies quite rapid access. And you are right that there’s even less of a third-party “safety net” for you when you are dealing with records required of the firm in connection with its separate account clients.
Q: How different is the mutual fund and private fund registration under SEC?
Significantly. Private funds that rely on one of the two Investment Company Act of 1940 Act exemptions (see Sections 3(c)(1) and 3(c)(7)) are carved out of that statute almost entirely. 1940 Act registered investment companies, on the other hand, are subject to the full panoply of regulation. It’s also important to note that PFIAR registers fund managers, not funds, so private funds will continue to be unregistered even after their managers register as investment advisers.
Q: Must we register for SMA business prior to the 14 person limit if we have US-domiciled mutual funds?
If you manage US-domiciled mutual funds (by which we assume you mean 1940 Act registered funds) now or under PFIAR you must automatically register as an investment adviser.
Q: Will the SEC look behind trusts to determine whether beneficiaries are US investors which therefore may require the fund to be registered?
That’s not certain at this point. Certain trusts with U.S. person beneficiaries can be treated as U.S. persons under SEC Regulation S, so it’s possible you could have similar treatment here. Again – broken record, we know – wait for the rule-making. (Also, remember that funds don’t register under PFIAR, managers do.)
Q: What happens in the case where a Form ADV registration of Investment Advisor has been registered previously. Does re registration have to take place?
We think you might be asking one of two different questions. If the question is that you registered but later deregistered, you will have to register again if you are not able to take advantage of an exemption as of July 21, 2011. If the question is that you are registered now and already have a Form ADV on file, you won’t do anything differently. You will still file your annual update next year as you always have. Watch out for the new Form ADV Part 2 requirements that we mentioned and be prepared to start to work on getting your disclosures in shape.
Q. What is the treatment for managed accounts under this exemption?
Under the FPA exemption, if the managed account is a US person it will generally count as one client when you are tallying up your number of US clients and you will count all of its AUM when tallying up your US client AUM. Under the $150m AUM exemption or the venture capital fund exemption, it looks like having a managed account client is automatically disqualifying so that you couldn’t rely on those exemptions.
Q. Are you able to be exempt from SEC registration if you register with the CFTC? E.g. our firm trades equities (through CFDs) and futures?
It depends. PFIAR adds an exemption from SEC registration that we didn’t talk about in our presentation that looks like it might be useful to you. CFTC-registered firms are apparently exempt until the business of the adviser becomes “predominately the provision of securities-related advice.” Not sure if this will be covered by rule-making of if the SEC will view it as self-explanatory.
Q. For a FPA with private funds only (no separate accounts) what is the AUM threshold – $25M or $150M.
It is $150m AUM, but we don’t know for sure how that $150m AUM will be measured. Presumably it’s across the whole business and not limited to the AUM of funds with US investors. Finally, and just to be clear, sometimes people talk about this exemption as if it allows $150m AUM per fund. That’s wrong.
Q. What’s the big deal about expanded recordkeeping and reporting?
There’s actually a lot going on here.
Part of the industry’s negative reaction is psychological. Most alternative investment managers pride themselves on being independent, entrepreneurial and, to some degree, private. Government-mandated recordkeeping and reporting is contrary to all of those things. Part is administrative. It just takes time, effort and infrastructure to comply (and with less than a year until the new registration rules apply, there’s precious little time to build out). Part is fear of the unknown. The SEC has been completely silent about how it wants the new recordkeeping and reporting to look. And nobody really knows how it plans to use the information.
Finally, a big part of the reaction is fear of losing control of proprietary investment strategy information. Coca-Cola probably had the same views about sharing its secret formula when ingredient labeling first came out, until they found they could fill in the blanks generically with natural flavors and artificial flavors. Let’s hope there are enough protections here as well.
Q. What are some "sleeper" provisions in the Act that managers should watch out for?
Enhanced rulemaking authority, SROs, fiduciary duty definitions, and whistle-blowers.
A stronger SEC – Enhanced SEC definitional and rulemaking authority has potentially far-reaching implications, at least once the agency emerges from the Dodd-Frank maelstrom and starts thinking about new directions for rulemaking.
SRO studies – These are mandated by the Act and will keep the possibility of SROs (self-regulatory organizations like FINRA) for either investment advisers generally or just for the private fund community alive for the next year or so.
Fiduciary duty definitions – If the SEC acts on the opportunity given to it by the Act to define a fiduciary duty for broker-dealers dealing with "retail" clients, that rulemaking could affect investment advisers by implication. The SEC also is authorized to extend the definition directly to cover investment advisers. Finally, the definition of "retail" in the statute is broader than you’d expect.
Whistle-blowers – The new whistle-blower provisions are starting to get so much press they may not be “sleepers” anymore, but watch out for expanded SEC protection, outreach and cash payments to whistle-blowers.
Q: I’ve heard that Dodd-Frank clamps down on systemically significant institutions. Are there parts of the asset management industry that are susceptible to direct systemically significant institution regulation?
In theory, large, leveraged and active trading fund managers could be targets, but right now it looks like you’d need a very public, very damaging hedge fund blowup to put hedge fund managers back on this screen. More likely, but still a long shot, could be money market funds or some of the huge public bond fund managers.
*Please Note: These materials represent views of select, current US regulatory requirements and certain changes to them, due to the legislation being adopted. The changes will be further affected by rules and regulations that are required to be implemented by the changed legislation. This article and its comments do not reflect or constitute legal, regulatory, or tax advice. Following a course of action outlined herein should be undertaken only after an analysis of the relevant facts and appropriate professional advice is obtained.