Investment Management Industry News Summary - July 2011

Investment Management Industry News Summary - July 2011

Publications

This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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Massachusetts Securities Division Proposes Changes to Investment Adviser Regulations

July 21, 2011 9:09 AM

The Massachusetts Securities Division has proposed changes to the regulations governing investment advisers that are located in Massachusetts or that otherwise have clients or funds with investors located in Massachusetts. If adopted, the amendments would impact the use of expert networks by investment advisers and eliminate one of the primary exemptions from Massachusetts state-level registration as an adviser. 

Under the proposed regulations, it would be considered dishonest or unethical conduct, punishable with administrative fines, censure, suspension or revocation of any registration, for an investment adviser to use a “matching” or “expert network” service (“ENS”) without obtaining a written certification from the expert consultant. The certification from the consultant must 1) describe all confidentiality restrictions that the consultant has, or reasonably expects to have, regarding confidential information, and 2) affirmatively state that the consultant will not provide any confidential information to the adviser. 

The requirement to obtain consultant certification would apply to all non-SEC registered investment advisers either (i) with an office located in Massachusetts or (ii) with clients or fund investors located in Massachusetts (irrespective of whether the adviser itself is located or registered in another state). It is unclear at this point whether the requirement would also apply to SEC-registered advisers. At a public hearing held on June 22, 2011, representatives of Secretary of State William Galvin tentatively stated that SEC-registered advisers that do business in Massachusetts would not be subject to the new ENS regulations. At the public hearing, the staff of the Massachusetts Securities Division indicated it was not the intention to bring SEC-registered advisers within the scope of the new ENS rule. 

Perhaps more significant because of the potential ramifications for small investment advisers is the proposed elimination of an exemption from Massachusetts state-level registration as an adviser.  This proposal would not affect SEC-registered investment advisers. However, non-SEC registered investment advisers either (i) with an office located in Massachusetts or (ii) with clients or fund investors located in Massachusetts (irrespective of whether the adviser itself is located or registered in another state) would no longer be able to rely upon a widely-used exemption from registration in Massachusetts. Currently, such advisers may rely upon an exemption from Massachusetts registration for advisers to “institutional buyers.” Institutional buyer is defined in Section 12.205(b) of the Massachusetts regulations to include funds composed of investors that each contributed at least $50,000 and qualified as an “accredited investor” (as defined in the rules under the Securities Act of 1933). The exemption would be eliminated by the proposed amendment by redefining the term “institutional buyer” in Section 12.205 to no longer include such funds.

The proposed new definition of “institutional buyer” would also include a grandfathering provision, however, to permit advisers that relied upon the exemption prior to the date of the amendment’s implementation to continue to do so, but only so long as no new investors or contributions by existing investors are accepted by the fund. For all other purposes, the exemption would no longer exist, impacting small investment advisers who may need to become registered in Massachusetts unless another exemption is available to them.

The Massachusetts Securities Division has proposed a new exemption from state-level adviser registration that would be applicable to advisers solely to so-called 3(c)(7) funds or venture capital funds. For some non-SEC registered advisers, this new exemption may alleviate the need to register as an investment adviser in Massachusetts. Licensure requirements may apply to individuals who are employed by advisers registered with Massachusetts.

The possible effective date of these proposed amendments is uncertain. With respect to the proposed amendment to the state-level registration rules, a representative from the Massachusetts Securities Division indicated at the June 22, 2011 public hearing that the Division is cognizant of the need to coordinate timing with federal changes in adviser registration requirements under Dodd-Frank. As previously reported, the deadline for investment advisers to comply with the new registration requirements under Dodd-Frank was recently extended by the SEC to March 30, 2012.

See http://www.sec.state.ma.us/sct/sctnewregs/newregsidx.htm for more information on changes proposed to Massachusetts securities laws.
 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

GAO Publishes Report on Private Fund Advisers

July 21, 2011 9:08 AM

On July 11, 2001, the U.S. Government Accountability Office (“GAO”) has published a report on the regulation of private fund advisers. The Dodd-Frank Act required GAO to examine the feasibility of forming a self-regulatory organization (SRO) to provide primary oversight of private fund advisers. The report discusses the feasibility of forming such an SRO, and the potential advantages and disadvantages of a private fund adviser SRO.

The report noted that the formation of a private fund adviser SRO would require legislation and would not be without challenges, including raising the necessary start-up capital and reaching agreements on the SRO fee and governance structures. GAO observed that the SEC likely will not have sufficient capacity to effectively examine registered investment advisers with adequate frequency without additional resources, and a private fund adviser SRO could supplement SEC's oversight of investment advisers and help address SEC's capacity challenges. However, the SEC would need to maintain the staff and resources necessary to examine the majority of investment advisers that do not advise private funds and to oversee the private fund adviser SRO, among other things. The report explained that by fragmenting regulation between advisers that advise private funds and those that do not, a private fund adviser SRO could lead to regulatory gaps, duplication, and inconsistencies.

See:http://www.gao.gov/new.items/d11623.pdf
 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Supreme Court Curtails Ability of Plaintiffs to Hold Secondary Actors Liable in Private Securities Fraud Actions

July 21, 2011 9:06 AM

The Supreme Court issued a 5-4 decision on June 13, 2011 holding that false statements included in a mutual fund prospectus were “made” by the fund, not the investment adviser to the fund. The Court held that since the false statements were not made by the adviser, the adviser cannot be held liable in a private action under Rule 10b-5 under the Exchange Act of 1934.

The Supreme Court held that for Rule 10b–5 purposes, the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it. Without control, a person or entity can merely suggest what to say, not “make” a statement in its own right. The majority held that although JCM, the adviser, may have been significantly involved in preparing the prospectuses, it did not itself “make” the statements at issue for Rule 10b–5 purposes. 

In coming to this conclusion, the Court considered the uniquely close relationship between a mutual fund and its investment adviser, but noted that the fund and the adviser are separate legal entities and that the corporate formalities were observed. Accordingly, the Court found that the adviser’s assistance in crafting the prospectus was subject to the fund’s ultimate control, and that reapportionment of liability in light of close relationships between mutual funds and advisers is the responsibility of Congress, not the courts.

Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. --- (2011).

See WilmerHale update at:  http://wilmerhaleupdates.com/ve/ZZxt61y82gLF75D2927
 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC Staff Issues No-Action Letter on “Advising Others”

July 21, 2011 9:05 AM

On June 30, 2011, the SEC’s Division of Investment Management staff stated that it would not recommend any enforcement action under Section 203(a) of the Investment Advisers Act of 1940 (“Advisers Act”) if a wholly-owned subsidiary of a foreign holding company does not register with the SEC. The subsidiary had asserted that it is not engaged in the business of advising “others” and accordingly was not an investment adviser. 

Section 202(a)(11) of the Advisers Act defines “investment adviser” to mean “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.”

The subsidiary was established and has been operated for the sole purpose of providing investment advice to the parent via four foreign funds in which the parent is the only investor. The adviser represented that it does not hold itself out to the public as an investment adviser, and provides investment advice only to the parent via the funds. The adviser also represented that the funds are established and operated solely for the benefit of the parent in order to enable the parent to pool and invest its premium proceeds in order to meet short, medium, and long term claim obligations and other operating costs of its insurance business, and consist solely of the parent’s assets. 

See: http://www.sec.gov/divisions/investment/noaction/2011/zenkoryen063011.pdf
 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC Staff Provides Guidance on Mid-Sized Advisers

July 21, 2011 9:03 AM

The Division of Investment Management has provided guidance on the regulatory requirements applicable to investment advisers that have between $25 million and $100 million of assets (mid-sized advisers). 

After July 21, 2011, a mid-sized adviser must register with the SEC if it is not required to be registered as an adviser with the state securities authority in the state where it maintains its principal office and place of business; or is not subject to examination as an adviser by the state where it maintains its principal office and place of business.

According to the Division’s recently published FAQ, the states in which a mid-sized adviser would not be “subject to examination” by the state securities authority are New York or Wyoming. When determining if it is “required to be registered” in the state where it maintains its principal office and place of business, a mid-sized adviser should consult the investment adviser laws or the state securities authority for that state to determine if it is required to register as an investment adviser in that state.

The FAQ also explained that a mid-sized adviser registered with the SEC as of July 21, 2011 must remain registered with the SEC until January 1, 2012 (unless an exemption from the SEC registration is available). A mid-sized adviser that is no longer eligible for SEC registration will need to be registered with the state securities authorities by June 28, 2012, and must withdraw its SEC registration no later than that date.

See: http://www.sec.gov/divisions/investment/midsizedadviserinfo.htm
 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC Adopts New Final Rule Defining “Family Office”

July 21, 2011 9:02 AM

On June 22, 2011, the SEC adopted a final rule to create a new exemption for family offices, or private trust funds, which were previously able to rely on the private adviser exemption to avoid registration.  

In the proposed rule, the SEC had defined family offices to include a “founder,” as well as the founder’s spouse, parents, lineal descendants and siblings. The final rule expands the list of people who may be considered family members. First, the final rule allows the family office to define the “family” by reference to a common ancestor, who may include a deceased relative. In addition, the final rule imposes a ten generation limit to prevent families from selecting a remote ancestor as the founding relative. The rule also expands the definition of lineal descendants to include foster children, minors of a legal guardian and former family members. Failure to satisfy the new conditions does not prevent a family office from either registering as an investment adviser or seeking an exemptive order from the SEC.   

The proposed rule also treats certain types of trusts as family clients for purposes of the exemption.  The final rule expands the types of trusts that can be treated as family clients, thus providing more flexibility to participate in different estate planning arrangements.  

The final rule will be effective August 29, 2011. However, the final rule implements a transition period for family offices to restructure their advising practices to comply with the new exemption. Previously exempt family offices will not be required to register with the SEC until March 30, 2012. Some family offices were exempt under the preexisting private adviser exemption, but are ineligible for the family office exemption because they have non-profit or charitable clients that receive funding from outside (i.e., non-family) clients. In these cases, the family office will remain exempt from SEC registration until December 31, 2013.

See the text of the final rule at: http://www.sec.gov/rules/final/2011/ia-3220.pdf
 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC Adopts Private Adviser Registration Rules

July 21, 2011 9:00 AM

On June 22, 2011, the SEC adopted final rules to implement amendments to the Investment Advisers Act of 1940 promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). The SEC adopted the amendments largely as proposed; however, the final rules modify the definition of an exempt venture capital fund to allow limited investments in non-qualifying assets. The final rules also revise investment adviser registration forms and implement a transitional exemption period that extends until March 30, 2012. 

Following the November 19, 2010 release of the proposed rules, the SEC received more than 70 comment letters from advisers, traders, professional organizations and law firms. The final rules require many previously exempt private fund advisers to register with the SEC. In addition, exempt private advisers are now required to report information about business operations, conflicts of interest, disciplinary history and investment strategies to the SEC. Chairman Mary Schapiro said the rules “give the SEC, and the public, insight into hedge fund and other private fund managers who previously conducted their work under the radar and outside the vision of regulators.”  

The final rules were adopted by a 3-2 vote, with Commissioners Casey and Paredes dissenting. Commissioner Paredes commented that the new reporting requirements for exempt advisers would erase any meaningful distinction between registered and non-registered advisers. Commissioner Casey also expressed concern that the new reporting requirements for exempt advisers would impose excessive compliance costs on funds that propel economic growth.

Private advisers, including hedge fund and private equity fund advisers, that are required to register under the new rules have been granted a transitional exemption period. As a result, previously exempt advisers will not be required to register until March 30, 2012. The new exemptions for venture capital funds and other private advisers are effective July 21, 2011.  

Venture Capital Funds

Although the Dodd-Frank Act eliminates the private adviser exemption, the proposed rules provided an exemption for advisers to venture capital funds. The final rules retain the proposed definition, but provide greater flexibility by allowing venture capital funds to invest up to 20 percent of committed capital in a basket of non-qualifying investments. The 20 percent basket will therefore significantly expand the number of investment advisers that qualify for the registration exemption. Chairman Schapiro noted that the SEC does not expect to conduct regular examinations of exempt advisers. Rather, the SEC will only conduct an examination when there is some indication of wrongdoing.  

New Reporting Requirements

The amended Form ADV establishes a uniform method of calculating assets under management.

The final rules require exempt reporting advisers to disclose basic identifying information, conflicts of interest and disciplinary history. However, the SEC did not adopt proposals that would have required advisers to disclose detailed information about private funds under management. As a result, the final rules modify Form ADV to reduce the amount of information required with respect to private funds.

Mid-Sized Advisers

The proposed rules also provided that advisers with less than $100 million in assets under management would no longer be eligible for SEC registration. The final rules raise the threshold for SEC registration to $110 million. Once registered with the SEC, an adviser does not need to withdraw its registration until it has less than $90 million in assets under management. The new $20 million buffer was designed to accommodate market fluctuations while giving effect to the $100 million threshold imposed by Congress.

The SEC revealed that the Investment Adviser Registration Depository (IARD) will not be able to update Form ADV until November 2011. As a result, the final rules provide until March 30, 2012 for advisers to determine whether they are eligible for SEC registration and to file an amended Form ADV. The final rules also provide until June 28, 2012 for newly ineligible advisers to register with the state and withdraw SEC registration.  

Finally, the proposed rules required an adviser to calculate its assets under management within 30 days of its transition filings. The final rules provide more flexibility by extending the time period from 30 to 90 days. An adviser will therefore have more time to calculate its assets under management, which ultimately determines whether the adviser will register with the SEC or with designated state authorities.    

See the text of the final rules at: http://www.sec.gov/rules/final/2011/ia-3222.pdf and http://www.sec.gov/rules/final/2011/ia-3221.pdf

See the WH alert at: http://wilmerhaleupdates.com/ve/ZZat61RjW90678592s

 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC Proposes Ways to Strengthen Audits and Reporting to Protect Customer Assets

July 20, 2011 3:11 PM

The SEC recently proposed three sets of amendments to the broker-dealer financial reporting rules under the Exchange Act. The proposals would, among other things, strengthen the audits of broker-dealers by requiring a heightened focus on custody activity, and increasing oversight of custody practices. The proposals would mandate the audit of the protections that are currently required to be put in place for customer assets. The first set of proposed amendments (collectively, the “Annual Reporting Amendments”) would update existing financial reporting requirements to facilitate the ability of the Public Company Accounting Oversight Board (the “PCAOB”) to implement oversight of independent public accountants of broker-dealers, as authorized by the Dodd-Frank Act, and eliminate any potentially redundant requirements. The second set of proposed amendments (collectively, the “Access to Audit Documentation Amendments”) would require broker-dealers that clear transactions or maintain custody of customer assets to consent to SEC and Designated Examining Authorities (“DEAs”) access to independent public accountants of broker-dealers to discuss the accountants’ findings with respect to annual broker-dealer audits and review related audit documentation. Finally, the third set of proposed amendments (collectively, the “Form Custody Requirements”) would enhance the ability of the SEC and DEA examiners to oversee broker-dealer custody practices.

Annual Reporting Amendments

In proposing these amendments, the SEC reexamined the existing annual audit report requirements of Sections 17(a) and (e) of the Exchange Act, and Rule 17a-5 thereunder, which, according to the SEC in the proposing release, have remained substantially unchanged since 1975. As a result, the Annual Reporting Amendments are being proposed to update the broker-dealer audit requirements and provide for the examination of compliance, and internal monitoring of compliance, with regulatory requirements and would provide the SEC with greater transparency regarding a broker-dealer’s compliance with the annual audit requirements. The proposed amendments would also provide an improved structure that would facilitate the PCAOB’s authority to set standards for, and implement inspection authority over, broker-dealer independent public accountants.

The proposed rules would amend Rule 17a-5 to require broker-dealers that maintain custody of customer assets (“carrying broker-dealers”) to file a new report asserting compliance with specified rules and related internal controls (the “Compliance Report”), and file a report from their independent public accountants (the “Examination Report”) that addresses the assertions in the Compliance Report. Broker-dealers that do not hold customer assets (“non-carrying broker-dealers”) would be required to file a report asserting their exemption from the requirements of Rule 15c3-3 (the “Exemption Report”).

Compliance Report: A report that would contain a statement as to whether the broker-dealer has established and maintained a system of internal controls to provide the broker-dealer with reasonable assurance of its ability to timely prevent or detect any instances of material non-compliance with Rule 15c3-1, Rule 15c3-3, Rule 17a-13 or rules prescribed by DEAs requiring broker-dealers to send account statements to customers (collectively, the “Financial Responsibility Rules”). The Compliance Report would also include the following three assertions by the broker-dealer:

  • whether the broker-dealer is in compliance in all material respects with the Financial Responsibility Rules as of its fiscal year-end;
  • whether the information used to assert compliance with the Financial Responsibility Rules was derived from the books and records of the broker-dealer; and
  • whether internal control over compliance with the Financial Responsibility Rules was effective during the most recent fiscal year, such that there were no instances of material weakness.

The proposed amendments require a description of each identified instance of “material non-compliance” and “material weakness” in internal control over compliance with the specified rules.

The SEC is proposing that “material non-compliance” replace the current reference to “material inadequacies” in Rule 17a-5. Under the proposed rules, non-compliance would be viewed as any failure to perform any of the procedures enumerated in the Financial Responsibility Rules. In determining whether such failure is material, the SEC would consider all relevant factors including, but not limited to: (1) the nature of the compliance requirements, which may or may not be quantifiable in monetary terms; (2) the nature and frequency of the non-compliance identified; and (3) qualitative considerations.

Some deficiencies, such as failing to maintain the required minimum amount of net capital, would automatically constitute material non-compliance. A material weakness would be viewed as a deficiency or a combination of deficiencies, in internal control over compliance with Financial Responsibility Rules, such that there is a reasonable possibility that material non-compliance with those provisions will not be prevented or detected on a timely basis. A broker-dealer could not assert compliance with the Financial Responsibility Rules as of its most recent fiscal year-end if it identifies one or more instances of material non-compliance.

Compliance Examination and Examination Report: This proposed requirement would replace the existing study-based independent public accountant reports by requiring carrying broker-dealers to engage an independent public accountant to examine the broker-dealer’s assertions in the Compliance Report (“Compliance Examination”) and issue an Examination Report prepared in accordance with PCAOB standards. The independent public accountant would not be required to opine, in the Examination Report, on the effectiveness of the broker-dealer’s internal control over financial reporting. However, the accountant’s existing obligation to gain an understanding and perform appropriate procedures relatives to the broker-dealer’s internal control over financial reporting would remain unchanged. The resulting Examination Report would then be filed with the SEC.

Notification Requirements: The proposed amendments would require an independent public accountant to notify the SEC within one business day, if, during the examination, the accountant determines that an instance of “material non-compliance” exists with respect to any of the Financial Responsibility Rules. The requirement would be triggered at the time the accountant determines that material non-compliance exists, and not at the completion of the examination. This requirement would replace the current requirement that a public accountant must call to the attention of the broker-dealer’s chief financial officer the existence of any material inadequacy.

Exemption Report: A non-carrying broker-dealer would be required to assert that it is exempt from the provisions of Rule 15c3-3 because it meets the conditions set forth in Paragraph (k) of Rule 15c3-3 with respect to all of its business activities. The non-carrying broker-dealer would also be required to engage an independent public accountant to review the assertions in the Exemption Report and based on that review, prepare a report in accordance with PCAOB standards. The accountant would be required to disclose in its report any material modifications of which it becomes aware during its review.

Change in Applicable Audit Standards: The Dodd-Frank Act has provided the PCAOB with authority to establish, subject to SEC approval, auditing and related attestation, quality control, ethics, and independence standards to be used by registered public accounting firms with respect to the preparation and issuance of audit reports to be included in broker-dealer filings with the SEC. Consequently, the SEC is proposing that the audit of the currently required financial reports, the proposed Compliance Examination, and the proposed review of the Exemption Report be performed pursuant to PCAOB standards. Due to the differences between PCAOB auditing standards and existing standards governing broker-dealers, the proposal would change the procedures accountants currently undertake as part of their engagement for audits of broker-dealers.

Filing of SIPC Reports: Currently, broker-dealers are required to file with the SEC, the broker-dealer’s DEA and the Securities Investor Protection Corporation (“SIPC”), a supplemental report (“Supplemental Report”) when SIPC raises SIPC Fund assessments above the minimum assessments provided for in the Securities Investor’s Protection Act. The SEC is proposing that the Supplemental Reports be filed with SIPC, and that SIPC, not the SEC, prescribe the form of the Supplemental Reports.

Access to Audit Documentation Amendments
In order to facilitate the examination of broker-dealers that clear customer transactions or carry customer accounts (“clearing broker-dealers”), the SEC is proposing that each broker-dealer be required to consent to permit its independent public accountant to make available to the SEC and the DEA examination staff the audit documentation associated with the annual audit reports required under Rule 17a-5, and discuss findings related to such audit reports with SEC and DEA examination staff. The proposed amendments would require:

  • that the Notice required pursuant to Rule 17a-5(f)(2) include a statement as to whether the broker-dealer’s engagement of its independent public accountant is for a single year or is of a continuing nature;
  • a representation by the broker-dealer that its engagement of the independent public accountant meets the required undertakings of Rule 17a-5; and
  • in the case of clearing broker-dealers, a representation that the broker-dealer agrees to allow representatives of the SEC or the DEA to review the audit documentation associated with the reports of the independent public accountant, if requested for the purposes of an examination of the broker-dealer.

Form Custody Amendments

In order to enhance the oversight of the custody function of broker-dealers, the SEC is proposing a new Form Custody, which is designed to elicit information about a broker-dealer’s custody practices and compliance with the requirements relating to the custody of customer and non-customer assets. The proposed Form Custody would be filed with the broker-dealer’s quarterly FOCUS Reports. The proposed Form Custody is comprised of nine line items designed to provide information about a broker-dealer’s custodial activities:

  • Item 1 – Accounts Introduced on a Fully Disclosed Basis: would require a broker-dealer to disclose whether it introduces customer accounts to another broker-dealer on a fully disclosed basis, and if so, the identity of each such broker-dealer. 
  • Item 2 – Accounts Introduced on an Omnibus Basis: would require the broker-dealer to disclose whether it introduces customer accounts to another broker-dealer on an omnibus basis, and if so, the identity of each such dealer.
  • Item 3 – Carrying Broker-Dealers: would require a carrying broker-dealer to indicate how it holds cash and securities accounts for customers or persons that are not customers within the definition of Rule 15c3-3; the types of locations where it holds securities; the frequency with which it performs reconciliations between its stock record and the records of those locations; and the types and amounts of securities held and whether they are on the broker-dealer’s records.
  • Item 4 – Carrying for Other Broker-Dealers: would require a broker-dealer to: (1) disclose whether it acts as a carrying broker-dealer for other broker-dealers on a fully disclosed basis or on an omnibus basis; (2) if applicable, disclose the number of broker-dealers for which it carries accounts on a fully disclosed or omnibus basis; (3) identify any affiliated broker-dealers that introduce accounts to the broker-dealer on a fully disclosed basis and on an omnibus basis; and (4) discuss the custodial responsibilities with respect to accounts held for the benefit of other broker-dealers.
  • Item 5 – Trade Confirmations: would require a broker-dealer to disclose whether it sends transaction confirmations to customers and other accountholders.
  • Item 6 – Account Statements: would require a broker-dealer to disclose whether it sends account statements directly to customers and other accountholders.
  • Item 7 – Electronic Access to Account Information: would require a broker-dealer to indicate whether it provides customers and other accountholders with electronic access to information about the securities and cash positions in their accounts.
  • Item 8 – Broker-Dealers Registered as Investment Advisers: would require a broker-dealer to indicate whether and how the broker-dealer operates as an investment adviser, disclose the number of its advisory clients, and provide information about the custodians holding the assets of its advisory clients.
  • Item 9 – Broker-Dealers Affiliated with Investment Advisers: would require a broker-dealer to indicate whether it is an affiliate of an investment adviser, whether the broker-dealer has custody of client assets of an affiliated investment adviser, and if so, the approximate U.S. dollar market value of the assets.
  • Other Amendments: the rule would amend Rule 17a-5 to delete the now moot provisions regarding readiness for the year 2000.

The SEC is seeking comments with respect to the proposed amendments. Comments are to be received on or before August 26, 2011.

For additional information, the SEC press release and the proposed rules can be found here: http://www.sec.gov/news/press/2011/2011-128.htm.  

 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC Provides Additional Guidance, Interim Relief and Exemptions for Security-Based Swap Provisions of the Dodd-Frank Act

July 20, 2011 2:40 PM

On July 1, the SEC adopted interim final rules providing certain conditional exemptions under the Securities Act of 1933 (the “Securities Act”), the Securities Exchange Act of 1934 (the “Exchange Act”) and the Trust Indenture Act of 1939 for those security-based swaps that became “securities” under the Securities Act and the Exchange Act on July 16, 2011. The interim final rules are part of the SEC’s broader efforts to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Specifically, the release makes clear that on July 16, 2011 (the effective date of Title VII of the Dodd-Frank Act (“Title VII”)), the requirements of the Exchange Act that are applicable to securities will not apply to security-based swaps; however, the Section 17(a) anti-fraud and manipulation provisions will continue to apply. Pending further rulemaking by the SEC, the interim final rules effectively maintain the existing legal framework for security-based swaps under the Exchange Act and permit certain security-based swaps to continue to trade and be cleared as they did before the passage of the Dodd-Frank Act.

Title VII makes several amendments to the Exchange Act in order to improve transparency, efficiency and competition in the financial markets. Among other requirements, Title VII imposes:

  • registration and comprehensive oversight of security-based swap dealers and major security-based swap participants;
  • reporting of security-based swaps to a registered security-based swap data repository, the SEC and the public;
  • centralized clearing of security-based swaps through a registered clearing agency or a clearing agency that is exempt from registration if such security-based swaps are of a type that must be cleared, unless an exemption otherwise exists; and
  • in the case of security-based swaps that are subject to clearing, execution of such security-based swap transactions on an exchange, on a security-based swap execution facility (“security-based SEF”) registered under the Exchange Act, or on a security-based SEF that is otherwise exempt from registration, unless no security-based SEF or exchange makes such security-based swap available for trading.

Title VII also expands the definition of “security” under the Securities Act and the Exchange Act to include “security-based swaps,” thereby subjecting them to the provisions of and rules under both Acts that apply to “securities.”

The SEC provided additional guidance regarding the terms “security-based swap” and “eligible contract participant” due to uncertainty surrounding compliance with the applicable registration requirements of the Securities Act, the Exchange Act and the indenture provisions of the Trust Indenture Act. In particular, several market participants raised concerns regarding the implications of expanding the definition of “security” to include security-based swaps, and requested temporary relief to complete analyses of these implications and submit requests for more targeted relief. Recognizing the substantial undertaking required by Title VII, the SEC proposed the following interim final rules:

  • Securities Act Rule 240: The interim final rules adopt Securities Act Rule 240 to exempt from all provisions of the Securities Act, except the anti-fraud provisions of Section 17(a), and subject to certain conditions, the offer or sale of those security-based swaps that under current law are “security-based swap agreements” and became “securities” under the Securities Act on July 16, 2011. Security-based swap agreements must be entered into between eligible contract participants and subject to individual negotiation. The new rule will permit the offer or sale of these security-based swaps between eligible contract participants without requiring compliance with Securities Act Section 5.
  • Exchange Act Rule 12a-11 and Rule 12h-1(i): The SEC also adopted interim final rules relating to the Exchange Act registration of security-based swaps. The interim final rule exempts any security-based swap offered and sold in reliance on Securities Act Rule 240 from the provisions of Exchange Act Sections 12(a) and 12(g). The exemption would permit trading activities relating to those security-based swaps that under current law are security-based swap agreements between eligible contract participants to continue; provided that the parties rely on the Securities Act Rule 240 exemption.
  • Trust Indenture Act Rule 4d-12: Adopted under Trust Indenture Act Section 304(d), this interim final rule exempts any security-based swap offered or sold in reliance on Securities Act Rule 240 from compliance with the provisions of the Trust Indenture Act. The SEC expressed the opinion that the protections of the Trust Indenture Act are currently not needed for eligible contract participants to whom a sale of a security-based swap is made in reliance on Securities Act Rule 240, and consequently, that the Trust Indenture Act does not provide any additional meaningful or substantive procedural protections.

The interim final rules will remain in effect until the compliance date for final rules that the SEC may adopt further defining the terms “security-based swap” and “eligible contract participants.” The SEC is seeking comment on, among other things, how the exemptions will affect the manner in which security-based swaps are currently transacted. The deadline for comments is August 15, 2011.

For additional information, the SEC press release and the interim final rules can be found here: http://www.sec.gov/news/press/2011/2011-141.htm.  

 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Extension of FBAR Deadline for Employees of Registered Investment Advisers Until June 30, 2012

July 20, 2011 8:19 AM

On June 17, 2011, the Financial Crimes Enforcement Network (“FinCEN”) issued a notice extending until June 30, 2012 the deadline for certain individuals to file their reports of Foreign Bank and Financial Accounts (“FBARs”).  The extension applies to officers and employees of registered investment advisers with signature or other authority over, but no financial interest in, foreign financial accounts of entities which are not registered under the Investment Company Act of 1940. 

Earlier this year, FinCEN published a final rule amending the Bank Secrecy Act regulations regarding reports of foreign financial accounts. The rule addressed the persons required to file FBAR reports and the types of accounts that are reportable. The rule also provided an exception for officers or employees of registered investment advisers with signature or other authority over certain foreign financial accounts, provided that those officers or employees had no financial interest in such accounts. The initial compliance date of June 30, 2011 has been extended due to issues surrounding processing FBAR filings for officers and employees of registered investment advisers who have signatory or other authority over, but no financial interest in the foreign financial accounts of investment companies that are not registered as described above. 

The extension applies to FBARs for the 2010, 2009 and earlier calendar years and earlier years for which the filing deadline was properly deferred under I.R.S. Notice 2009-62 or I.R.S. Notice 2010-23, 2010-11 I.R.B. 441.

For more information, the notice can be found here:  http://www.fincen.gov/statutes_regs/guidance/pdf/FBARFinCENNotice.pdf

See WilmerHale’s publication on the extension here:    http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=9844

 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

FINRA Encourages Firms to Assist Investment Advisers Seeking to Comply with Pay-to-Play Rules

July 20, 2011 8:17 AM

On June 6, 2011, the Financial Industry Regulatory Authority (“FINRA”) issued an Information Notice encouraging broker-dealers to make reasonable efforts to assist investment advisers seeking information pursuant to Rule 206(4)-5 under the Investment Advisers Act of 1940 (the “Advisers Act”). The so-called “pay-to-play” rules prohibit an investment adviser from providing advisory services for compensation to a government client for a period of two years after the adviser or certain of its employees makes a contribution to certain elected officials or candidates. The rule further prohibits an investment adviser from providing or agreeing to provide payment to third parties for the solicitation of advisory business from any government entity, unless such parties are themselves subject to pay-to-play restrictions. Government entities are defined to include all state and local governments, their agencies and instrumentalities, and all public pension plans and other collective government funds, including Sections 403(b), 457 and 529 government plans. Finally, the rule prevents investment advisers from soliciting or coordinating contributions to certain elected officials or candidates or making payments to political parties when the adviser is providing or seeking government business. The rule was adopted in July 1, 2010 to prevent corruption and abuses in of the process of awarding public contracts. 

Under the pay-to-play rules, investment advisers are reasonably expected to know, or to acquire, information about any government plans included in their managed assets and the identity of those plans. The notice specifically addresses the challenge that arises when participant contributions to Sections 403(b) and 457 government plans are commingled into omnibus accounts, making it difficult to distinguish government entity investors. The information notice does not directly impose any requirements on broker-dealers, but rather, encourages broker-dealer firms to make reasonable efforts to cooperate with investment advisers seeking information about fund holdings through omnibus accounts in order to comply with the pay-to-play rules. Investment advisers to registered investment companies that are covered pools under Rule 206(4)-5 have until September 13, 2011 to put into place system enhancements or business arrangements that may be necessary to identify any government plans or programs that are investment options. 

For additional information, the FINRA Notice can be accessed here: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p123757.pdf
 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

CFTC Hosts Roundtable on Commodity Pool Issues

July 20, 2011 8:10 AM

On July 6, 2011, the CFTC held a roundtable discussion to discuss proposed changes to its regulation of commodity pool operators (“CPO”). The CFTC has proposed to repeal the current exemptions to CPO registration under rules 4.13(a)(3) and (a)(4), and to revise the requirements for determining which persons should be required to register as a CPO under Rule 4.5.[1]

The majority of the roundtable discussion centered on the proposed changes to rule 4.5, which would permit an investment company to claim an exclusion from registration as a CPO, if:

§           the entity is using commodity futures, commodity options contracts or swaps for bona fide hedging purposes (as defined under Rule 1.3(z)(1))[2];

§          the initial margin and premiums for any other trading of these instruments do not exceed 5% of the liquidation value of the entity’s portfolio; and

§          the entity does not market itself as a means for trading in the commodity futures, commodity options, or swaps markets.[3] 

The discussion regarding rule 4.5 centered on the marketing restriction and the 5% threshold test. Several participants[4] remarked that the marketing restriction was overbroad and that the 5% threshold was too narrow, thus potentially requiring funds to register as CPOs, even though funds engage in relatively non-risky trading activity. The CFTC staff offered as a substitute for the 5% portfolio threshold, the net notional value test currently in rule 4.13(a)(3)(ii)B(1).[5] 

Several participants suggested that the CFTC gather data on the ways in which currently exempt funds were using commodity futures, commodity options, or swaps before deciding on these proposed rule changes. CFTC staff responded that, if needed, it may require a “special call” of the industry to gather information. Participants largely agreed that investment advisers, and not fund directors or trustees, should be required to register as CPOs.

With regard to the proposed rescission of § 4.13(a)(3), the CFTC staff requested participants’ views on an appropriate de minimis test if the CFTC determines to maintain the exemption under § 4.13(a)(3) in some form. 

Finally, many participants requested that the CFTC and the SEC harmonize their rules. The CFTC staff encouraged the participants to provide “line-by-line specifics” about how the CFTC’s proposals regarding disclosure, financial reporting, and recordkeeping needed to be harmonized with the SEC’s rules. The CFTC staff cautioned, however, that, because of statutory definitional differences between the laws governing the two agencies, some of the rules may not be able to be harmonized.

Although it is not possible to predict from a roundtable discussion the final rules that the CFTC staff may recommend or that the CFTC will eventually vote to adopt, it appears from the tone and substance of the discussion that the CFTC will consider retaining some type of de minimis exemption from CPO registration, that it remains deeply concerned about the issues of investment company trading of commodity futures interests, which led to its proposed revisions to rule 4.5 and that any harmonization of CFTC and SEC rules with regard to disclosure, financial reporting, and recordkeeping by registered investment funds and commodity pool operators is likely to be incomplete, at best.

Additional information on the roundtable can be found here:  http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff070611.html

[1].             “Commodity Pool Operators and Commodity Trading Advisors:  Amendments to Compliance Obligations,” 76 Fed. Reg. 7976 (February 11, 2011).

[2].             Rule 1.3(z)(1)defines “bona fide hedging” as:  “[T]ransactions or positions in a contract for future delivery on any contract market, or in a commodity option, where such transactions or positions normally represent a substitute for transactions to be made or positions to be taken at a later time in a physical marketing channel, and where they are economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise, and where they arise from:  (i) The potential change in the value of assets which a person owns, produces, manufactures, processes, or merchandises or anticipates owning, producing, manufacturing, processing, or merchandising;  (ii) The potential change in the value of liabilities which a person owns or anticipates incurring; or (iii) The potential change in the value of services which a person provides, purchases, or anticipates providing or purchasing.  Notwithstanding the foregoing, no transactions or positions shall be classified as bona fide hedging unless their purpose is to offset price risks incidental to commercial cash or spot operations and such positions are established and liquidated in an orderly manner in accordance with sound commercial practices ….”

[3].             These revisions reinstate the provisions that were in Rule 4.5 prior to the 2003 amendments to the rule (but just for registered investment companies). 76 Fed. Reg. 7983-4.

[4].             Participants at the meeting included various representatives from the fund industry such as Fidelity Investments, PIMCO, Vanguard, Goldman Sachs Asset Management, the Securities Trader Association, the National Futures Association, and the U.S. Chamber of Commerce. 

[5].             § 4.13(a)(3)(ii)B(1) describes the net notional value test as follows: “The term ‘notional value’ shall be calculated for each such futures position by multiplying the number of contracts by the size of the contract, in contract units (taking into account any multiplier specified in the contract), by the current market price per unit, and for each such option position by multiplying the number of contracts by the size of the contract, adjusted by its delta, in contract units (taking into account any multiplier specified in the contract), by the strike price per unit, and for each such retail forex transaction, by calculating the value in U.S. Dollars of such transaction, at the time the transaction was established, excluding for this purpose the value in U.S. Dollars of offsetting long and short transactions, if any .…”

 
 
 

 
This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.