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Posted on Friday, February 28 2014 at 9:32 pm by

SEC Provides No-Action Relief for M&A Brokers

On January 31, the staff of the Securities and Exchange Commission (“SEC”) issued a no-action letter (“No-Action Letter”) [1] permitting an “M&A Broker”, under certain circumstances, to facilitate mergers, acquisitions, business sales, and business combinations (together, “M&A Transactions”) in connection with the transfer of ownership of a “privately-held company” (any company that does not have any class of securities registered, or required to be registered, with the SEC under Section 12 of the Securities Exchange Act of 1934 and is not required to file periodic information, documents, or reports under Section 15(d) of the Exchange Act) without the M&A Broker registering as a broker-dealer under section 15(b) of the Exchange Act. The specific terms and conditions in the No-Action Letter are outlined below.

While the details of the definition of M&A Broker are complicated, the No-Action Letter has caught the securities industry by surprise. The No-Action Letter provides a potential exemption from SEC broker-dealer registration for many M&A industry consultants commonly referred to as “business brokers”, even if they are paid “finders” or “success” fees for securities-based M&A transactions between privately-held companies. In particular, the No-Action Letter permits an M&A Broker [2] to (i) advertise a privately-held company for sale with information such as the description of the business, general location, and price range, (ii) participate in the negotiations of the M&A Transaction, (iii) advise the parties to issue securities, or otherwise to effect the transfer of the business by means of securities, or assess the value of any securities sold, and (iv) receive transaction-based or other compensation, without registering as a broker-dealer with the SEC.

In particular, the SEC noted the following regarding M&A Brokers:

  • M&A Brokers may not have the ability to bind a party to an M&A Transaction.
  • M&A Brokers may not directly, or indirectly through any of its affiliates, provide financing for an M&A Transaction.
  • M&A Brokers may not have custody, control, or possession of or otherwise handle funds or securities issued or exchanged in connection with an M&A Transaction or other securities transaction for the account of others.
  • M&A Transactions may not involve a public offering, but instead must be conducted in compliance with an applicable exemption from registration under the Securities Act of 1933.
  • No party to any M&A Transaction may be a “shell company”,[3] other than a “business combination related shell company”.[4]
  • M&A Brokers representing both buyers and sellers must provide clear written disclosure as to the parties represented and obtain written consent from both parties to the joint representation. In addition, an M&A Broker facilitating an M&A Transaction with a group of buyers may do so only if the group is formed without the assistance of the M&A Broker.
  • The buyer, or group of buyers, in any M&A Transaction must, upon completion of the M&A Transaction, control and actively operate the company or the business conducted with the assets of the business.[5]
  • No M&A Transaction may result in the transfer of interests to a passive buyer or group of passive buyers.
  • Any securities received by the buyer or M&A Broker in an M&A Transaction will be restricted securities within the meaning of Rule 144(a)(3) under the Securities Act because the securities would have been issued in a transaction not involving a public offering.
  • M&A Brokers and each officer, director or employee of an M&A Broker: (i) cannot have been barred from association with a broker­dealer by the SEC, any state or any self-regulatory organization; and (ii) may not be suspended from association with a broker-dealer.

Future Considerations

The No-Action Letter is a welcome step towards clarifying the registration requirements for M&A Brokers; however, it remains to be seen what, if any, effect it will have on determinations under state securities laws and their varied definitions of “brokers”, “dealers” and “finders”. Although it is reasonable to assume that states that have adopted laws similar to federal law in this area may likewise adopt the interpretation presented in the No-Action Letter, only time will tell if this proves to be the case. We also recommend that individuals and companies looking to rely on the No-Action Letter to avoid SEC broker-dealer registration carefully consider the No-Action Letter’s requirements for transactions to fit under its parameters (namely, the requirements that qualifying transactions involve a buyer that will take voting control, assume executive officer or management positions or otherwise have the power to exert control over the seller after the transaction). Additionally, we note that the No-Action Letter does not address continuing issues regarding broker-dealer registration of private equity fund advisers that receive deal-based fees, who likely would not be able to comply with the M&A Broker definition. Nevertheless, the No-Action Letter’s stark departure from the SEC’s historical position that transaction-based compensation is the “hallmark of broker-dealer activity” is a positive step towards addressing, at the federal level, at least some of these issues.

For more information on the No-Action Letter, please contact any member of the Investment Management Team.


[1] SEC No-Action Letter re: M&A Brokers, dated January 31, 2014. A copy of the No-Action Letter is available here.

[2] An “M&A Broker” is defined in the No-Action Letter as a person engaged in the business of effecting securities transactions solely in connection with the transfer of ownership and control of a privately-held company (defined below) through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the company, to a buyer that will actively operate the company or its assets, whether through the power to elect officers and approve budgets or by service as an executive or other executive manager, among other things.

[3] A “shell” company is defined in the No-Action Letter as a company that: (1) has no or nominal operations; and (2) has: (i) no or nominal assets; (ii) assets consisting solely of cash and cash equivalents; or (iii) assets consisting of any amount of cash and cash equivalents and nominal other assets. In this context, a going concern need not be profitable, and could even be emerging from bankruptcy, so long as it has actually been conducting business, including soliciting or effecting business transactions or engaging in research and development activities.

[4] A “business combination related shell company” is defined in the No-Action Letter as a shell company (as defined in Rule 405 of the Securities Act) that is (1) formed by an entity that is not a shell company solely for the purpose of changing the corporate domicile of that entity solely within the United States or (2) formed by an entity defined in Securities Act Rule 165(f) among one or more entities other than the shell company, none of which is a shell company.

[5] A buyer, or group of buyers collectively, would have the necessary control if it has the power, directly or indirectly, to direct the management or policies of a company, whether through ownership of securities, by contract, or otherwise. The necessary control will be presumed to exist if, upon completion of the transaction, the buyer or group of buyers has the right to vote 25% or more of a class of voting securities; has the power to sell or direct the sale of 25% or more of a class of voting securities; or in the case of a partnership or limited liability company, has the right to receive upon dissolution or has contributed 25% or more of the capital. In addition, the buyer, or group of buyers, must actively operate the company or the business conducted with the assets of the company.

 

 

Posted on Wednesday, January 15 2014 at 8:58 pm by

SEC Releases 2014 Exam Priorities

On January 9, 2014, the Securities and Exchange Commission (the “SEC”) announced its 2014 examination priorities (the “Exam Priorities”) as part of the SEC’s National Examination Program (the “NEP”) to foster communication with both investors and registered entities. The Exam Priorities are a “road map” for how investment advisers, funds, broker-dealers and others in the asset management industry will be reviewed by the SEC’s exam staff in the year ahead. The Exam Priorities describe multiple levels of NEP initiatives, including NEP-wide initiatives and “program area-specific initiatives” (e.g., initiatives that focus on investment advisers or broker-dealers).

NEP-Wide Initiatives

Some of the more significant NEP-wide initiatives include the following:

  • Fraud Detection and Prevention. This initiative focuses on the NEP’s use of quantitative and qualitative tools and techniques to identify market participants engaged in fraudulent or unethical behavior.
  • Corporate Governance, Conflicts of Interest, and Enterprise Risk Management. This initiative is designed to: (i) evaluate firms’ control environment and “tone at the top,” (ii) understand firms’ approach to conflict and risk management, and (iii) initiate a dialogue on key risks and regulatory requirements.
  • Technology. This initiative focuses on firms’ governance and use of technology, including operational capability, market access, information security and preparedness to respond to sudden malfunctions and system outages.
  • Dual Registrants. This initiative derives from concern that the convergence among broker-dealer and investment adviser activity creates a significant risk. Accordingly, the NEP will examine conflicts of interest, impacts to investors from different supervisory structures and legal standards of conduct related to dual registrants’ and their representatives’ provision of brokerage and investment advisory services.
  • New Laws and Regulation. This initiative focuses on general solicitation practices and verification of accredited investor status under newly adopted Rule 506(c) for Regulation D offerings. The NEP will also focus on compliance with regulatory requirements for crowdfunding compliance as these new rules become effective.

Program Area-Specific Initiatives

The Exam Priorities’ program area-specific initiatives are further categorized into “core risks”, generally selected based on issues identified in recently conducted examinations; “new and emerging issues and initiatives”, which the SEC generally believes pose increased risks due to changes in the industry; and “policy topics”, which generally represent areas of focus because the SEC is seeking to better understand them.

Some of the more significant area-specific initiatives for investment advisers/investment companies and broker-dealers include the following:

 A. Investment Adviser/Investment Company Program

Core Risks

Safety of Assets and Custody. This initiative focuses on non-compliance with Rule 206(4)-2 under the Advisers Act (“Custody Rule”). Examiners will pay particular attention to those instances where advisers fail to realize they have custody and therefore fail to comply with requirements of the Custody Rule.

Conflicts of Interest Inherent in Certain Investment Adviser Business Models. This initiative focuses on conflicts of interest inherent in an adviser’s business model, including matters related to compensation and investment allocations.

Marketing/Performance. This initiative considers the accuracy and completeness of advisers’ claims about their investment objectives and performance, especially in connection with newly effective rules adopted under the Jumpstart Our Business Startups (“JOBS”) Act.

New and Emerging Issues and Initiatives Never-Before Examined Advisers. This initiative involves focused, risk-based examinations of advisers that have been registered for more than three years but have not yet been examined under the NEP. The staff will also continue the use of shorter Presence Exams for newly registered advisers, which focus on key areas of marketing, portfolio management, conflicts of interest, safety of client assets and valuation.

Wrap Fee Programs. This initiative focuses on assessing whether wrap fee program advisers are fulfilling their fiduciary and contractual obligations to clients.

Quantitative Trading Models. This initiative involves examining investment advisers with substantial reliance on quantitative portfolio management and trading strategies to assess, among other things, whether these firms have adopted and implemented compliance policies and procedures tailored to the performance and maintenance of their proprietary models.

Payments for Distribution in Guise. This initiative involves review of the variety of payments made by advisers and mutual funds to distributors and intermediaries, the adequacy of disclosure made to fund boards about these payments and boards’ oversight of the same.

Fixed Income Investment Companies. This initiative focuses on risks associated with a changing interest rate environment and the impact this may have on bond funds and related disclosures of risks to investors.

Policy Topics. Policy Topics discussed in the Exam Priorities include a focus on “alternative” investment companies (i.e., mutual funds with certain hedge fund-like strategies) and securities lending arrangements.

B. Broker-Dealer Exam Program  

Some of the Core Risks for Broker-Dealers discussed in the Exam Priorities are as follows: 

Sales Practices/Fraud. This initiative focuses on detecting and preventing fraud and other violations in connection with sales practices to retail investors. 

Supervision. This initiative considers broker-dealers’ supervision of: (i) independent contractors and financial advisors in “remote” locations and large branch offices, (ii) registered representatives with significant disciplinary histories, and (iii) private securities transactions. 

Trading. This initiative involves broker-dealers’ market access controls related to, among other things, erroneous orders, the use of technology (with a focus on algorithmic and high frequency trading), information leakage, and cyber security. 

* * * * * * * 

This description of the Exam Priorities is not exhaustive. In addition, while the NEP expects to allocate significant resources throughout 2014 to the examination of the issues described herein and the other issues identified in the Exam Priorities, the NEP will conduct additional examinations in 2014 focused on risks, issues and policy matters that are not discussed or identified in the Exam Priorities. 

The Exam Priorities can be found here.

Posted on Tuesday, September 18 2012 at 11:30 pm by

SEC Issues Proposed Rules Regarding Elimination of General Solicitation Ban

The Securities and Exchange Commission (the “SEC”) has issued proposed rules that would permit certain forms of “general solicitation” in private offerings made in reliance on Rule 506 of Regulation D or Rule 144A under the Securities Act of 1933 (the “Securities Act”).  

Rule 506 Offerings

Rule 506 of Regulation D provides a non-exclusive safe harbor that permits the sale of securities in private placements to certain persons, including purchasers who the issuer reasonably believes are accredited investors and up to 35 other purchasers subject to certain conditions.  In addition, offerings made pursuant to Rule 506 are not subject to any state securities registration requirements.  Currently, Rule 506 prohibits any form of general solicitation or general advertising in connection with a sale of securities under Rule 506.

The JOBS Act directed the SEC to amend Rule 506 by July 4, 2012, to permit general solicitation or general advertising in Rule 506 offerings, provided the only purchasers of the securities are accredited investors.

The proposed rules would permit general advertisements in connection with Rule 506 offerings if the issuer takes “reasonable steps to verify that the purchasers of the securities are accredited investors” and “all purchasers of securities must be accredited investors, either because they come within one of the enumerated categories of persons that qualify as accredited investors or the issuer reasonably believes that they do, at the time of the sale of the securities”.  However, issuers that do not engage in a general solicitation may to continue to adhere to Rule 506 as it currently exists and sell to up to 35 non-accredited investors if general solicitation is not employed.

While the proposed rules require issuers to take “reasonable steps” to verify that purchasers of the securities are accredited investors, they do not specify the methods necessary to satisfy this requirement.  The SEC specifically avoided providing specifics in order to provide sufficient flexibility to accommodate different types of transactions and changes in market practices and to avoid the market giving unnecessary weight to any factors the SEC may have otherwise provided.  It should be recognized, however, that this approach by the SEC is likely to create uncertainty among issuers as to what steps will be sufficient to comply with the proposed rules.  

The proposed rules instead provide that whether the steps taken are “reasonable” would be an objective determination, based on the particular facts and circumstances of each transaction.  The proposed rules do, however, provide that an issuer should consider the following factors when evaluating the reasonableness of the steps taken to verify that a purchaser is an accredited investor:

  • the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
  • the amount and type of information that the issuer has about the purchaser; and
  • the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.

With regard to the last factor, the proposed rules indicate that an issuer that solicits new investors through a website accessible to the general public or through a widely disseminated email or social media solicitation would likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party, such as a registered broker-dealer.  In the case of website offerings, the SEC does not believe that an issuer would have taken reasonable steps to verify accredited investor status if it required only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status.  In the case of a widely disseminated email or social media solicitation, the SEC believes that an issuer would be entitled to rely on a third party that has verified a person’s status as an accredited investor, provided that the issuer has a reasonable basis to rely on such third-party verification.  Additionally, the SEC also believes that a purchaser’s ability to meet a high minimum investment amount could be relevant to whether an issuer’s verification steps would be reasonable.  For example, the ability of a purchaser to satisfy a minimum investment amount requirement that is sufficiently high such that only accredited investors could reasonably be expected to meet it, with a direct cash investment that is not financed by the issuer or by any other third party, could be taken into consideration in verifying accredited investor status.

Regardless of the particular steps taken, issuers will need to retain adequate records that document the steps taken to verify that a purchaser was an accredited investor.  Any issuer claiming an exemption from the registration requirements of Section 5 has the burden of showing that it is entitled to that exemption.  However, if a person who does not meet the criteria for any category of accredited investor purchases securities in a Rule 506(c) offering, we believe that the issuer would not lose the ability to rely on the proposed Rule 506(c) exemption for that offering, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor.

Effect on Sections 3(c)(1) and 3(c)(7) under the Investment Company Act

Privately offered funds, such as hedge funds, venture capital funds and private equity funds, typically rely on Section 4(a)(2) and the Rule 506 safe harbor to offer and sell their interests without registration under the Securities Act.  In addition, privately offered funds generally rely on exclusions from the definition of “investment company” under Section 3(c)(1) and Section 3(c)(7) the Investment Company Act, which enables them to be excluded from the regulatory provisions of that Act.  Privately offered funds are precluded, however, from relying on either of these two exclusions if they make a public offering of their securities.  The proposed rules provide that SEC believes the effect of the proposed rules is to permit privately offered funds to make a general solicitation without losing either of the exclusions under the Investment Company Act.

Amendment to Rule 144A

Rule 144A provides a non-exclusive safe harbor exemption from the registration requirements of the Securities Act for resales of certain “restricted securities” to qualified institutional buyers (“QIBs”).  In order for a transaction to come within existing Rule 144A, a seller must have a reasonable basis for believing that the offeree or purchaser is a QIB and must take reasonable steps to ensure that the purchaser is aware that the seller may rely on Rule 144A.  The proposed rules revise Rule 144A to provide that securities sold pursuant to Rule 144A may be offered to persons other than QIBs, including by means of general solicitation, provided that securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe is a QIB.  Under the proposed rules, resales of securities pursuant to Rule 144A could be conducted using general solicitation, so long as the purchasers are limited to QIBs.

If you have any questions regarding the matters addressed above, please contact us.

Posted on Sunday, July 1 2012 at 9:01 am by

SEC Staff Member Speaks on the SEC’s Approach to Examining Newly-Registered Private Equity Advisers

Carlo di Florio, Director of the Office of Compliance Inspections and Examinations (“OCIE”) at the SEC, recently addressed the Private Equity International Private Fund Compliance Forum and answered various questions regarding how the SEC will prepare for and examine the nearly 4,000 newly-registered private fund advisers that registered with the SEC as a result of the recent deadline under the Dodd-Frank Act.  Some of the highlights of Mr. di Florio’s speech follow.

Mr. di Florio described how OCIE’s National Examination Program (“NEP”) attempts to manage and mitigate risks presented by private equity funds, as well as large hedge funds, through a three-fold examination strategy.  First, the NEP will have a phase of industry outreach and education.  Next, there will be coordinated examinations of a large percentage of new registrants, focusing on high-risk areas of their business.  Finally, the NEP will publish a series of “after-action” reports on themes and issues identified.

Mr. di Florio indicated that one of the focuses of the NEP is to educate investment advisers regarding compliance, including adopting and implementing written policies and procedures, designating a Chief Compliance Officer (“CCO”), maintaining certain books and records, filing annual updates of Form ADV, ensuring that advertising complies with regulatory rules and implementing a code of ethics.  He also noted that NEP’s purpose includes strengthening OCIE’s communications with senior management of private equity firms in order to assess the corporate culture set at the top of the organization’s, senior management’s and firm principal’s support for CCOs, firms’ approaches to enterprise-wide risk management and identification of industry-wide risks.

To identify which candidates to select for examination, the NEP will seek to identify firms and practices that present the greatest risk.  Mr. di Florio gave examples of basic risk characteristics that the NEP would be likely to track, including material changes in business activities, changes in key personnel, the regulatory history of the firm and anomalies in key metrics such as fee or performance information.

Mr. di Florio recommends that, in order to avoid attracting NEP attention and potential examination, firms should be proactive about identifying conflicts and remediating those conflicts with strong policies.  Furthermore, he commented that firms should also place importance on creating a firm-wide ethical culture.  In the case of an examination, a firm should possess strong records and know how to readily access data, document ongoing monitoring and testing of policies and procedures, and be forthcoming about problems.

If a firm is selected for examination, Mr. di Florio noted that the examination itself will generally focus on three key inquiries:  Is the firm’s process for identifying and assessing potential problems and conflicts of interest effective?  Is that process likely to identify new problems and conflicts that may occur as the future unfolds?  How effective and well-managed are the firm’s policies and procedures, as well as its process for creating and adapting those policies and procedures, in addressing potential problems and conflicts?

The full address by Mr. di Florio is available here.

Posted on Wednesday, June 6 2012 at 9:16 am by

Form PF Filing Deadlines Rapidly Approaching

As most private fund investment advisers have heard, the SEC and the Commodity Futures Trading Commission (“CFTC”) adopted new rules under the Commodity Exchange Act (“CEA”) and the Investment Advisers Act of 1940 that require Form PF filings by private fund advisers. The new Form PF filing requirement applies to SEC-registered investment advisers, as well as CFTC-registered commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”). The information collected by Form PF is designed to assist the Financial Stability Oversight Council, created under the Dodd-Frank Act, in its assessment of systemic risk in the U.S. financial system and the private fund industry. The initial filing date for Form PF is quickly approaching for certain private fund advisers, such as “large liquidity fund advisers” and “large hedge fund advisers”. Below is a breakdown of requirements and filing dates for each classification of private fund advisers.

Who must file a Form PF?
An investment adviser must file Form PF if it: (1) is registered or required to register with the SEC; (2) advises one or more private funds; and (3) had at least $150 million in regulatory Assets Under Management (“AUM”) attributable to private funds as of the end of its most recently completed fiscal year. These conditions also apply to CPOs and CTAs that manage any commodity pool that is a “private fund.”

What information is required on Form PF?
The amount and type of information required on Form PF varies based on both the size of the adviser and the types of funds managed. All private fund advisers are required to complete Sections 1a and 1b. Additionally, Section 1c must be completed by hedge fund advisers for each hedge fund they advise. Most Form PF filers or “smaller advisers” (i.e., advisers who had greater than $150 million in private fund AUM, but less than a “large” threshold at the end of the most recently completed fiscal year) will only need to complete Sections 1a and 1b of Form PF, which covers basic information dealing with the adviser’s identity and AUM. However, three types of “Large Private Fund Advisers” are required to complete additional sections:

  • Section 2 of Form PF: Large hedge fund advisers (i.e., advisers who had at least $1.5 billion in hedge fund AUM as of the end of any month during the prior fiscal quarter) must complete Section 2. This section requires additional information regarding the hedge funds these advisers manage.
  • Section 3 of Form PF: Large liquidity fund advisers (i.e., advisers who manage one or more liquidity funds and who had at least $1 billion in combined liquidity fund and registered money market fund assets as of the end of any month in the prior fiscal quarter) must compete Section 3 of Form PF. Section 3 requires information concerning funds valuation, valuation methodology, liquidity and certain identified positions.
  • Section 4 of Form PF: Large private equity fund advisers (i.e., advisers who had at least $2 billion in private equity fund AUM as of the last day of the most recent fiscal year) must complete Section 4. This section requires information dealing with the private equity fund’s activities, portfolio companies and certain creditors.

When are the reporting deadlines, compliance dates, and initial filing dates for Form PF?
Reporting deadlines, compliance dates and initial filing dates vary depending on the type and size of private fund advisers. Large liquidity fund advisers, large hedge fund advisers and large private equity fund advisers have rapidly approaching deadlines. These private fund advisers all have a compliance date of June 15, 2012. Other notable and upcoming deadlines are the initial filing dates for large liquidity fund advisers and large hedge fund advisers, which are July 15, 2012 and August 29, 2012, respectively. Other types of private fund advisers have later reporting deadlines and filing dates.

What is the reporting frequency of Form PF?
Large liquidity fund advisers and large hedge fund advisers must file Form PF quarterly, while large private equity fund advisers and smaller advisers are only required to file Form PF annually.

The CFTC and the SEC’s Joint Final Rules regarding the reporting of Form PF are available here.

Posted on Friday, April 6 2012 at 9:00 am by

Implications of the JOBS Act

The Jumpstart Our Business Startups Act (the “JOBS Act”), which ushers in a series of reforms designed to facilitate capital formation by startups and other small or emerging enterprises by easing securities law compliance requirements, was signed into law by President Obama on April 5, 2012. The principal reforms of the JOBS Act range from expanding the allowable publicity for certain private placements, to simplifying initial public offerings for “emerging growth companies”, to reducing some of the ongoing compliance obligations for emerging growth companies during the early stage of status as a public company. We recently described the key practical implications of the JOBS Act’s principal reform in our Legal Alert dated April 5, 2012, which can be found here.

While the JOBS Act appears to have been targeted at operating companies, it nevertheless has significant potential implications for privately offered investment funds. One of the most significant provisions of the JOBS Act for privately offered funds (and all private securities offerings) is the removal of the prohibition on general solicitation and advertising for securities offerings made pursuant to Rule 506 of Regulation D under the Securities Act of 1933 (commonly referred to as a “Reg D Offering”) – so long as sales are made only to accredited investors. This loosening of the most fundamental restriction on Rule 506 Offerings effectively takes the “private” out of “private placement”, and is expected by many to have a significant impact on small business capital formation. We recently discussed the implications of the removal of this prohibition in our Legal Alert dated April 24, 2012, which can be found here.

Although it is currently unclear how the SEC will chose to amend its regulations to implement the changes to Rule 506 required by the JOBS Act, allowing general solicitation and advertising would significantly impact how hedge funds and other private investment vehicles are offered, since it potentially allows these funds to publicly broadcast their securities offerings to an unlimited pool of potential accredited investors. The JOBS Act requires that the SEC implement such rule changes with 90 days, but delays in this timeline due to a rulemaking backlog at the SEC is expected.

Kilpatrick Townsend will continue to provide further updates regarding the JOBS Act as more information becomes available.

Posted on Tuesday, March 13 2012 at 5:13 pm by

FINRA Publishes its 2012 Annual Regulatory and Examination Priorities

The Financial Industry Regulatory Authority (“FINRA”) recently published its 2012 annual regulatory and examination priorities (the “2012 Examination Priorities”) to highlight new and continuing areas of significance to its regulatory programs, including topics of heightened importance to FINRA’s Enforcement Departments. The 2012 Examination Priorities represent risks that FINRA examines both broadly across the membership and in the course of targeted reviews. The 2012 Examination Priorities indicate that FINRA’s examination program is risk-based, in that the scope, content, frequency and nature of each examination will depend on the operational and risk characteristics associated with the respective firm, including the scope and scale of the firm’s operations, the products and services it sells, and the types
of clients or counterparties with which it does business. FINRA recommends that each member consider any issues discussed in the 2012 Examination Priorities that are applicable to the member, and assess whether the member’s internal controls, supervisory systems and risk management practices properly address the matters discussed.

Some of the 2012 Examination Priorities include:

  • Business Conduct and Sales Practice Concerns for Retail Customers. The 2012 Examination Priorities reflect FINRA concerns regarding the full disclosure of material risks, mispricing and overcharging issues, and the suitability of products for consumers based on those underlying risks. FINRA has specifically identified yield chasing, liquidity, the consistency of investment cash flows with investor needs and transparency regarding cash flows and financial condition of potential investments as specific concerns. The 2012 Examination Priorities also indicate that suitability reviews will retain their importance in 2012, and call attention to the new Suitability Rule (FINRA Rule 2111) and Know Your Customer Rule (FINRA Rule 2090) that become effective on July 9, 2012.
  • Private Securities Transactions and Outside Business Activities. FINRA examiners will focus on the private securities transactions of registered representatives and will review firm supervision of private securities transactions and determinations made pursuant to FINRA Rule 3270 regarding outside business activities.
  • Integrity of Supervision and Internal Controls. The 2012 Examination Priorities remind each member firm of its obligation to maintain supervisory systems and underlying internal control procedures specifically tailored to its business model, the products and services it sells and the types of clients or counterparties with which it does business, especially for firms that offer higher risk products or services.
  • Information Technology and Cyber Security. FINRA continues to be concerned about information technology and cyber security threats, and FINRA recommends that firms reassess their policies and procedures to ensure that they are adequate to protect customer assets from such risks.
  • Fees. FINRA remains concerned about firms charging retail investors hidden, mislabeled or excessive fees. FINRA will continue to investigate firms that appear to be taking advantage of investors through fee schemes.
  • Branch Office Inspections. FINRA believes that the branch inspection process is a critical component of a comprehensive risk-management program and can help protect investors and the interests of the firm, and FINRA examiners will review a firm’s internal branch office inspection program and also conduct their own branch examinations of the firm’s branch network.
  • Social Media and Electronic Communications. Social media remains an important concern to FINRA. The 2012 Examination Priorities remind members that FINRA has consistently maintained that certain core regulatory requirements apply to all communications with the public, irrespective of the medium or device used to communicate.

The full text of the 2012 Examination Priorities can be found here.

Posted on Saturday, February 18 2012 at 2:58 pm by

SEC Tightens Rules on Performance Fees Charged by Investment Advisers

On February 15, 2012, the SEC issued a revised version of Rule 205-3 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), which is the rule regarding performance fees that may be charged by registered investment advisers (the “Revised Rule”). The Revised Rule will require clients eligible to pay performance-based fees (“qualified clients”) to have at least $1 million of assets under management with the adviser, up from $750,000, or a net worth of at least $2 million, up from $1.5 million. These rule changes conform Rule 205-3’s dollar thresholds to the levels set by an SEC order in July 2011.

Similar to the recently revised definition of “accredited investor” found in Rule 501 of the Securities Act of 1933, which we discussed here, the Revised Rule excludes the value of the investor’s home and certain related debt from the net worth calculation. In addition, the Revised Rule also adds certain grandfathering provisions permitting advisers to continue to charge certain clients performance fees if such clients were considered “qualified clients” and had the performance-based fee arrangement with the adviser prior to the establishment of the new dollar thresholds described above. In addition, newly registering investment advisers are permitted to continue charging performance fees to those clients they were already charging performance fees prior to registration.

We encourage registered investment advisers that charge performance fees to their clients to review and, as necessary, update their client agreements and/or fund offering documents to help ensure compliance with the Revised Rule.

The SEC’s release regarding the Revised Rule, is available here.

Posted on Monday, February 13 2012 at 10:16 am by

CFTC Narrows Registration Exemptions for Private Fund and Mutual Fund Advisers

On February 9, 2012, the Commodity Futures Trading Commission (“CFTC”) significantly overhauled several of its rules relating to commodity pool operators (“CPOs”), including amending CFTC Rule 4.5 and rescinding CFTC Rule 4.13(a)(4).

The amended Rule 4.5 significantly limits the ability of advisers to registered investment companies (i.e., mutual funds) to rely on the rule’s exclusion from CFTC regulation, and will likely require many advisers to mutual funds that invest in commodity futures, commodity options and swaps to register as CPOs with the CFTC. Compliance with amendments to Rule 4.5 as set forth in CFTC Rule is required by the later of December 31, 2012 or within 60 days following the CFTC’s adoption of final rules defining the term “swap”.

The rescission of CFTC Rule 4.13(a)(4) eliminates the CPO registration exemption typically used by advisers to private funds that are offered to highly sophisticated investors (commonly referred to as “qualified purchaser funds” or “3(c)(7) Funds”). An adviser who previously relied upon CFTC Rule 4.13(a)(4), will now either have to restrict its commodity interest trading to qualify for the de minimus exemption available under CFTC Rule 4.13(a)(3) or register as a CPO. Those who are required to register, may be able to qualify for Rule 4.7, which applies a less burdensome system of regulation to CPOs that advise funds offered only to “qualified eligible persons”, a term that includes “qualified purchasers” eligible to invest in 3(c)(7) Funds. Advisers that have relied upon the CFTC Rule 4.13(a)(4) registration exemption prior to the effective date of the amendments (likely to be in April 2012) will have until December 31, 2012 to register as a CPO or qualify for another exemption from registration. The compliance date for all other advisers will be the effective date of the amendments.

The CFTC Rule is available here.

Posted on Tuesday, January 31 2012 at 9:00 am by

FINRA’s IARD System Will Be Available on Some Saturdays to Help Accommodate Investment Advisers who Have Waited Until the Last Minute to Register

In addition to being available from 7:00 a.m. to 11:00 p.m. ET Monday through Friday, the IARD system will also be available on Saturday, February 4, 2012, and Saturday, February 11, 2012 between 8:00 a.m. and 6:00 p.m. ET.

The IARD System Availability is available here.