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 Friday, June 15 2012 at 8:15 pm by

SEC Approves Amended FINRA Rule 5123 on Private Placement of Securities

On June 7, 2012, the Securities and Exchange Commission (the “SEC”) approved a revised version of Financial Industry Regulatory Authority (“FINRA”) Rule 5123 (“Rule 5123”) on an accelerated basis. The new rule will marginally increase the reporting burdens on FINRA member firms that sell certain private placements to certain classes of accredited investors. The effective date for Rule 5123 has not yet been determined.

Under revised Rule 5123, FINRA member firms that sell a security in a nonpublic offering are required to:

(1)  submit to FINRA a copy of any existing offering document, including Private Placement Memoranda, term sheets, or other offering documents, used in connection with a private placement within 15 calendar days of the date of the first sale, in addition to any material amendments to documents that were previously-filed; or

(2)  indicate to FINRA that no such offering documents were used in connection with such sale.

FINRA will use the information gathered from Rule 5123 filings to aid in the detection and prevention of fraud and to assist with the identification of problematic terms and conditions found in private placement offering documents. All documents filed pursuant to Rule 5123 will receive confidential treatment and will only be used for the purpose of determining compliance with FINRA rules and other relevant regulatory purposes.

Various exemptions from the Rule 5123 filing requirements are available depending on the type of offering and the type of purchasers that are involved. We encourage all FINRA member firms to carefully review the requirements and exemptions contained in the SEC order granting accelerated approval of FINRA Rule 5123 (the “Rule 5123 Order”).

The Rule 5123 Order is available by clicking 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 Wednesday, May 30 2012 at 7:53 pm by

Recent Retirement Plan Fee Disclosures Now Required

The first disclosures by fiduciaries, registered investment advisers and certain other service providers to retirement plans under section 408(b)(2) of ERISA (the “408(b)(2) Disclosures”) are due on July 1, 2012. The 408(b)(2) Disclosures apply to service providers (including investment advisers) to retirement plans subject to the fiduciary provisions of ERISA, which include most 401(k) plans and pension plans, and generally require disclosures regarding services provided to, and fees payable by, retirement plans. Service providers who do not comply with the 408(b)(2) Disclosures may be subject to penalties by the Department of Labor. For more information, see the DOL’s fact sheet on the 408(b)(2) Disclosures, available here.

Posted on Tuesday, April 24 2012 at 11:49 pm by

The JOBS Act: What to Expect from the Not-So-Private Private Placement Regulations

One of the most significant provisions of the Jumpstart Our Business Startups Act (the “JOBS Act”), which was signed into law by President Obama on April 5, 2012, 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 (“Rule 506 Offerings”) – so long as sales are made only to accredited investors.

This loosening of the most fundamental restriction on Rule 506 Offerings, which effectively takes the “private” out of “private placement”, is expected by many to have a much greater impact on small business capital formation than the headline-grabbing crowdfunding provisions of the JOBS Act. This is because the crowdfunding provisions only allow for relatively small offerings and impose a fairly complex and potentially burdensome regulatory scheme. The elimination of advertising prohibitions for Rule 506 Offerings, on the other hand, is a simple change with immediate impact because it will allow for Rule 506 Offerings to be broadcast to an unlimited number of investors for an unlimited amount of money so long as sales are made only to accredited investors.

….to read the rest of this article, please select this link.

Posted on Wednesday, April 18 2012 at 11:47 pm by

SEC Solicits Comments on JOBS Act Rulemaking Ahead of Publishing Proposed Rules

The SEC has posted an invitation for interested parties to provide preliminary comments regarding the rulemaking it must conduct in connection with the JOBS Act. While it is not common practice for the SEC to solicit public comments before it has actually promulgated proposed rules, it is not unprecedented either—it employed the same process in connection with its substantial rulemaking responsibilities under the Dodd-Frank Act. Interested parties will also have an opportunity to comment on JOBS Act rules during the formal comment period after publication of proposed regulations in the Federal Register. The preliminary comments can be submitted electronically here.

Please contact us if you would like assistance in submitting comments.

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 Thursday, April 5 2012 at 11:36 pm by

New JOBS Act Facilitates Private and Public Capital Formation

The President is expected to sign into law this week the new Jumpstart Our Business Startups (JOBS) Act, which ushers in a series of reforms to facilitate capital formation by startups and other small or emerging enterprises by easing securities law compliance requirements. The principal reforms range from expanding sales techniques 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.

Although a few provisions of the JOBS Act are self-effectuating from its effective date, the JOBS Act requires substantial rulemaking by the Securities and Exchange Commission (“SEC”) for full implementation of its reforms. Given the substantial SEC rulemaking backlog (much of which relates to required actions under the Dodd-Frank Act), the rulemaking timelines in the JOBS Act will be extremely difficult to meet.

This Legal Alert discusses the key practical implications of the JOBS Act’s principal reforms, assuming implementation by the contemplated SEC rulemaking.

….to read the rest of this article, please select this link.

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