Sadis & Goldberg LLP

President Obama Signs the Dodd-Frank Wall Street Reform and Consumer Protection Act


Note:  Change to the Definition of an Accredited Investor is Effective Immediately.   

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Financial Bill") into law. Set forth below are certain aspects of the Financial Bill which impact investment managers to hedge funds and private equity funds.  

The Financial Bill revises one of the definitions of an "accredited investor" under the Securities Act of 1933 ("1933 Act").   Specifically, in determining if a natural person is an "accredited investor" who meets the $1 million net worth test, the value of such person's primary residence must now be excluded from the $1 million net worth calculation.  Previously, a natural person's primary residence (net of any mortgage) was included in calculating a natural person's net worth.  The other definitions of "accredited investor" under the 1933 Act are currently remaining the same.  This change in definition is effective immediately.  As a result, we urge you to contact us as soon as possible as the Confidential Private Placement Memorandum and Subscription Documents for any investment funds you manage will need to be revised for this new definition of "accredited investor".  Please note that, absent further guidance from the Securities and Exchange Commission ("SEC"), we currently believe that the new "accredited investor" definition only applies to (i) new investors in your hedge funds and (ii) existing investors in your hedge funds that make an additional capital contribution.  We do not currently believe that you need to recertify existing investors in your hedge funds that are not making additional capital contributions.  Likewise, with respect to private equity funds, if an investor has already made a capital commitment to the fund, we do not believe that subsequent draw-downs of capital by the fund from such investor will require you to recertify such investor.  However, as with hedge funds, any investor that is making a new capital commitment to the private equity fund would need to meet the new definition of "accredited investor".    

Under the Financial Bill, the Investment Advisers Act of 1940 ("Advisers Act") will also be amended to require many investment advisers that are currently exempt from registration with the SEC to register.  Generally, the Financial Bill requires all investment advisers to hedge funds and/or private equity funds that manage $150 million or more in assets to register with the SEC.  Importantly, the "private adviser" exemption which many hedge fund and private equity fund managers relied upon in the past is being eliminated.  The "private adviser" exemption enabled an investment adviser to avoid SEC registration if it: (i) did not act as an investment adviser to a registered investment company or business development company; (ii) had fewer than 15 clients (counting each fund as 1 client); and (iii) did not hold itself out to the public as an investment adviser.  Please note that the SEC will need to issue additional guidance on numerous aspects of the Financial Bill relating to investment adviser registration and coordinate their efforts with various State regulators.  Unlike the change in the "accredited investor" definition set forth above, the new rules under the Advisers Act will become effective on July 21, 2011.     

If you have any questions concerning this Financial Services Alert or any related matters, please contact Lance Friedler, 212-573-8030.

                                       
 
The information contained herein was prepared by Sadis & Goldberg LLP for general informational purposes for clients and friends of Sadis & Goldberg LLP.  Its contents should not be construed as legal advice, and readers should not act upon the information in this Tax Alert without consulting counsel.  This information is presented without any representation or warranty as to its accuracy, completeness or timeliness.  Transmission or receipt of this information does not create an attorney-client relationship with Sadis & Goldberg LLP.  Electronic mail or other communications with Sadis & Goldberg LLP cannot be guaranteed to be confidential and will not create an attorney-client relationship with Sadis & Goldberg LLP.  

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Custody Deadline Looming for Advisers to Funds


 

To avoid becoming subject to additional requirements under SEC Rule 206(4)-2 of the Investment Advisers Act of 1940 (the "Custody Rule"), most advisers to hedge funds must deliver audited financial statements by April 30, 2010. Advisers whose clients include private investment funds must ensure that audited financial statements are delivered to all investors within 120 days of the fund's fiscal year end. An adviser to a "fund of funds" may distribute the audited financials to investors within 180 days from the end of the fund of funds' fiscal year end. The SEC defines a "fund of funds" as a pooled investment vehicle that invests 10 percent or more of its total assets in other pooled investment vehicles that are not, and are not advised by, a related person of the pool, its general partner, or its adviser. In general, the audited financial statements must be prepared in accordance with GAAP.

 

Advisers that do not distribute the audited financial statements by the required deadline will be deemed to have custody of investor assets under the Custody Rule and be subject to additional requirements, including, but not limited to, engaging an independent public accountant to perform a surprise audit before December 31, 2010.

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Attracting Retail and Institutional Investors in Europe - UCITS III


 

Entrepreneurial U.S. hedge fund managers should consider offering products under the European Union's Undertakings for Collective Investment in Transferable Securities ("UCITS III") framework.  UCITS III is the latest version of the Europe-wide regulation that allows for the creation and distribution of investment fund products throughout the European Union to retail and institutional investors.  The primary advantage to a UCITS III fund is that it may be offered to retail and institutional investors in all EU member states after its initial organization, which generally takes place in Dublin or Luxembourg.

 

According to HedgeFund Intelligence, half of all hedge fund managers are either planning or have already launched a UCITS III compliant vehicle.  UCITS III compliant vehicles are also becoming popular in Asian and Latin American countries as investors and regulators become more comfortable with the UCITS III framework.  According to JP Morgan Chase, over 40% of new UCITS sales are outside of the European Union.

 

Even though these figures appear to support a convergence between hedge funds and UCITS III vehicles, due to the UCITS III framework, not every hedge fund can be "reformatted" into a UCITS III compliant vehicle.  More liquid strategies such as absolute return, managed futures, trend followers and long-short equity can work well within a UCITS III structure; however, strategies (i) with an event driven focus, (ii) that invest in illiquid and difficult to value securities, and (iii) that rely heavily on leverage (like certain arbitrage funds) may have difficulties in operating under a UCITS III compliant structure.  Additionally, managers should be aware that under the UCITS III framework, they (i) may only invest in a prescribed list of eligible assets, (ii) are prohibited from shorting securities, (iii) are subject to limitations on the use of leverage, (iv) are subject to certain portfolio diversification mandates (e.g., no more than 10% of the fund's net asset value ("NAV") may be invested in any one transferable security), and (v) must provide investors with at least bi-monthly liquidity. 

 

However, through the use of financial derivative instruments ("FDIs") (one of the permitted assets), UCITS III compliant vehicles may employ synthetic leverage (up to 100% of NAV) and shorting, as long as the assets underlying the FDIs are considered as being eligible under the UCITS III framework.  Currently, nearly all derivatives (e.g., CFDs, repos, total return swaps and CDSs) can be used by "sophisticated" UCITS III compliant vehicles (i.e., those that employ FDIs for strategic/investment purposes) to replicate many hedge fund strategies.  All "sophisticated" UCITS III compliant vehicles are required to employ robust risk management procedures (e.g., managers must apply value-at-risk (VaR) analysis in order to assess the global exposure the UCITS compliant vehicle is undertaking and such analysis must be combined with portfolio stress-testing and back-testing).

 

The UCITS III framework will remain in place until July 2011 when the individual European Union member states are required to implement the UCITS IV Directive, adopted by the European Commission on January 13, 2009, which repeals the current UCITS III framework.  Our expectation is that the cross-border and operational benefits from UCITS IV will attract increased interest from fund managers over the coming years.

 

UCITS III compliant vehicles can offer U.S. hedge fund managers a vastly expanded pool of potential investors and distribution channels, specifically retail investors in Europe, who may not otherwise invest directly in a hedge fund, and institutional investors in Europe, who are attracted to the regulated risk management, liquidity and high transparency of UCITS III compliant vehicles. 

 

Please contact Lance Friedler at 212.573.8030 (or lfriedler@sglawyers.com) or Micah Nessan at 212.573.8034 (or mnessan@sglawyers.com) for more information on launching a UCITS III fund. 

 

 

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New SEC Personnel Emphasize More Focused Adviser Examinations


The U.S. Securities & Exchange Commission ("SEC") has significantly increased its examination and enforcement efforts in recent times. SEC examinations may be routine or based on specific cause. Cause examinations typically begin with an unannounced visit from the SEC. The purpose of the SEC examinations are to protect investors by determining whether advisers are complying with the law, adhering to the disclosures that they have provided to their clients, and maintaining appropriate compliance programs to ensure compliance with the law. While few businesses expect to become the subject of government investigations, it happens every day. Planning for an SEC examination is a critical part of an adviser's operations and preparation is vital.

 

The SEC will continue to hire and appoint experienced personnel designed to strengthen SEC examinations. On January 4, 2010, Mr. Carlo V. di Florio was named the Director of the SEC's Office of Compliance Inspections and Examinations ("OCIE"), which was formerly headed by Lori Richards. Mr. di Florio was formerly with PricewaterhouseCoopers ("PwC"), where he was a partner in the Financial Services Regulatory Practice and one of the PwC's national leaders in corporate governance, enterprise risk management, and regulatory compliance and ethics. As head of OCIE, Mr. di Florio is required to oversee the SEC's nationwide examination programs for investment advisers, broker/dealers, mutual funds, credit rating agencies, and self-regulatory organizations among other entities. Mr. di Florio has experience with investigating corporate fraud, corruption, conflicts of interest and money laundering and has directed international teams and engagements across numerous jurisdictions around the world.[1]

 

"A strong inspections and examinations unit is instrumental to the SEC's investor protection efforts. Investors rely on our examiners to ensure that their financial professionals comply with the law," said SEC Chairman Mary Schapiro, in a statement. "Carlo brings the energy, insight, and experience necessary to ensure that we keep pace with the rapid changes in the industry and continue to build upon the reforms of the past year."[2]

 

Mr. di Florio will also work closely with the SEC's recently created investigative units and their leaders as follows: asset management, headed by Bruce Karpati and Robert Kaplan; market abuse, led by Daniel Hawke; structured and new products, Kenneth Lench; foreign corrupt practices, Cheryl Scarboro; and municipal securities and public pensions, Elaine Greenberg.

 

Remember, the best time to consider your options is before you get the call. We advise our clients with regard to registration, compliance obligations, informal inquiries, no-action letters, examinations, formal investigations and enforcement actions. We also draft compliance manuals, create internal controls and perform mock audits. Please feel free to contact Daniel G. Viola at 212.573.8038 (or dviola@sglawyers.com) regarding your compliance needs or with any questions.

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[1] http://www.sec.gov/news/press/2010/2010-1.htm

[2] Id.

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November 14, 2009 is the Deadline to File Updated Disclosure Information on Form U4s


 

The Form U4 was amended to include additional disclosure questions. All associated persons of broker-dealers and certain investment adviser representatives must file an updated Form U4 answering the additional disclosure questions. Form U4s must be updated by November 14, 2009. States oversee their own Form U4 filing requirements for registered investment adviser representatives and Form U4 compliance requirements should be reviewed on a state-by-state basis.

To make the revised Form U4 filing process less onerous for broker-dealers, FINRA Rule 1010 permits broker-dealers to file amendments related to the new Form U4 disclosure section without obtaining the manual signature of associated persons, subject to certain conditions. Broker-dealers must use reasonable efforts to (1) provide the associated person with a copy of the amended disclosure information and (2) obtain the associated person's written acknowledgement (which may be electronic) that the information has been received and reviewed. Such written acknowledgments should be retained in order to satisfy the record retention requirements set forth under Rule 17a-4 of the Securities Exchange Act of 1934.

If you would like additional information, please do not hesitate to contact Daniel G. Viola at (212) 573-8038, dviola@sglawyers.com.

 

 

 

  

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New Massachusetts Privacy Protection Requirements


On January 1, 2010, new regulations will become effective in Massachusetts that will require businesses, including private investment funds and investment advisers, which store personal information of Massachusetts residents to take specific steps to safeguard such information. These regulations, entitled "Standards for the Protection of Personal Information of Residents of the Commonwealth" (the "Privacy Regulations"), apply to the storage of data in paper or electronic format. Personal information is considered to be the combination of a name along with a Social Security number, bank account number, credit card number or state issued identification card number. Businesses that maintain such personal information about residents of Massachusetts will be required to implement, maintain and monitor a detailed, written information security program. Computer system security requirements include administering secure user authentication protocols, secure access control measures and firewalls and maintaining current security software. In addition, such businesses must establish and maintain a security system that, wherever technically feasible, encrypts any personal information that is stored on portable devices, transmitted wirelessly or conducted on public networks.

Massachusetts added the "technical feasibility" standard to the regulation in August to make the rule more consistent with federal law and to take reasonableness into account. Encryption is considered to be "technically feasible" if "there is a reasonable means through technology to accomplish a required result." (Frequently Asked Questions Regarding 201 CMR 17.00 http://www.mass.gov/Eoca/docs/idtheft/201CMR17faqs.pdf.) Whenever encryption is not technically feasible, best practices should be implemented to protect personal information, such as not sending emails that contain personal information.

Although the Privacy Regulations specify elements that should be incorporated into an information security program, because the regulations may be difficult for small businesses to implement to the same extent as large businesses, small businesses are permitted to tailor their programs. Factors that small businesses may consider in the implementation of their program include: (1) the size, scope and type of business; (2) the amount of available resources; (3) the amount of data stored by the business; and (4) the need for security and confidentiality of information.

Through the Privacy Regulations, Massachusetts is placing the onus on businesses to proactively prevent breaches of private data by requiring the implementation of specific data protection and compliance standards.

If you have any questions as to how the Privacy Regulations apply to your business, please do not hesitate to contact Daniel G. Viola at (212) 573-8038, dviola@sglawyers.com.

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