Private Fund Update February 9, 2015 Scott E. Gluck, Esq. Venable LLP Washington, DC Office: t 202.344.4426 c 540.454.4820 Los Angeles Office: t 310.229.9900 c 540.454.4820 sgluck@Venable.com www.Venable.com NOTE: The Association for Corporate Growth is having its next Private Equity Regulatory Task Force (PERT) meeting/conference call this Thursday, February 12 at 4:00 p.m. ET. This comes on the heels of a few busy weeks for PERT, which included meetings with the SEC's Division of Investment Management and the Deputy Director of OCIE. This call is limited to private equity compliance officers, financial officers, and inhouse counsel. To participate, please contact Amber Landis at firstname.lastname@example.org or call her at 312.957.4272. Here is my most current Private Fund Update, which includes: • The SEC's 2015 OCIE examination priorities; • The SEC's recent cybersecurity examination sweep survey; and • PEGCC's comment letter on AIFMD. Venable LLP tracks a wide range of regulatory issues, so please contact me for more information regarding anything in this update. The 114th Congress House of Representatives The full House of Representatives passed H.R. 37, the "Promoting Job Creation and Reducing Small Business Burdens Act," which cobbled together nearly a dozen separate bills from the last Congress. Of particular relevance, the bill would: • Exempt "M&A Brokers" from registration under the 1934 Securities Exchange Act. However, to qualify as an M&A Broker, the party cannot receive, hold, transmit, or have custody of the funds or securities to be exchanged – thereby excluding most private equity funds from relief; and • Provide regulatory relief to investment advisers of SBICs by clarifying that: o The definition of a venture capital fund includes an SBIC fund; o The AUM of SBIC funds does not count towards the $150 million AUM IAA registration threshold; and o The same exemption applies with respect to any state or local law requiring the registration, licensing, or qualifications of investment advisers. H.R. 37 passed the House by a vote of 271-154, with 29 Democrats voting in favor. Thus far, the House Financial Services Committee has been focused on housing finance/GSE reform, holding three hearings on the FHFA, FHA, and HUD.The Senate Thus far, the Senate has focused on regulatory relief for community banks and credit unions, with the Senate Banking Committee holding two hearings this week on the issue (here and here). The Administration President's Proposed FY 2016 Budget The President released his proposed FY 2016 budget last week. Of particular note, the President proposes over $1.7 billion in funding for the Securities and Exchange Commission (SEC) and $322 million for the Commodity Futures Trading Commission (CFTC) – a proposed increase of over 25%. As noted previously, in the SEC's FY 2015 Budget Request, the two largest requested funding increases are for the Office of Compliance Inspections and Examinations (OCIE) and the Division of Enforcement, with Chairwoman White seeking to add 316 staff positions at OCIE and 126 at Enforcement. FSOC Announces Changes in Non-bank Designation Process Last week, the Financial Stability Oversight Council (FSOC) voted to adopt certain changes relating to its process for reviewing nonbank financial companies for potential designation as systemically important financial institutions (SIFI). The changes fall into three categories: • More Engagement – FSOC will inform companies earlier when they come under review and provide additional opportunities for engagement with FSOC staff. • More Transparency – FSOC will make available to the public more information about the SIFI designation process. • Annual Reevaluations – FSOC will amend its annual review process to allow more engagement between designated companies and FSOC staff. FSOC also released Supplemental Procedures Relating to Nonbank Financial Company Determinations and FAQs Regarding Nonbank Designations. Securities and Exchange Commission OCIE Examination Priorities for 2015 – Includes Private Equity Fees and Expenses OCIE released its Examination Priorities for 2015. The three key areas identified are protecting retail investors, assessing market-wide risks, and using data analytics to detect illegal activity. However, OCIE notes that "Given the high rate of deficiencies that we have observed among advisers to private equity funds in connection with fees and expenses, we will continue to conduct examinations in this area." Cybersecurity Examination Sweep Summary The SEC's Office of Compliance Inspections and Examinations (OCIE) released a Cybersecurity Examination Sweep Summary, which contains observations based on OCIE's examination of more than 100 broker-dealers and investment advisers focused on how these firms (i) identify cybersecurity risks; (ii) establish cybersecurity policies, procedures, and oversight processes; (iii) protect their networks and information; (iv) identify and address risks associated with remote access to client information, funds transfer requests, and third-party vendors; and (v) detect unauthorized activity. Observations include: • The vast majority of examined broker-dealers (93%) and advisers (83%) have adopted written information security policies; • 93% of broker-dealers and 79% of advisers conduct periodic risk assessments, on a firm-wide basis to identify cybersecurity threats, vulnerabilities, and potential business consequences, although fewer apply these requirements to vendors; and• 88% of broker-dealers and 74% of advisers reported that they have been the subject of a cyberrelated incident directly or through one or more of their vendors. The majority of the cyber-related incidents are related to malware and fraudulent emails. OCIE also released an Investor Bulletin on how investors can better protect their online brokerage accounts from fraud. Relevant Enforcement Actions/Administrative Proceedings Although there have been a few enforcement actions relating to overt fraud by investment advisers, one I wanted to bring to your attention is an administrative proceeding involving New Line Capital, relating to improper registration and material misstatements made in its Forms ADV. Specifically, New Line represented that its principal office and place of business was in Wyoming, which does not regulate investment advisers, in order to be able to maintain the firm's SEC registration after the 2010 Dodd-Frank Act increased the AUM requirement for SEC registration (Wyoming is the only state that does not regulate investment advisers, which allowed New Line to keep its SEC registration). Also noteworthy are charges filed against F-Squared Investments, which agreed to pay $35 million and admit wrongdoing to settle charges it defrauded investors through false performance advertising about its flagship product. According to the allegations, F-Squared falsely advertised a successful seven-year track record when, in reality, the algorithm was not even in existence during the seven-year period. FSquared specifically advertised the investment strategy as "not backtested" when the data was actually derived through backtesting. The hypothetical data contained a performance calculation error that inflated the results by approximately 350%. Personnel Changes at the SEC Last week, David Grim was named Acting Director of the Division of Investment Management. He replaces Norm Champ, the division's former director, who left the SEC at the end of January. Commodity Futures Trading Commission White Paper by CFTC Commissioner Christopher Giancarlo In late January, CFTC Commissioner Christopher Giancarlo released a White Paper titled "Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank," in which he argues that there is a mismatch between the CFTC's swaps trading regulatory framework and the liquidity and trading dynamics of the global swaps market. Giancarlo criticizes the CFTC's framework as overengineered, disproportionately modeled on the US futures market, and biased against both human discretion and technological innovation. As a result, Giancarlo believes that the current regulatory regime is (among other things) driving global market participants away from transacting with entities subject to US swaps regulation, increasing market liquidity risk and wasting taxpayer money. He then introduces an alternative swaps trading regulatory platform focused on comprehensiveness, cohesiveness, flexibility, professionalism, and transparency. Association for Corporate Growth (ACG) Recent Private Equity Regulatory Task Force (PERT) Activities The past few weeks have been very busy for ACG's Private Equity Regulatory Task Force (PERT), which consists of middle-market private equity fund chief financial officers, chief compliance officers, and inhouse general council. In December, PERT held its second general meeting, which was attended by over 50 PERT members and prospects. To help the group better address key regulatory challenges, PERT's steering committee approved the creation of six subgroups: • Broker-dealer registration; • Co-investments;• Code of conduct; • Fees and expenses; • Marketing and advertising; and • Valuations. Last week, PERT members met with counsel from the SEC's Division of Investment Management to discuss issues arising under the Investment Advisers Act. The following day, Marc Wyatt, Deputy Director of OCIE, addressed more than 100 ACG members. Registration Opens for InterGrowth Early registration has opened for ACG's InterGrowth 2015, which will take place April 13-15 at the Waldorf Astoria and Hilton Bonnet Creek in Orlando, Florida. Greg Norman is the keynote speaker. Report on Key Findings of SEC Task Force Survey ACG released the key findings of its ACG SEC Task Force Survey, which targeted private equity chief compliance, financial, and operations officers, as well as in-house legal counsel. Over 200 people responded to the survey. Key findings include: • Middle-market private equity officers are concerned with a broad range of issues; • SEC presence examinations appear to have improved over time; • The SEC could improve its outreach to the middle-market private equity industry; and • Respondents want ACG's SEC Task Force to carry out a broad range of activities. ACG also held a webinar describing the survey findings in greater detail. Small Business Investor Alliance (SBIA) SBIC Regulations Class – February 19, 2015 The SBIA and the SBA will be holding an SBIC Regulations Class on February 19, 2015. The class is mandatory for any fund seeking an SBIC license. Space is limited and classes usually sell out, but interested persons can contact the SBIA at events@SBIA.org to be added to the waiting list. Private Equity Growth Capital Council (PEGCC) PEGCC Releases Q2 2014 Private Equity Performance Update PEGCC released its Private Equity Performance Update for Q2 2014. The Update shows that as of June 30, 2014, returns from private equity funds (net of fees) beat the S&P 500 (including dividends) for the 10-year horizon by 6.5 percentage points. The S&P 500 outperforms the private equity benchmark return for the 1, 3, and 5-year horizons. Comment Letter on AIFMD PEGCC sent a comment letter to the European Securities and Markets Authority (ESMA) in response to ESMA's Call for Evidence - AIFMD Passport and Third Country AIFMs. The letter argues that due to the robust and comprehensive US regulatory regime, there are "no significant obstacles regarding investor protection, market disruption, competition and the monitoring of systemic risk" that would impede the application of the Passporting Regime to US AIFMs and the alternative investment funds (both US and non-US) they manage.Articles of Note Here are some articles you may find interesting: • Private Funds Management, 2/6/15 (subscription required): "SEC Official: Don't Be Afraid to Ask Questions," – Describing OCIE Deputy Director Marc Wyatt's remarks at ACG's Policy Summit in Washington, DC. • PE Hub, 2/2/15: "Frank Advocates Changes to Dodd-Frank PE Registration" – Former House Financial Services Chairman Barney Frank stated at the recent PEI CFO/CCO conference that he believes Congress should consider increasing the $150 million threshold above which private equity firms must register with the SEC under the IAA. • Reuters, 1/22/15: "SEC Official Sees No Immediate Crackdown on Private Equity" – Igor Rozenblit says that any enforcement cases against private equity firms over how they handled fees and expenses could take years to build, but that may not be necessary in many instances. • Dealbook, 1/22/15: "After Inspecting Private Equity Funds, S.E.C. Examiners to Broaden Focus" Igor Rozenblit says that OCIE will look beyond buyout funds to examine "adjacent illiquid asset classes" and "liquid asset classes," potentially including funds that invest in real estate and similar assets. • ILPA, 1/8/15: "Response to the ESMA call for evidence on the AIFMD Passport and Third Country AIFMs" – The International Limited Partners Association (ILPA) wrote a comment letter in response to ESMA's Call for Evidence regarding AIFMD. Upcoming Dates and Events Here are some upcoming dates and events you should be aware of: • February 9-10 – SBIA Southern Private Equity Conference • Thursday, February 12 – PERT meeting/conference call • Thursday, February 19 – PERT Valuations Subcommittee conference call • Thursday, February 19 – ACG Charlotte Middle-Market Policy Summit • Thursday, February 19 – SBIC Regulations Class • Tuesday, February 24 – PERT Co-Investment Subcommittee conference call • April 13-15 – InterGrowth 2015 If you would like to opt out of receiving this communication, just let me know. © 2014 Venable LLP. This email is published by the law firm Venable LLP and is not intended to provide legal advice or opinion. Such advice may only be given when related to specific fact situations that Venable has accepted an engagement as counsel to address. ATTORNEY ADVERTISING.