As we begin the new year, we thought it would be helpful to remind our clients that manage separate accounts or private funds, whether hedge funds, private equity funds, commingled funds, collateralized loan obligations, or commodity pools, of certain obligations that may be applicable to them as “Investment Managers” under various U.S. federal and state laws and regulations.
Some of the guidance contained in this memorandum relates to strict legal requirements imposed by statute or regulatory agencies while other guidance is more accurately characterized as best practices recommendations. The beginning of the new year may be a logical time to review and satisfy, or at least schedule the review of, these obligations, many of which apply to both registered and unregistered advisers.
For your convenience, a table of contents can be found on the following page so that you may more easily reference the information that is relevant to your organization. Additionally, a brief summary of key dates for 2015 and regulatory highlights from 2014 can be found at the end of this briefing in Appendices A and B respectively.
Please contact us should you have any questions regarding compliance with any of the following or their applicability to your specific situation.
This summary is not intended to provide a complete review of an Investment Manager’s obligations relating to compliance with applicable tax, partnership, limited liability, trust, corporate or securities laws or rules, or non-U.S. or U.S. state law requirements.1
1 This briefing is not intended to be exhaustive, or to provide a detailed statement of the specifics of any particular obligation. The following necessarily does not include all annual or periodic obligations applicable to all Investment Managers. Similarly, many of the obligations described below may not be applicable to all Investment Managers.
© 2015 Winston & Strawn LLP
Table of Contents
- Update and file Form ADV.
Investment Managers that are registered with the Securities and Exchange Commission (“SEC”) as investment advisers (“Registered Managers”) under the Investment Advisers Act of 1940 (the “Advisers Act”) must update and file their Form ADV with
the SEC on an annual basis within 90 days of the Registered Manager’s fiscal year end (March 31, 2015 for those with a fiscal year end of December 31). In addition, a Registered Manager must update its Form ADV promptly at any time certain information becomes inaccurate.
ii. Confirm state notice filings/investment adviser representative renewals.
Registered Managers should review their current advisory activities in the states in which they conduct business and confirm that all required state notice filings have been made on the Investment Adviser Registration Depository website (“IARD”). Registered Managers also should confirm whether any of their personnel need to be registered as “investment adviser representatives” in one or more states and,
if so, register those persons or renew such persons’ registrations with the applicable states, as needed.
Practice Tip: Registered Managers should confirm that their IARD electronic accounts are adequately funded so as to cover payment of all applicable registration renewal fees with both the SEC and with any states. For purposes of funding the account and scheduling payments therefrom, please note that it may take several days for deposited funds to appear in the IARD account.
iii. Prepare and file Form PF.
Form PF is required of Registered Managers that manage private funds with assets under management attributable to those funds of at least $150 million.
A Registered Manager that is characterized as a “large hedge fund adviser” or a “large liquidity fund
adviser” is required to file Form PF with the SEC within, respectively, 60 days of the end of each calendar quarter or 15 days of the end of each calendar quarter.
For other Registered Managers, Form PF is due 120 days after the end of the Registered Manager’s fiscal year (April 30, 2015, for those with a fiscal year end of December 31). The rules regarding what constitutes
a “large hedge fund adviser,” “large liquidity fund adviser,” “large private equity adviser,” and when an adviser must aggregate information about certain funds can be complex; please contact your usual Winston and Strawn attorney with any questions or for additional guidance.
Registered Managers that are dually registered with the CFTC will satisfy certain CFTC reporting
obligations by filing private fund information on Form PF. Specifically, the dually registered adviser will not need to file Schedules B and C of Form CPO-PQR if the adviser files information on all relevant pools on Form PF. Please see below for a further discussion of CFTC filing requirements.
Practice Tip: Registered Managers to private funds with a fiscal year end of December
31 and that are subject to the Form PF filing requirements should begin the process of completing Form PF now as the information required to be reported may require coordination with the Registered Manager’s back office function and/or service providers.
i. Deliver brochure to clients.
Under the Advisers Act, Registered Managers are required to provide new and prospective clients with a narrative brochure (Part 2A of Form ADV) regarding the firm as well as brochure supplements (Part 2B of Form ADV) regarding certain of the firm’s advisory personnel. Registered Managers must deliver to clients, within 120 days of the end of the Registered Manager’s fiscal year, either (i) a free updated brochure that includes, or is accompanied by, a summary of material changes, or (ii) a summary
of material changes that includes an offer to provide a copy of the updated brochure and information on how a client may obtain the brochure.
ii. Deliver fund’s audited financial statements.
Under the Advisers Act’s “Custody Rule,” Registered Managers of private funds who are deemed to have custody of client assets and wish to avoid complying with the “surprise audit” requirement of the Custody
Rule must provide audited financial statements of their funds, prepared in accordance with U.S. generally accepted accounting principles, to the fund’s investors within 120 days of the fund’s fiscal year-end (or 180 days for a fund-of-funds). Registered Managers that do not satisfy the delivery of audited financial statement requirement must confirm that they are compliant with all obligations under the Custody Rule, including the annual surprise audit requirement.
Practice Tip: The SEC has recently taken enforcement actions against an advisory firm and its chief compliance officer for substantial and repeated late deliveries of audited financial statements. Clients should review their practices to ensure compliance with the SEC’s custody rules.
iii. Privacy Notice.
c. Other requirements.
i. Review required compliance procedures.
Pursuant to Rule 206(4)-7(b), promulgated under the Advisers Act, Registered Managers must review their compliance policies and procedures at least annually to assess their effectiveness. This review also should include an assessment of the adequacy
of the firm’s code of ethics, including an assessment of its effectiveness as implemented. At a minimum, Registered Managers should ensure their policies and procedures have been updated to address legal and regulatory changes (including compliance with any disclosure or reporting standards), all significant compliance matters that arose during the previous year, any significant changes in the business activities of the Registered Manager or its affiliates, and any other changes in regulatory guidance or agency rules that would suggest a need to revise the Registered Manager’s policies and procedures. As part of this review, Registered Managers should determine whether they need to provide any compliance or
ethics-related training to employees, or enhancements
in light of current business practices and regulatory developments. Written evidence of such reviews should be retained.
Practice Tip: Registered Managers should pay particular attention to their policies and
procedures that relate to areas of recent focus by the SEC, such as: valuation, conflicts of interest, confidentiality of client information and insider trading. Attention should also
be given to those areas highlighted by the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) in the SEC’s National Exam Program’s Examination Priorities
for 2015, a copy of which may be found at: SEC 2015 Exam Priorities. As stated therein, priorities for this year will include reviews of: (i) recommendations to retail clients of account types, fee structures, and the disclosures related thereto; (ii) sales practices, particularly those directed at movement of employer-sponsored
retirement accounts; (iii) recommendations made to investors, particularly with respect to complex or structured products; (iv) registrants’ supervision of representatives with previous disciplinary or other indications of misconduct and of branch offices and personnel associated with such branches; (v)
alternative investment companies, particularly their policies related to leverage, liquidity, and valuation as well as internal control factors dealing with staffing, boards, and compliance personnel; (vi) cybersecurity programs; (vii) best execution, particularly potential conflicts of interest arising from rebates and other payments to route order flow; (viii) microcap fraud; (ix) anti-money laundering; (x) proxy voting; (xi) investment companies that have previously not been examined and (xii) fees and expenses charged by private equity funds.
Additionally, the SEC is expected to continue a 2014 initiative focused on investment advisers that have not yet been subject to an examination but have been registered
for more than three years. There will be a particular emphasis on wrap fee programs, quantitative trading models and payments by advisers and funds to entities that distribute mutual funds.
Registered Managers should review and stress-test their business continuity/disaster recovery plans no less than annually and make any necessary
adjustments. Written evidence of these reviews should be retained.
iii. “Pay-to-Play” Practices.
Rule 206(4)-5 under the Advisers Act restricts the political contribution and solicitation practices of Investment Managers and certain of their related persons. Specifically, Rule 206(4)-5 prohibits an Investment Manager from (i) receiving compensation for providing advisory services to government entities for a specified period of time after making political contributions to people or parties that may have the ability to influence a government entity’s decision
to employ such Investment Manager. Investment Managers should review their policies and procedures annually to (i) ensure that employees are aware of Rule 206(4)-5 and (ii) that the Investment Manager
has an accurate record of contributions made by both the Investment Manager and its covered employees. Investment Managers subject to Rule 206(4)-5 should keep books and records of the relevant contributions as well as their annual reviews.
II. Requirements for CPOs and CTAs
a. Filings for Registered CPOs and CTAs.
i. Review and update NFA registration.
CPOs and CTAs registered with the CFTC must update their registration information via the National Futures Association (“NFA”) Online Registration System’s annual registration questionnaire and must also pay their annual NFA membership dues and annual records maintenance fees on or before the anniversary of their registration’s effectiveness. The NFA will deem a failure to complete the review of the annual registration questionnaire within 30 days
following the date established by the NFA as a request for withdrawal from registration.
ii. File and distribute commodity pool certified annual reports.
Registered CPOs must file certified annual reports for their pools with the NFA within 90 days of the pool’s fiscal year-end (including pools that are fund-of-funds).
The certified reports must be filed electronically through the NFA’s EasyFile system. The Registered CPO also must distribute the certified reports to the pool’s participants within the above 90 day deadline, unless the NFA grants an extension.
iii. File annual reaffirmation.
Persons that claim an exemption under CFTC Regulations 4.5, 4.13(a)(1), 4.13(a)(2), 4.13(a)(3), 4.13(a)
(5) or 4.14(a)(8), including registered CPOs and CTAs, must annually reaffirm their exemptions. Investment Managers claiming one or more of these exemptions will have 60 days after each calendar year-end
to reaffirm the notice of exemption through NFA’s Electronic Exemption System. Any person that fails to file a notice reaffirming the exemption will be deemed to have requested a withdrawal of the exemption.
iv. CFTC and NFA Form CPO-PQR.
A registered CPO is required to file certain information on CFTC Form CPO-PQR. The CFTC Form CPO-PQR
filing requirements are based upon the CPO’s size and whether the CPO also is dually registered as an investment adviser with the SEC and files a Form PF. CFTC Form CPO-PQR contains three sections:
Schedule A, Schedule B and Schedule C. Large CPOs, that is those with at least $1.5 billion of assets under management, are required to file Schedules A, B and C of CFTC Form CPO-PQR quarterly within 60 days of each quarter-end. Mid-Sized CPOs, that is those with at least $150 million, but less than $1.5 billion, of assets under management are required to file Schedules A and B of CFTC Form CPO-PQR annually within 90 days after year-end. Small CPOs, that is those with less
than $150 million of assets under management, are required to file Schedule A of CFTC Form CPO-PQR plus a Schedule of Investments annually within 90 days after year-end.
CPOs may also be required to file quarterly NFA Form CPO-PQR, which consists of certain questions from Schedule A and step 6 of Schedule B of CFTC Form CPO-PQR. As noted above, CPOs that are dually registered as investment advisers with the SEC may satisfy certain of their CFTC Form CPO-PQR filing obligations by filing Form PF with the SEC.
All registered CTAs must file CFTC Form CTA-PR annually within 45 days of the end of the fiscal year. In addition, each registered CTA that is an NFA member must also file NFA Form CTA-PR within 45 days of each quarter-end. NFA Member CTAs can meet their CFTC filing requirement by filing their NFA Form CTA- PR for that quarter. CFTC Form CTA-PR and NFA Form CTA-PR are identical and cover certain identifying information about the CTA, the CTA’s trading program, and performance information.
b. Deliveries - Privacy Notice.
c. Other requirements.
i. Complete NFA self-examination questionnaire.
Under NFA rules, registered CPOs/CTAs must complete and sign the NFA’s “self-examination questionnaire” and applicable supplements on an annual basis. The completed questionnaire is not filed with the NFA; instead, Investment Managers must retain the questionnaire in their files for five years, with the questionnaire being readily accessible during the first two years. Investment Managers that have branch offices should complete a separate questionnaire for each branch office. As part of this review, CPOs/CTAs should review any established compliance policies and procedures and confirm whether amendments to those procedures, or additional procedures, may be warranted in light of the CPOs’/CTAs’ current business.
ii. Comply with NFA-required ethics training policy.
Under the NFA’s required ethics training rules, registered CPOs/CTAs should periodically consider whether any of their registered associated persons are in need of additional ethics-related training.
iii. Review NFA-required business continuity/ disaster recovery plan.
Under the NFA’s rules, registered CPOs/CTAs should periodically “stress test” their required business continuity/disaster recovery plans to assess their effectiveness and make any necessary adjustments. Such plans also should be updated to reflect any material changes to operations.
iv. Determine registration status of exempt clients.
NFA Bylaw 1101 prohibits NFA members from carrying an account, accepting an order or handling a transaction in commodity futures contracts for
any non-member of the NFA that is required to be registered with the CFTC. Registered CPOs/CTAs must take reasonable steps to determine the registration and membership status of clients who were previously exempt. Pursuant to NFA Notice I-14-06, the NFA
has made information about pool operators and pools available through the BASIC System which lists whether individuals either have properly filed an annual notice affirming their exemption under CFTC Regulation 4.5, 4.13(a)(1), 4.13(a)(2), 4.13(a)(3), or 4.13(a)
(5) 4.14(a)(8) or have withdrawn their exemption. For any exclusions or exemptions that do not require annual affirmation, proper steps by the NFA member may involve contacting clients to determine whether they have registered or if they intend to file a notice affirming their exemption, as applicable, and obtaining a written representation to that effect.
III. Generally Applicable Filing Requirements
a. Amend Schedules 13G or 13D.
Investment Managers whose client or proprietary accounts, separately or in the aggregate, are beneficial owners of five percent or more of a registered voting equity security, and who have reported these positions on Schedule 13G, must update these filings annually within 45 days of the end of the calendar year, unless there is no change to any of the information reported in the previous filing (please note there is an exception for changes to a
holder’s percentage ownership due solely to a change in the number of outstanding shares).
Investment Managers reporting on Schedule 13D are required to amend their filings “promptly” upon the occurrence of any “material changes” including, but not limited to, any increase or decrease representing one percent or more in their holdings of a registered voting equity security. Investment Managers whose client or proprietary accounts are beneficial owners of ten percent or more of a registered voting equity
security also must determine whether they are subject to any reporting obligations, or potential “short-swing” profit liability or other restrictions, under Section 16 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Practice Tip: As part of the SEC’s “broken windows” approach to enforcement, on September 10 2014, the SEC announced charges against 28 officers, directors and investment firms for failing to make timely filings of reports on Form 4 and Schedules 13D and 13G under the Exchange Act. In addition, the SEC brought charges against six public companies for contributing to the failure
of their officers and directors to file timely reports. While the charges were brought against individuals and companies that had repeated and/or extreme violations, these charges demonstrate both the SEC’s new technological tools allowing them to more easily find and cite individuals for violations as well as the SEC’s stated interest in going after relatively minor violations as a means of encouraging broader compliance with the SEC’s overall rule set. A copy of the press
b. File Form 13F.
All “institutional investment managers” must file a Form 13F disclosing certain information regarding their holdings with the SEC if they exercise investment discretion with respect to $100 million or more in securities subject to Section 13(f ) of the Exchange Act. The official list of Section 13(f ) securities can be found at: http://www.sec.gov/divisions/investment/13flists. htm. The first filing of Form 13F must occur within 45 days after the end of a calendar year during which
the Investment Manager reaches the $100 million filing threshold (calculated as of the last trading day of any month in that year), and within 45 days of the
end of each calendar quarter thereafter. The reporting obligation continues for so long as the Investment
Manager satisfies the $100 million filing threshold (again, calculated as of the last trading day of any month during the year).
c. Amend Form 13H.
Pursuant to Rule 13h-1 of the Exchange Act, all Investment Managers and other persons that meet the “Large Trader” definition must update their Form 13H on an annual basis within 45 days after the calendar year-end. In addition, if any information in Form 13H becomes inaccurate for any reason, Large Traders must file an amended Form 13H by the end of the calendar quarter during which the information
becomes inaccurate. Large Traders must also disclose their large trader identification number to each broker- dealer effecting covered transactions on their behalf. The definition of a Large Trader and its application can be complex. Clients that may be unclear of their large trader status are urged to contact their usual Winston and Strawn attorney for additional guidance.
d. “FBAR” filing requirements and Form 114.
United States persons with “financial interests” in, or signature authority over, “financial accounts” in foreign countries that in the aggregate exceed $10,000 in value at any time during the calendar year, must file
a Report on Foreign Bank and Financial Accounts (“FBAR”) on Financial Crimes Enforcement Network (“FinCEN,” a unit of the U.S. Department of the Treasury) Report 114 by June 30th of the following year. Investment Managers must evaluate annually whether accounts maintained on behalf of clients, particularly offshore private funds, trigger FBAR filing obligations.
An officer or employee of a financial institution that is registered with and examined by the SEC or CFTC is not required to report signature authority over a foreign financial account owned or maintained by the financial institution. Even for those individuals who do not meet the preceding exception, the filing deadline for individuals with signature authority over, but no financial interest in, foreign financial accounts
of their employer or a closely related entity, has been extended to June 30, 2016, by FinCEN Notice 2014-1.
e. Form SLT.
Certain entities are required to complete and submit the Department of the Treasury’s Form SLT, which aims to capture information regarding transactions of
long-term securities2 between United States residents and foreign entities. United States entities (including hedge funds, private equity funds and commingled funds) that either issue securities to foreign residents and/or hold securities issued by foreign entities,
are required to file a Form SLT if the amount of such securities exceeds $1 billion (and such securities are not otherwise held by a U.S.-resident third
party custodian). For private funds that meet these thresholds, the funds’ Investment Managers likely will be the reporting person for purposes of Form SLT. Entities subject to Form SLT reporting requirements must complete and file a Form SLT on a monthly basis. Additionally, once the $1 billion threshold is met in a month, the reporting entity must provide a Form SLT each month for the remainder of the calendar year, regardless of whether the $1 billion threshold is met in later months of that calendar year.
IV. Other Requirements or Best Practices (including those relating to unregistered Investment Managers)
a. Exempt reporting advisers.
Advisers relying on the private fund adviser exemption or the venture capital fund adviser exemption generally must file a report as “Exempt Reporting Advisers” (“ERAs”) by completing certain items on
Part 1 of Form ADV. The deadline for submitting this report is within 60 days of initially becoming an ERA. Thereafter, ERAs must update their Form ADV on an annual basis within 90 days of the end of the fiscal year.
i. Privacy Law.
In addition, Investment Managers that are not subject to Regulation S-P or CFTC Rules, because they are not registered, are still generally subject to the Federal Trade Commission privacy requirements and also
may be subject to state privacy laws that may impose additional requirements.
2 Long-term securities are securities without a stated maturity date (such as equities) or with an original term-to-maturity greater than one year.
ii. Business Continuity/Disaster Recovery Plans.
Investment Managers not otherwise subject to a requirement that they implement a business continuity/ disaster recovery plan should consider promulgating such a plan, stress-testing and reviewing it at least annually, and making any necessary adjustments to the plan based on the results of the review. Written evidence of these reviews should be retained.
iii. “Pay-to-Play” Practices.
ERAs and certain of their associated persons are subject to the same “pay-to-play” restrictions
(discussed above) as Registered Managers. Generally, these restrictions place limits on contributions being made to, or solicitation of contributions for, people
or parties that may have the ability to influence the decision of a government entity to utilize the advisers’ services. Please see item I.c.iii above for a more detailed discussion.
b. Confirm ongoing new issues eligibility.
In order for Investment Managers to purchase “new issues” for a fund or separately managed client account, Investment Managers should provide their brokers with annual written representations from the account’s beneficial owners confirming their continued eligibility to purchase new issues under
(i) Financial Industry Regulatory Authority (“FINRA”) Rule 5130, which prohibits the sale by broker-dealers of new issues to customers that have not provided certain written representations within the previous 12 months, and (ii) FINRA Rule 5131, which prohibits the allocation of shares of a new issue to any account in which certain persons have a beneficial interest and such persons have the ability to influence or direct the provision of investment banking services to the FINRA member. The annual representations under both Rules 5130 and 5131 may be updated through “negative consent” letters.
c. Review compliance procedures.
While most Investment Managers are subject to a mandatory annual review requirement, as a best practice, even Investment Managers not subject to the requirement should still review, at least annually, all established policies and procedures, whether or not such policies are in writing, to confirm the policies’
continued efficacy in light of the Investment Manager’s current business practices, market conditions, and any
legal or regulatory changes. Investment Managers that do not have written policies and procedures should consider, based on the Investment Manager’s current business, whether establishing such written policies and procedures might be in its interest.
d. Review U-4 updates (sales practice violations and allegations).
Registered Managers should review allegations of sales practice violations made against a registered person in an arbitration or litigation—even in cases where the registered person is not a named party— and amend the registered person’s Form U-4 to disclose such information as required.
Practice Tip: Supervision of recidivist representatives, (i.e., those with a track record of misconduct), was listed by OCIE as an examination priority for 2015.
e. Review anti-money laundering and OFAC programs.
Under current law, Investment Managers are not required to comply with U.S. anti-money laundering (“AML”) regulations. Nevertheless, Investment Managers that have agreed with their counterparties, intermediaries (e.g., prime brokers), clients, or other parties to maintain such a program are required
to perform those responsibilities. In addition, all Investment Managers are subject to certain related regulations (e.g., U.S. Treasury Office of Foreign Assets Control (“OFAC”) reporting requirement and Internal Revenue Code/Bank Secrecy Act reporting procedures for cash transactions). In light of these responsibilities, Investment Managers should review their AML programs, including their AML risk
assessment, on an annual basis to determine whether the program is reasonably designed to ensure compliance with any undertakings to which they have agreed as well as all related regulations, reporting requirements and similar obligations to which they may be subject as a matter of law. For Investment Managers that have agreed to comply with AML requirements, this review must be independent of the business unit responsible for the account and may
be conducted by an outside professional or internal audit/appropriate officers and employees of the Investment Manager who have sufficient knowledge of the applicable regulations and economic sanctions programs.
Practice Tip: AML was listed by OCIE as an examination priority for 2015.
f. Review fund offering materials.
Except for commodity pool disclosure documents that are filed with the NFA, private fund offering materials do not automatically “expire” after a certain time period. However, as a general securities law disclosure matter, and for purposes of federal and state anti-fraud laws, Investment Managers must
continually ensure that their fund offering materials are kept up-to-date and contain all material disclosures that may be required in order for the fund investor
to be able to make an informed investment decision. Accordingly, the beginning of the year may be an appropriate time for Investment Managers to review their offering materials and confirm whether any updates or amendments are needed. Investment Managers should particularly account for the impact, if any, of recent regulatory reform and tax changes on their funds. Among other things, Investment
Managers should review the fund’s current investment objectives and strategies, valuation practices, redemption policies, risk disclosures (including but not limited to, disclosures regarding market volatility and counterparty risk), current Investment Manager personnel, relationships with service providers
and advisors, and any relevant legal or regulatory developments.
g. Review liability insurance needs.
As a general matter, Investment Managers are not required to purchase management liability insurance, such as directors and officers liability coverage, fiduciary liability coverage, or errors and omissions liability coverage. Investment Managers that do not have such coverage should periodically assess whether management liability insurance makes sense for them in light of their current business and, if so, the type and amount of coverage. Investment Managers that do have management liability insurance should consider reviewing the adequacy of such coverage.
h. Comply with state and municipal lobbyist regulations.
Investment Managers who provide investment advisory services to state or municipal pension or retirement plans (“Government Plans”) should consider whether they or their personnel are considered
lobbyists in each jurisdiction in which they solicit Government Plans. Traditionally, the regulation of lobbyists at the state- and municipal-levels has largely been limited to those individuals or entities that sought to influence legislative or rulemaking actions. However, many jurisdictions have begun to define lobbying more broadly to include the act of soliciting investment advisory business from Government Plans.
While each state’s lobbying laws are different, those persons or entities that fall within the definition of “lobbyist” are typically required to fulfill some or all of the following requirements: registration with a governmental body and payment of a fee; attending lobbyist education training; and filing periodic reports containing expenditures and other relevant information. Persons who fail to comply with these requirements may be subject to fines, revocation
of one’s lobbyist privileges or other sanctions. As a result, Investment Managers who solicit Government Plans should become familiar with the lobbying regulations for each jurisdiction in which they solicit Government Plans.
i. Renew Form D and review state blue sky filings.
Investment Managers to private funds are reminded of the annual mandatory electronic filing for continuous offerings on Form D. Please note that Form D was amended slightly in 2014 to address changes to
Rule 506 of Regulation D and Rule 144A under the Securities Act of 1933 (the “Securities Act”),
creating the “bad actor” rule (discussed immediately below) and altering the prohibition against general solicitation.
Also, many state securities “blue sky” filings expire on a periodic basis and must be renewed. Consequently, now may be an appropriate time for an Investment Manager to review the blue sky filings for its funds and determine whether any updated filings, or additional filings, are necessary. Please contact your usual Winston & Strawn attorney if you would like assistance from our dedicated “blue sky” team with any necessary SEC or state filings.
j. Bad actor review.
Investment Managers involved in Rule 506 of Regulation D offerings are now required to obtain the information necessary to confirm that no “bad
actors” are involved in the 506 offerings conducted by their fund clients. Investment Managers whose fund clients are engaged in a continuous offering should consider confirming that the fund’s “covered persons” (generally, the fund, the fund’s directors, general partners, and managing members, executive officers, and other officers of the fund that participate in the offering, 20% beneficial owners of the fund, promoters connected to the fund, and the fund’s investment manager and its principals) have not experienced a “disqualifying event.” “Disqualifying events” generally include certain (i) criminal convictions; (ii) court/
SEC injunctions or stop orders; and (iii) SEC or self- regulatory agency disciplinary proceedings.
k. Volcker Rule considerations.
The “Volcker Rule,” more properly known as Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), became effective in 2012, however, regulated entities had until July 2014 to become compliant with the final implementing rules. The Federal Reserve Board extended the conformance deadline to July 21, 2015,
and, in the case of “covered funds” that were in place prior to December 31, 2013, the deadline has been extended to July 21, 2016. The Federal Reserve Board is considering further extending the deadline to July 21, 2017.
The Volcker Rule generally prohibits a bank and its affiliates from engaging in proprietary trading and, more pertinently, from acquiring or retaining any ownership interest in, or sponsoring, a hedge fund or private equity fund. The Volcker Rule provides for a conformance period for divestitures that ranges from two to ten years depending on (i) the willingness of the appropriate regulator to grant extensions and (ii) the liquidity of a particular fund in which the banking entity had an investment and was contractually committed to invest in as of May 1, 2010. A number of exceptions are available, two of the primary exceptions being for (i) banking entity-organized funds that are only offered to customers of such entities, and in which the banking entity only maintains a de minimis investment and (ii) investment funds outside the U.S., that are not offered in the U.S. and where the banking entity is a foreign banking firm (not controlled by a U.S. banking firm).
In addition, the Volcker Rule prohibits any banking entity that serves as an investment manager, investment adviser, or sponsor of a fund, and any of the banking entity’s affiliates, from extending credit to the fund, purchasing assets from the fund, accepting the fund’s shares as collateral for a loan to another person, or issuing a guarantee on behalf of the fund.
l. Identity theft procedures.
In 2013, the SEC, in combination with the CFTC, adopted rules related to implementation of identity theft programs by certain entities subject to SEC or CFTC regulation. As part of an Investment Manager’s annual review of its policies and procedures, an Investment Manager should evaluate whether the identity theft rules are applicable and if so, (i) adopt policies and procedures to detect and address identity theft or (ii) if such policies have already been adopted, review and update such policies, as necessary.
m. Cybersecurity review.
In 2014, the SEC announced a cybersecurity initiative intended to help firms create sound corporate governance related to cybersecurity, protect networks and information, detect unauthorized activity, and identify cybersecurity risks related to remote customer access, fund transfer requests, vendors and other third parties. OCIE’s Director, Drew Bowden, has stated that OCIE will publish cybersecurity guidance for financial advisors this year. Once published, it is recommended that Managers carefully review their cybersecurity programs against OCIE’s guidance.
Practice Tip: Cybersecurity has been a focus area for a number of years and has only gained more prominence with the frequent national news coverage regarding infiltration of corporate and government systems. Cybersecurity has been listed by OCIE as an examination priority for 2015.
V. ERISA-Related Requirements and Best Practices
The Employee Retirement Income Security Act of 1974, as amended (“ERISA”) and related Department of Labor (“DOL”) regulations are important to Investment Managers that accept clients who are ERISA plans
or that manage private funds that are subject to ERISA. Certain important ongoing ERISA compliance considerations are summarized below.
a. Ongoing Plan and Participant Level Disclosures.
i. Disclosures of service provider compensation.
The DOL’s final regulations requiring written disclosure of compensation and other information by covered service providers to ERISA-governed retirement plans or ERISA-governed funds continue to apply for both existing and new contracts or arrangements between covered plans and covered service providers. These regulations are commonly referred to as the DOL’s “408(b)(2)” or “service provider” regulations.
As a recap, covered service providers include those providing fiduciary services directly to an ERISA plan or to a “plan assets” entity (such as a group trust or private investment fund exceeding the 25% “significant participation” test) and those providing investment advisory services directly to a plan, among others.
The 408(b)(2) regulations generally require disclosure of all compensation paid to the covered service provider, its affiliates and/or its sub-contractors. This includes non-monetary compensation, as well as indirect compensation received from parties other than the plan or plan sponsor. These disclosures must be provided before a contract or arrangement with
an ERISA plan takes effect, is extended or renewed (and when the disclosed information changes). The 408(b)(2) regulations do not apply to funds that satisfy the 25% significant participation test (i.e., funds with “benefit plan investor” participation of less than 25%) or to funds qualifying as “operating companies,” such as venture capital operating companies or real estate operating companies. If a fund that was not previously a plan assets entity becomes one, fiduciaries to that fund must make the required disclosures within 30 days from the date on which the fiduciary knows that the fund is a plan assets entity.
When it issued the regulations in 2012, the DOL indicated that it intended to publish, in a separate proposal in the future, a guide or similar requirement to assist responsible plan fiduciaries’ review of the required disclosures. In March of this past year,
the DOL proposed an amendment to the 408(b)(2) regulations. Under the proposal, covered service providers would be required to furnish a guide with
initial disclosures if the initial disclosures are contained in multiple or lengthy documents. The summary guide would comprise a separate document and would specifically identify where each required disclosure would be found in the other document(s) so that the responsible plan fiduciary would be able to quickly and easily find the information. The proposal did
not contain a model guide although the DOL stated that the model it had previously published as an appendix to the 408(b)(2) regulations is an example of what it believes guides to initial disclosures may look like in practice. The proposal has engendered much discussion, and there is no certainty regarding its effective date. Accordingly, covered service providers are under no current obligation to provide a guide. ERISA plan fiduciaries are required to report to the DOL the failure of covered service providers to provide disclosure no later than 90 days after
the ERISA plan fiduciary requests the disclosure.
In addition, if the covered service providers fails to meet the 90-day deadline, the ERISA plan fiduciary is required to determine whether to terminate or continue the contract or arrangement, and if the failure to disclose relates to future services, the plan fiduciary must terminate the service arrangement as expeditiously as possible. Non-compliant covered service providers may be subject to penalties.
ii. Ongoing disclosures to plan participants in ERISA-governed participant-directed plans.
Plan administrators to ERISA plans are required to provide to participant-directed, individual account investors under 401(k) or other defined contribution plans certain investment fee and expense information, among other information under regulations commonly referred to as the DOL’s “404(a)” regulations. Although service providers are not directly obligated to make these disclosures (unless they have contractually agreed to do so), practically speaking, many, if
not most, plan administrators look to their service providers for much of the information required to be disclosed. The regulations provide that a plan administrator will not be liable for the completeness and accuracy of information provided by a plan
service provider if the plan administrator relies on that information reasonably and in good faith. Investment Managers who provide products or services to 401(k) or other defined contribution plans may wish to
periodically re-evaluate the manner in which they have provided this information, particularly in response to any questions raised by plan clients.
The regulations require disclosure of certain information about the plan’s investment options in a comparative chart format so that all investment options under the plan can be compared in an “apples-to- apples” manner. Although in 2014 the DOL briefly reopened the comment period for its proposed rules for special disclosures for “target-date funds” to coordinate with the SEC’s expanded comment period for its own related rules, the DOL regulations have not yet been finalized.
b. Continue to watch for DOL re- proposal of the definition of “fiduciary.”
In October 2010, the DOL issued proposed regulations expanding the circumstances under which a party
who provides investment advice to an ERISA plan or an IRA would be considered a “fiduciary” under
ERISA, changing a well-established regulation which has been in place since 1975. The original proposal generated significant controversy, criticism and concerns, and was withdrawn in 2011. Although the DOL intended to re-propose the regulations in 2014, it did not do so. However, it is expected to re-propose the regulations in January 2015 although as of the publication date of this briefing, they have not been issued. The DOL changed the date to allow itself
time to get input from more stakeholders. Investment Managers who provide services to ERISA plans, IRAs or private funds subject to ERISA and their affiliates may wish to stay abreast of developments on this regulatory initiative.
c. CFTC-related considerations for ERISA plans.
Under the Dodd-Frank Act, ERISA-governed retirement plans are not excluded from the CFTC’s definition of “major swap participant,” although the regulation does exclude swaps “maintained by employee benefit plans for hedging or mitigating risks in the operation of the plan” from certain of the numerical tests proposed to determine “major swap participant” status.
Under the CFTC’s business conduct rules, plans are categorized as “special entities,” with respect to which a swap dealer may have heightened duties.
To avoid these duties, a “swap dealer” (other than a swap dealer also acting as an advisor to an ERISA plan counterparty) must have a reasonable basis to believe that the ERISA plan counterparty has a representative that is an ERISA fiduciary. The rules also include a
safe harbor that provides that a swap dealer will not be acting as an advisor to an ERISA plan counterparty if the ERISA plan counterparty represents in writing that it has an ERISA fiduciary to evaluate the swap transactions and the ERISA fiduciary represents
in writing that it will not rely on the swap dealer’s recommendations, among other representations. The International Swaps and Derivatives Association’s industry-wide standard protocols include representations and covenants for special entities, designed to assist swap dealers in meeting the safe harbor.
d. Group Trust Participation
i. Consider permitting Puerto Rican plan participation in group trusts.
The eligibility of Puerto Rican plans to participate in tax-exempt “group trusts” established under Revenue Ruling 81-100 has been unsettled for some time. In August, the IRS issued Revenue Ruling 2014-24. It amends Revenue Ruling 81-100 to expressly permit pension, profit sharing and stock bonus plans that are only qualified under Section 1165 of the Puerto Rico Internal Revenue Code to participate in group trusts. Group trust sponsors may wish to review their
documents regarding the participation of Puerto Rican plans in their group trusts and to amend them to permit participation of Puerto Rican plans.
ii. Consider participation of “separate accounts” in group trusts.
In the same Revenue Ruling 2014-24, the IRS amended Revenue Ruling 81-100 to clarify the conditions under which assets of insurance company separate accounts may invest in a group trust. Requirements include that: assets of the separate account consist solely of assets from group trust retiree benefit plans; the insurance company timely enters into an agreement with the trustee of the group trust that meets the requirements of Rev. Rul. 2014- 24; and assets of the separate account are insulated from the claims of insurance company’s creditors.
If plan assets are invested through an insurance company’s separate account in a 81-100 group trust as of December 8, 2014, the trustee of the group trust and the insurance company must enter into a written arrangement meeting the requirements of Rev. Rul. 2014-24 before January 1, 2016. Otherwise, the group trust trustee and the insurance company must enter into a written arrangement no later than the time of the investment. Group trust sponsors may wish to review their documents regarding the participation of insurance company separate accounts in their group trusts.
e. Update on the Sun Capital Case.
The ERISA liability landscape for private equity funds remains uncertain after the Supreme Court denied a request to review the First Circuit’s decision in Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund, 724 F.3d 129 (1st
Cir. 2013). In that case, the First Circuit effectively determined that a private equity fund could be found to be engaging in a “trade or business” and therefore potentially subject to multiemployer plan withdrawal liabilities assessed against one of its portfolio companies. Generally, when an employer
withdraws from a multiemployer pension plan, the law may impose withdrawal liability (i.e., the employer’s proportionate share of the plan’s unfunded vested benefits) on the employer and any “trades or businesses” that are members of the employer’s controlled group. In Sun Capital, the First Circuit rejected the core argument that has been used by private equity funds to defend against controlled group exposure for pension plan liability – that such funds are not engaged in a “trade or business”
and thus cannot be part of a controlled group. The court engaged in a very fact-specific analysis of the business operations of the funds in question (including the activities of the funds’ general partners, the content of the partnership agreements and private placement memos, and the allocation of management fees) to conclude that at least one of the funds was
in fact engaged in a trade or business, rather than a passive investor. What remains now to be seen is whether other cases emerge with courts applying a similar analysis. As of now, the decision by the First Circuit is an outlier.
f. Ongoing ERISA Compliance and Monitoring.
i. Review private fund compliance with the 25% significant participation test.
Investment Managers managing private funds that seek to satisfy the 25% significant participation test should consider periodically reviewing their
processes for best practices. For example, Investment Managers of private funds may wish to reconfirm whether their fund-of-funds investors or other fund investors are “benefit plan investors” subject to
ERISA or Section 4975 of the Code for purposes of reconfirming their funds’ compliance with the 25% significant participation test and, if so, the extent to which that investor’s assets are plan assets. Only the portion of these investors’ assets that are subject
to ERISA and Section 4975 of the Code need be counted for this purpose. As this percentage can fluctuate over time, we recommend establishing an “upper limit” percentage which the investor will agree not to exceed. As noted above, if a fund becomes
a plan assets fund, the service provider disclosure regulations require that disclosures be provided to ERISA investors within 30 days of the Investment Manager knowing that the fund is a plan assets fund.
ii. Review private fund compliance with the “operating company” exception.
Investment Managers that have decided to qualify their funds as “venture capital operating companies” or “real estate operating companies” must continue monitoring compliance with the operating company exception on an annual basis, as per the DOL’s
plan assets regulations until the funds are in their distribution periods. Investment Managers may also wish to consider qualifying their new funds as
operating companies. This will permit them to attract more capital from benefit plan investors without being subject to ERISA’s fiduciary requirements. Initial qualification as a venture capital or real estate operating company is relatively easy to attain
for funds that take a controlling interest in their portfolio companies or routinely negotiate for some management rights with respect to the portfolio companies; likewise, ongoing compliance should not be burdensome for such funds.
iii. Comply with Form 5500 fee disclosures.
Form 5500 is the annual report required to be filed by ERISA plans with the Internal Revenue Service (“IRS”) and the DOL. In addition, Form 5500 filings may also be filed on a voluntary/elective basis by collective trusts and other funds, the assets of which are treated as ERISA plan assets.
Schedule C to Form 5500 requires disclosures of fees and other compensation received by service providers (such as Investment Managers) to ERISA plans. Although the Form 5500 filing is generally the
responsibility of the ERISA plan investor, plans will look to Investment Managers to provide the information that is needed for the filing. Investment Managers of plan asset funds may elect to file Forms 5500s on behalf of the funds, in which case they will need to comply with these additional compensation reporting requirements. Plan investors sometimes request that investment managers make such filings as it relieves the plan investor from some of its more detailed filing requirements.
Importantly, these reporting rules apply to direct and indirect compensation in connection with funds that satisfy the 25% significant participation test to
prevent fund assets from being treated as ERISA plan assets (with the exception of compensation received from operating companies, including venture capital operating funds and real estate operating funds).
iv. Update and confirm your ongoing ERISA- related compliance generally.
As a best practice, Investment Managers that manage plan assets should periodically review their existing investment policies and investment guidelines and trading practices and relationships to confirm that they are consistent with current requirements under ERISA. Significant changes in trading practices and investment policies and investment guidelines also should be reviewed for ERISA compliance. ERISA- related policies and procedures also should be reviewed periodically, such as cross-trading policies, proxy voting policies and gift and gratuity policies, to reflect changes in the Investment Manager’s practices or changes in the law.
v. Review compliance with ERISA’s fidelity bond requirements, if applicable.
Investment Managers with ERISA plan clients or those managing plan assets are required by ERISA to maintain a fidelity bond unless the Investment Manager has determined that it is exempt from ERISA’s fidelity bond requirements. Ongoing bonding
arrangements should be reviewed on an annual basis to confirm that the Investment Manager is maintaining the bond in the correct amount and with the correct terms to satisfy ERISA’s requirements.
Investment Managers may wish to review whether changes in their ERISA plan clients require changes to bonding arrangements (for example, an ERISA plan that did not previously hold employer securities may have acquired employer securities, necessitating a higher bond amount). Changes to a fund advised by the Investment Manager may also dictate changes
to the fidelity bond (for example, if a plan assets fund reduces benefit plan investor participation in the fund, such that it satisfies the 25% significant participation test, a fidelity bond may no longer be required and, conversely, when a fund no longer satisfies the 25% significant participation test, the fidelity bonding rules would generally be triggered on that date).
vi. Review developments in the law applicable to governmental plan clients.
Investment Managers who manage the assets of governmental plans (which are not subject to ERISA) should review developments in the past year in
the law applicable to those plans that may affect plan investments. State or local laws may include
restrictions on the use of placement agents, enhanced disclosure requirements for plan service providers, limitations or restrictions on permissible investments such as investments in certain countries or limits
on certain categories of alternative investments. Also, Investment Managers should consider the consequences of a governmental plan’s request to be treated as an ERISA plan in a plan asset vehicle. If an Investment Manager agrees to such a request, the language in the agreement should be carefully
tailored so that it is not overbroad and will not trigger unwanted consequences. In their subscription agreements, Investment Managers should ensure that governmental plan investors disclose any laws or regulations that may govern their investments.
vii. Indicia of ownership requirements.
ERISA requires that the “indicia of ownership” of plan assets must be within the jurisdiction of the district courts of the United States. Any fund that holds plan assets will have to observe this requirement. While this is not a concern for funds that solely hold assets such as securities located in the United States, the DOL has published regulations that generally permit foreign assets to be held outside the United States provided that the assets are under the management and
control of a fiduciary such as an investment adviser registered under the Advisers Act that has total client assets under its management and control in excess
$50,000,000 and shareholders’ or partners’ equity in excess of $750,000. The above is necessarily a brief description of the somewhat complicated “indicia of ownership” rules. Accordingly, Investment Managers of plan assets funds that trade or intend to trade outside the United States may wish to review their policies.
If you have any questions about the matters contained in this Client Briefing or would like assistance in complying with any of the above requirements, please contact any of the Winston & Strawn professionals listed below or click here.
Basil Godellas (firstname.lastname@example.org) Christine Edwards (email@example.com) Jerry Loeser (firstname.lastname@example.org)
Joshua Yang (email@example.com) Sarah Hesse (firstname.lastname@example.org) Sterling Sears (email@example.com)
Glen Barrentine (firstname.lastname@example.org) Adrienne Scerbak (email@example.com)
Quarterly – within 15 days of quarter end
Quarterly – within 45 days of quarter end
Quarterly – within 60 days of quarter end
Annually – within 15 days after fiscal year end (January 15, 2015 if a December 31 fiscal year end)
Annually – 45 days after calendar year end (February 17, 2015)
Annually – within 60 days of calendar year end (March 2, 2015)
Annually – within 60 days of fiscal year end (March 2, 2015 if a December 31 fiscal year end)
Annually – within 90 days of calendar year end (March 31, 2015)
Annually – within 90 days of fiscal year end (March 31, 2015 if a December 31 fiscal year end)
Annually – within 120 days after fiscal year end (April 30, 2015 if a December 31 fiscal year end)
June 30, 2015
Credit Risk Retention Rules
December 24, 2014 – the final Credit Risk Retention Rule – mandated by the Dodd-Frank Act—generally requires the securitizer of asset-backed securities to retain not less than 5 percent of the credit risk of
the assets collateralizing the asset-backed securities.
The final rule was approved by the Comptroller of the Currency, the Federal Reserve System, the
Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Securities and Exchange Commission, and the Housing and Urban Development Department, and was published in the
Federal Register on December 24, 2014. The final rule is available at: Credit Risk Retention Rule
CTA Family Office Exemption
November 5, 2014 – CFTC issued CFTC Letter No. 14-143 providing no-action relief from registration as
a CTA for “family offices.” The relief provides that the CFTC will not institute enforcement action against family offices that do not register as a CTA and who provide advisory services solely to “family clients,” as such terms are defined by SEC regulations. However, the relief is not self-executing and family offices that wish to take advantage of such relief must submit a claim for relief, similar to the exemption available for family offices from registration as a Commodity Pool Operator pursuant to CFTC Letter No 12-37. The letter is available at: CFTC Letter 14-143
Delegating CPO Relief
October 15, 2014 – the CFTC issued CFTC Letter 14- 126 regarding the Division’s exemptive relief for the delegation of certain CPO functions. Letter 14-126 addressed and clarified the criteria necessary for exemptive relief when the CPO of a commodity pool delegates all of its investment management authority to another registered CPO. The new letter further streamlined the process set out earlier in 2014 and provided that such relief would be self-executing. A Winston and Strawn client briefing on the letter is available at: Winston CPO Delegation Letter
CFTC Harmonization with SEC Rule 506(c) September 9, 2014 – the CFTC issued CFTC Letter No14-116 which provides relief from certain provisions in Regulations 4.7(b) and 4.13(a)(3) in recognition of the
addition of 506(c) to Regulation D and the amendment of Rule 144A under the Securities Act. A copy of the letter is available at: CFTC Letter 14-116
July 22, 2014 – Alternative Investment Fund Managers Directive (“AIFMD”) became effective throughout
most of the European Economic Area (“EEA”) member states. U.S. Investment Advisers must either cease marketing funds in such states or become compliant with the relevant provisions of AIFMD.
July 1, 2014 – certain provisions of the Foreign Account Tax Compliance Act (“FATCA”) became effective. U.S. Funds should ensure that they are using the most current version of IRS Forms W-9, W-8, and W-8BEN-E, as updated by the IRS for FATCA. Subject to certain exceptions, U.S Funds also have an obligation to determine the FATCA status of current investors prior to June 30, 2016.
June 30, 2014 – the SEC released guidance stating that investment advisers who have “retained a third party to assist with its proxy voting responsibilities [must maintain] . . . sufficient ongoing oversight of the third party in order to ensure that the investment adviser, acting through the third party, continues
to vote proxies in the best interests of its clients.” Investment Advisers are encouraged to review their current policies and procedures related to proxy advisers to ensure they are complying with this guidance. A copy of the guidance is available at: SEC Proxy Adviser Guidance
April 15, 2014 – the SEC issued a risk alert providing information and a sample of documents that may be requested by the Office of Compliance Inspections and Examinations in their ongoing review of registered entities as part of the SEC’s cybersecurity initiative. A copy of the risk alert and guidance is available at: SEC Cybersecurity Risk Alert
Additional SEC Resources to Focus on PE and Hedge Funds
April, 2014 – Reuters released an article stating that the SEC was forming a dedicated group of examiners to focus on private equity and hedge funds, specifically targeting valuation of assets, fee disclosure, sufficiency of information available to investors, and marketing/communication with investors.
FINRA Loosens Anti-Spinning Rule
February 3, 2014 – an amendment to FINRA Rule 5131(b) (the “spinning provision”) became effective. This amendment eases the compliance burden on member firms by generally allowing them to inquire into the status of control persons of an investing fund, rather than attempting to look through to the status