In this Alert, we offer a summary of some of the primary periodic compliance requirements or best practices for fund and investment advisers. Accordingly, while this summary discusses various obligations relating to tax, partnership, limited liability, trust and corporate compliance issues, it is not intended to be exhaustive and some of the obligations apply only to registered investment advisers.
Investment Partnership Issues (Private Equity, Hedge Funds, Venture Funds, Real Estate, etc.)
Review Fund Offering Documents
While fund offering materials do not expire automatically, in order to comply with general securities laws, investment advisers must review and keep current their fund offering materials and all material disclosures required for investors to make informed investment decisions. For example, fund offering documents should be updated, as applicable, with regard to performance, changes in management, performance statistics, annual financial information, other brokerage practices and tax and legal requirements.
Review State Blue Sky Filing
Some state securities “blue sky” filings expire periodically and need to be renewed. Accordingly, investment advisers should review the “blue sky” filings for their funds and determine whether they need to be updated. In addition, they should review the states of residence of both existing and potential investors who may purchase interests or shares in order to ensure continued compliance with applicable state securities laws.
Regulation D Filing
The Securities and Exchange Commission (“SEC”) amended its rules to revise the information required to be furnished on Form D, effective September 15, 2008, and, after a transition period, to require the form to be filed electronically beginning on March 16, 2009. In its release amending Form D, the SEC clarified when amendments to a Form D are required and included the requirement that for a continuous offering an amendment must be filed annually on or before the first anniversary of the Form D filing.
You should review whether any amendments to Form D filings will be required in the next year. If you anticipate any Form D filings after March 15, 2009, you will need to obtain SEC electronic filing codes (if you do not already have them) in order to access the SEC’s electronic filing system.
“Plan Asset” Rule Changes
As a best practice, investment advisers managing “plan assets” should review their compliance with the requirements under the Employee Retirement Income Security Act of 1974 (“ERISA”). “Plan assets” include the assets of a fund attributable to investors that are plans under ERISA Title I (and certain other arrangements), if at least 25% of the value of any class is held by “benefit plan investors.” Thus, if a fund’s assets include “plan assets,” the adviser must comply with ERISA’s fiduciary requirements. In addition, transactions involving the fund are subject to the prohibited transaction rules of the Internal Revenue Code and ERISA.
Those funds that choose to stay below the 25% threshold should note that there have been some changes as to how the 25% is calculated. The new rules exclude foreign plans, governmental plans and certain church plans from the definition of “benefit plan investor,” which thus do not count toward the 25% threshold. Also, a fund-of-funds with investors deemed to be “benefit plan investors” is now considered a “benefit plan investor” only to the extent that the fund-of-fund’s equity interests are held by benefit plan investors. Accordingly, if benefit plan investors only hold 30% of the equity interests in a fund-of-funds that holds a $10,000,000 equity interest in a fund, only $3,000,000 now counts as owned by a benefit plan investor, and is counted for purposes of the fund’s 25% calculation. Those investment advisers that would like additional information regarding how these changes may impact them should contact us. In addition, investment advisers that manage funds should also request updated representations from the fund investors regarding what percent of those investors are benefit plan investors. That information may affect the calculation of the fund’s 25% calculation.
Compliance under the Pension Protection Act of 2006 (“PPA”) should also be evaluated. This includes complying with the increased bonding requirements of the PPA, which mandates a $1,000,000 fidelity bond (as opposed to a $500,000 fidelity bond) for investors with plans investing in “employer securities,” as well as statutory exemptions from prohibited transaction rules for electronic communication networks trades and cross-trading. Similarly, investment advisers managing the assets of governmental plans should monitor developments applicable to those plans.
New Issues Compliance
Investment advisers that may purchase stock in initial public offerings for accounts must obtain written representations every 12 months from the accounts’ beneficial owners regarding their continued eligibility to participate in “new issues” under FINRA (formerly the NASD) Rule 2790. Representations of funds-of-funds through their questionnaires regarding their ability to participate in “new issues” profits and losses are valid for one year, but a recertification must be obtained annually thereafter. Investment advisers should contact us regarding the appropriate documentation to use for recertification, and the proper use of “negative consent” letters.
Review Anti-Money Laundering and OFAC Programs
Any anti-money laundering programs established by investment advisers under the Bank Secrecy Act, as amended by the USA Patriot Act, should be reviewed on an annual basis to determine if they are reasonably designed to ensure compliance in light of the business and customer bases of the investment advisers. Advisers should also confirm that their compliance programs comply with any economic sanctions programs of the Office of Foreign Assets Control. The foregoing reviews should be independent, performed by internal audits, outside professionals or appropriate officers or employees of the investment adviser with the requisite knowledge.
Liquidating Person Designation
To the extent that a fund under a limited partnership agreement provides for a “Liquidating Person” to liquidate the partnership’s assets if the general partner is unable to do so, the investment adviser managing the fund should confirm that there is no desire to appoint or replace the current “Liquidating Person.”
Securities Law Requirements and Best Practices
Annual Privacy Notice
Compliance Procedures Review
As a best practice, investment advisers should annually review their established policies and procedures. The policies and procedures should be reviewed to ascertain whether each employee has certified their compliance with those procedures on a quarterly or annual basis, and submitted certification to a compliance officer by the end of each year.
Schedules 13D or 13G
Investment advisers may be required to file Schedule 13D or 13G if they exercise voting power or investment discretion of five percent (5%) or more of a class of securities of a publicly traded company. Any material changes to Schedule 13D must be reported promptly. If an investment adviser previously filed a Schedule 13G, they are required to file an amended schedule annually if there are any changes since the most recent filing. All such changes must be done by February 14 of the following calendar year.
Forms 3, 4 and 5
Filing of an initial ownership report with the SEC on Form 3 may be required of investment advisers that exercise investment discretion or voting power over more than 10 percent (10%) of a class of equity securities of a public company. That filing must be made within 10 days after exceeding the 10% threshold. Also, an insider’s changes in the beneficial ownership of securities must generally be reported on Form 4 within two business days after the date of the transaction at issue. Form 5 must be submitted by all persons who were insiders of a publicly traded company during the reporting year, to report transactions that were not required to be reported on Form 4 and had not voluntarily been reported earlier on Form 4. Form 5 must be submitted within 45 days after the fiscal year.
Investment advisers, whether or not they are registered with the SEC, must file a report of holdings on Form 13F within 45 days after the end of the first calendar year in which they reached the $100 million threshold investment (as of the end of any month) in 13(f) securities traded on a national securities exchange. Quarterly filings are required thereafter. In general, 13(f) securities include exchange-traded securities, shares of closed-end investment companies and certain convertible debt securities.
New Short Sale Reporting Obligations
The SEC has adopted Rule 10a-3T which requires institutional investors who exercise discretion over accounts holding $100 million or more in Section 13(f) securities to file information on a weekly basis reporting their short sales and positions of Section 13(f) securities (other than options). This reporting requirement covers transactions having a fair market value of $10 million or more. Reports must be filed on nonpublic Form SH and need only be filed for weeks where the investor has actually effected short sales. Rule 10a-3T is effective from October 18, 2008 through July 31, 2009; it will cease to be effective thereafter unless the SEC extends it.
Review Liability Insurance
While investment advisers are not required to purchase management liability insurance, given the increasing number of investor lawsuits and continued regulatory scrutiny of funds, it may be prudent to periodically assess whether management liability insurance coverage would be useful.
Management Company Allocations
For limited liability companies or limited partnerships, equity interests may have been given to key employees. If your operating or limited partnership agreement provides for the adjustment of a participant’s interest for the coming year on or before a specified date, investment advisers or general partners should make those allocation decisions in writing and in accordance with the applicable operating agreement by the specified deadline (typically January 31 of that year).
Due to the complexity of the SEC rules for determining the 100-investor limit in Section 3(c)(1) of the Investment Company Act of 1940, we recommend that investment advisers that manage domestic or offshore funds relying on the definition of “investment company” in that section contact us to confirm that the fund is in compliance.
Commodities and Futures Trading
Registered commodity pool operators (“CPOs”) or commodity trading advisers (“CTAs”) must update their registration through the National Futures Association’s online system, and pay their annual membership dues before the anniversary date of the CPO’s or CTA’s effective registration date. Failure to submit the review within 30 days of the established deadline will be deemed a request withdrawal from registration.
Registered CPOs or CTAs must also complete an annual “self-examination questionnaire” as required by the National Futures Association (“NFA”). The completed questionnaire is not submitted to the NFA, but instead should be retained by investment advisers for their records. Investment advisers must also fill out a separate questionnaire for each branch office.
Registered CPOs that manage non-exempt pools and Commodity Futures Trading Commission (“CFTC”) rule 4.7-exempt pools must prepare annual reports for each pool within 90 days of the end of the pool’s fiscal year (or within 120 days for funds-of-funds), with one copy provided to each pool participant, and one copy provided to the NFA. Requests for extensions must be made within 90 days after the deadline. Certified reports must be distributed to the pools’ participants within the 90 or 120 day deadlines. The CPO’s disclosure document may also need to be filed with the CFTC and the NFA, and must be updated regularly pursuant to the CFTC rules.
However, under broader exemptions available under CFTC rule 4.13, CPOs who will operate pools available only to “qualified eligible persons” may be exempt from registration as a CPO as well as exempt from the above filing requirements. CPOs should review this rule to determine its applicability.
Requirements for Federally Registered Investment Advisers
Annual Update of Form ADV
The SEC requires investment advisers registered as advisers with the SEC to update the information on their Form ADVs within 90 days after the end of the adviser’s fiscal year end. In addition, the form must be updated promptly if certain information becomes inaccurate. While Part I of Form ADV is filed electronically on the SEC’s Investment Adviser Registration Depository (“IARD”) system, the non-electronic Part II does not need to be filed with the SEC. Rather, the updated Part II must be delivered to prospective clients, as well as placed in the adviser’s files, which is then deemed to be filed with the SEC.
Furthermore, Part II (or the equivalent “brochure” statement) must be offered annually to private fund investors and separate account clients under the “brochure rule” of Rule 204-3 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”).
Confirm State Requirements
Investment advisers should review and confirm all applicable state requirements. Depending on the state, certain state regulators may require state-registered, or even SEC-registered, investment advisers to make notice filings and pay fees in states where it has clients or a place of business. SEC-registered investment advisers should receive electronic materials from FINRA in the fall with instructions on renewing state notice filings and fees through the IARD system. In addition, investment advisers should confirm whether any personnel need to be registered as investment adviser representatives in any states. Please contact us to determine specific applicable state law requirements.
Annual Review of Compliance Procedures and Code of Ethics
SEC-registered advisers must annually review their compliance policies and procedures to assess their effectiveness in light of issues that arose during the previous year, changes in investment advisers’ business activities and any changes in the Advisers Act or rules that might suggest a need for revision. The review should be documented and must include a review of the investment adviser’s code of ethics, which must also be evaluated annually for the effectiveness of its implementation. Pursuant to this review, investment advisers should analyze the need for ethics training of employees. In addition, each supervised person must be provided with a copy of the investment adviser’s code of ethics and acknowledge receipt of it.
SEC-registered investment advisers should also review business continuity and disaster recovery plans at least annually.
Although the SEC requires only annual reviews, investment advisers should consider whether significant compliance events, legal or regulatory developments or changes in business arrangements warrant the need for an interim review.
Annual Audited Financial Statements
Pursuant to the custody rules of Rule 206(4)-2(b)(3) under the Advisers Act, SEC-registered investment advisers that manage private funds and are deemed to have client assets in custody must provide audited financial statements of their funds. These statements must be provided to the funds’ investors within 120 days of the funds’ fiscal year-ends, or within 180 days for funds-of-funds, in order to comply with the full requirements of the custody rules.
IARD Account Funding
Investment advisers should confirm that IARD electronic accounts are adequately funded to cover payment of registration renewal fees for the year.