Kramer Levin’s Funds Talk provides legal commentary on the news and events that matter most to alternative asset managers and funds.

SEC Adopts Rule Changes to Investment Advisers’ Act, Registration Requirements

The Securities and Exchange Commission (“SEC”) has adopted amendments to several Investment Advisers Act (“the Act”) rules, as well as changes to the Form ADV.

The amendments, announced on Aug. 25, are designed to enhance the reporting and disclosure of information by investment advisers, while improving the SEC and investors’ access to quality information. Once effective, advisers will be required to disclose more information in their Form ADV filings regarding several aspects of their operations, including their separately managed account business, branch office operations and use of social media. In addition, the amendments codified previous SEC guidance that allowed private fund advisers operating a single advisory business to register with the SEC using a single Form ADV.

The SEC’s Form ADV is the standard form investment advisers are required to file when registering with both the SEC and applicable states’ securities agencies. It requires information outlining an adviser’s business, including ownership, clients, employees, practices, affiliations and any disciplinary events involving the adviser or its employees. This information, which becomes publicly available, is used to process registrations and manage regulatory and examination programs. The form also requires investment advisers to create narrative brochures to be provided to clients. Written in “plain English,” these must convey such information as advisory services offered, fee schedule, disciplinary information and conflicts of interest.

Additional Information 

With the overarching goal of strengthening regulatory efforts and protecting investors, the amendments follow the SEC’s proposal from May 20, 2015, which included potential changes to various parts of Form ADV. The adopted amendments will require investment advisers to include additional information on their separately managed account business, including figures on the use of borrowing, derivatives and other aspects of their activities. Further changes to the Act’s Rule 204-2 will also require advisers to keep records related to the calculation and distribution of performance information, which will be used by SEC examinations staff to evaluate adviser performance claims for potentially misleading or fraudulent communications with investors. This will be required to be retained if these records are provided to any person. It previously only had to be retained if it was provided to 10 or more persons.

Umbrella Registration 

Other amendments to Part 1A of Form ADV codify a more efficient process for the registration of multiple private fund adviser entities operating a single advisory business on a single form, colloquially known as “umbrella registration.” The Dodd-Frank Act ended the previous exemption that allowed many advisers to private funds, such as hedge funds and private equity funds, to remain unregistered. However, since private fund advisers often organize as a group of separate but related advisers due to regulatory, tax and legal considerations, some advisers filed multiple registration forms with the SEC for each of their legal entities – creating cost, inefficiencies and confusion for regulators and investors alike. Although the SEC provided guidance on umbrella registrations in 2012, uncertainty persisted since the registration form is designed for use by a single legal entity. The amendments seek to address this obstacle by providing a series of five conditions advisers can use to determine whether umbrella registration is an option. If eligible, advisers are then required to file a single Form ADV that includes all information related to the filing adviser and each relying adviser, and must also include this information in any other reports or filings required by the Act or its rules. Although umbrella registration is not mandatory, the SEC believes its use will both simplify the registration process for affected advisers and provide the regulator with improved, more consistent data that will create a clearer picture of their activities and better allow for comparison between private fund advisers.

Social Media and Other Changes 

The SEC is also amending sections of Form ADV that require an adviser to disclose and identify any affiliated websites. The form will be expanded to also ask whether the adviser has any accounts on social media platforms, such as Twitter, Facebook or LinkedIn, and to request the address of each of the adviser’s social media pages. This information will be used to help prepare examinations of advisers’ activities and also to compare the information circulated via social media. In so doing, the SEC is notifying advisers that any activities on social media are being monitored and will be considered alongside websites and other more traditional means of promotion for compliance and regulatory purposes. Finally, the SEC is adopting amendments to the Act’s books and records rule and technical amendments to several rules to eliminate outdated transition provisions. Investment advisers are required to be in compliance with the amended rules by Oct. 1, 2017. Accordingly, given the annual updating process most advisers go through in the first quarter of each year, this means that most advisers will not have to adjust to the new Form ADV until their 2018 annual update.

Kramer Levin Files Amicus Brief for SIFMA and The Clearing House in Federal Housing Finance Agency v. Nomura Holding America

The Court of Appeals for the Second Circuit has scheduled argument for Nov. 8, 2016, in Federal Housing Finance Agency v. Nomura Holding America Inc. et al. This is one of the few significant mortgage-backed securities cases to go to trial. The trial court entered judgment in favor of plaintiff, the Federal Housing Finance Agency (“FHFA”), on claims under Section 12(a)(2) of the Securities Act of 1933 and parallel provisions of the Virginia and District of Columbia Blue Sky Laws arising from defendants’ sale of residential mortgage-backed securities to Fannie Mae and Freddie Mac. The judgment against Nomura Holding America, Inc. and related entities and individuals (“Nomura”) and RBS Securities, Inc. is for a total of $806 million. They have appealed.

Kramer Levin filed an amicus brief in support of the appeal on behalf of the Securities Industry and Financial Markets Association (“SIFMA”), an association of hundreds of securities firms, banks and asset managers, and The Clearing House Association L.L.C. (“The Clearing House”), the oldest bank association and payments company in the U.S., whose owner banks hold more than half of all U.S. deposits and employ more than two million people. Our amicus brief addresses three issues:

First, we argue that FHFA’s claims are time-barred under the applicable Virginia and District of Columbia Blue Sky Law statutes of repose. The district court held the statutes of repose were preempted by a provision of the Housing and Economic Recovery Act of 2008 (“HERA”) that extends the “statute of limitations” for FHFA to bring “contract” or “tort” claims. Our brief argues this holding infringes on important federalism principles. Virginia and the District of Columbia chose to define and limit the causes of action they created, and HERA should not be read to redefine those claims.

Second, we argue the court erred in finding as a matter of law, and precluding trial, on the question whether defendants can establish the “reasonable care” defense under Section 12(a)(2) of the Securities Act and parallel provisions of the Blue Sky Laws to FHFA’s claims. We argue that issues for trial were raised by the court’s findings that Nomura examined nearly 40% of the loans before it bought them and offered evidence that it met industry-wide due diligence standards, and that RBS tested two of the loan pools to be securitized.

Finally, we argue the court erred in ruling as a matter of law, and precluding trial, on the question whether defendants can establish their statutory loss causation defense that some or all of FHFA’s losses were caused in whole or in part by the economic collapse in 2008, and not by the prospectuses or oral communications with respect to the securities at issue on which FHFA grounds its claims. Those securities at issue represent less than 0.1% of the private label residential mortgage-backed securities issued during the relevant period. The court found this defense is barred because defendants cannot prove the economic collapse was “unrelated to the phenomena underlying the[ir] alleged misrepresentations.” We argue the court did not apply the correct standard under Section 12(b), which is whether any portion of the depreciation in the value of the security did not result from the part of the prospectus or oral communication on which the plaintiff grounds the defendant’s liability, not whether the depreciation was “unrelated to the phenomena underlying the alleged misrepresentation.”

We have filed eight amicus briefs on behalf of SIFMA within the past two years — one in the United States Supreme Court, four in the Second Circuit, two in the Fifth Circuit and one in the Ninth Circuit. The Clearing House joined four of these briefs and the American Bankers Association joined two.

SEC Approves FINRA’s Capital Acquisition Broker Rules

On Aug. 18, 2016, the Securities and Exchange Commission (“SEC”) approved various Financial Industry Regulatory Authority (“FINRA”) rule changes, allowing for the adoption of FINRA’s capital acquisition broker (“CAB”) regime. The CAB regime will become effective no later than Feb. 14, 2017.

The proposed rule changes create a separate set of rules that would apply exclusively to firms that meet the definition of a “capital acquisition broker” and elect to be governed under these rules. This new regulatory regime could assist private fund managers that seek to raise capital for their funds through an affiliated entity or that engage in certain activities such as advising companies on M&A transactions. It is important to note that a broker-dealer that is a CAB would not be able to perform many tasks traditionally connected with broker-dealers, such as acting as an introducing broker, handling customer funds or securities, or participating in proprietary trading of securities or market-making activities.

The CAB rules were designed to acknowledge the relatively limited scope of such participants and exempt them from the more stringent rules FINRA created to govern the activities of traditional broker-dealers.

This disparity in the range of activities performed by firms registered as broker-dealers was highlighted in a recent SEC administrative proceeding against Blackstreet Capital Management and its principal owner, Murry N. Gunty. Among other violations, the enforcement action alleged that Blackstreet violated broker-dealer registration requirements when it performed brokerage services on behalf of fund portfolio companies. Ultimately, Blackstreet and Gunty agreed to pay approximately $3.1 million to settle the proceeding, which demonstrated the SEC’s renewed interest in the receipt of transaction fees by private equity fund advisers as part of a determination of whether such advisers may need to register as broker-dealers.

CAB Rules

To qualify as a capital acquisition broker, a broker must be engaged in one or more of the following:

  • Advising an issuer, including a private fund, concerning securities offerings or other capital raising activities;  
  • Advising a company on the purchase or sale of a business or assets or regarding corporate restructuring, including a going-private transaction, divestiture or merger;  
  • Advising a company on its selection of an investment banker; ​
  • Assisting in the preparation of offering materials on behalf of an issuer; ​
  • Providing fairness opinions, valuation services, expert testimony, litigation support and negotiation and structuring services; ​
  • Qualifying, identifying, soliciting or acting as a placement agent or finder (i) on behalf of an issuer in connection with a sale of newly issued, unregistered securities to institutional investors, or (ii) on behalf of an issuer or control person in connection with a change of control of a privately held company; or ​
  • Effecting securities transactions solely in connection with the transfer of ownership and control of a privately held company through a transaction involving securities or assets of the company, to a buyer that will actively operate the company in accordance with the terms and conditions of an SEC rule, release, interpretation or “no-action” letter that permits a person to engage in such activities without having to register as a broker or dealer pursuant to Section 15(b) of the Securities Exchange Act of 1934.

With respect to a private fund manager utilizing an affiliated entity to assist in the capital raising activities of the private fund, the CAB regime will be helpful so long as the private fund manager limits the affiliated entity’s capital raising activities to 3(c)(7) funds. This is due to the fact that all of the investors from which the CAB raises capital must be “institutional investors.” An institutional investor includes qualified purchasers but does not include accredited investors. As a result, the CAB regime is effectively only applicable to CABs that raise capital for 3(c)(7) funds and cannot be utilized with respect to 3(c)(1) funds unless all of the investors in the 3(c)(1) fund separately qualify as institutional investors. In addition, private fund managers may be able to use the CAB regime to solve for the concerns arising under the Blackstreet enforcement action, assuming they limit their activities to those in which a CAB may participate and they comply with the obligations imposed on CABs.

In this regard, qualified FINRA members opting to elect CAB status will receive relief from the obligation to comply with a variety of FINRA broker-dealer rules. However, they will be subject to FINRA bylaws “unless the context requires otherwise,” as well as various streamlined rules to accompany CAB status. These include rules governing conduct, supervision and responsibilities related to associated persons, finances and operations, securities offerings and other areas of a firm’s operations.

The CAB regime should alleviate the uncertainty created by the various scope of activities of firms registered as broker-dealers. However, the rules will also impose several limitations on firms that choose to elect CAB status, forcing them to weigh the benefits against the constraints as they review their activities and decide which status is appropriate under the new regime.