Dodd-Frank Wall Street Reform and Consumer Protection Act  

  • Private Fund Investment Advisers Registration Act  

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") into law. Included in Title IV of the Dodd-Frank Act is the Private Fund Investment Advisers Registration Act of 2010 (the "Registration Act"), which eliminates (i) the "private adviser exemption" from Securities and Exchange Commission (the "SEC") registration currently contained in Section 203(b)(3) of the Investment Advisers Act of 1940 (the "Advisers Act") for investment advisers who do not hold themselves out to the public as investment advisers and have fewer than 15 clients; and (ii) the intrastate exemption from SEC registration for investment advisers with any private fund client. As a result of the foregoing, many investment advisers to private funds (with some exceptions) will be required to register with the SEC. For a description of the registration and reporting requirements under the Registration Act, please see our article entitled "Registration and Reporting Implications of the Private Fund Investment Advisers Registration Act" beginning on page 4.

Immediately upon enactment of the Registration Act, the net worth standard for an "accredited investor" that is a natural person, as set forth in Rules 215 and 501(a)(5) of the Securities Act of 1933 (the "Securities Act"), was adjusted to exclude from the calculation of net worth the "value of the primary residence" of the investor. Pending implementation of the changes to the SEC's rules required by the Registration Act, the SEC issued Compliance and Disclosure Interpretations clarifying that the related amount of indebtedness secured by the primary residence up to its fair market value may also be excluded. Indebtedness secured by the residence in excess of the value of the home, however, should be considered a liability and deducted from the investor's net worth. As a result, investment advisers should update their subscription booklets to reflect this change. The SEC is required to review and modify such definition periodically.

Within one year after July 21, 2010 (and periodically thereafter), the SEC is required to adjust for inflation the net worth and/or asset-based qualifications applicable to a "qualified client" under the Advisers Act.

Other than as specifically noted above, the Registration Act becomes effective on July 21, 2011, during which time the SEC is expected to adopt rules and regulations providing procedures for registration and reporting. Investment advisers to private funds may voluntarily register with the SEC during this one-year period.

Please see our June 30, 2010 client memorandum entitled "House-Senate Conference Committee Approves Private Fund Investment Advisers Registration Act" for further information on this topic.


  • The Volcker Rule

Section 619 of the Dodd-Frank Act contains the so called "Volcker Rule" which prohibits any "banking entity" from engaging in proprietary trading or sponsoring or investing in hedge funds or private equity funds, subject to limited exceptions. "Banking entity" is defined to include any insured depository institution, any company that controls an insured depository institution or that is regulated as a bank holding company, and any affiliate or subsidiary of any such entity.

The Volcker Rule generally prohibits a banking entity from acquiring or retaining any equity, partnership or other ownership interest in or sponsoring any hedge fund or private equity fund. "Sponsoring" is defined broadly as (i) serving as a general partner, managing member or trustee of a fund; (ii) selecting or controlling a majority of the directors, trustees or management of the fund; or (iii) sharing with a fund, for corporate, marketing, promotional or other purposes, the same name or a variation of the same name. "Hedge fund" and "private equity fund" are defined to include any issuer that would be an investment company subject to registration under the Investment Company Act of 1940, but for an exemption provided by Section 3(c)(1) or Section 3(c)(7) thereunder, and any other issuer that the regulators determine, by rule, should be subject to the Volcker Rule.

The Dodd-Frank Act provides exceptions for the following permitted activities:


  • organizing and offering a hedge fund or private equity fund, including sponsoring such a fund, as long as all of the following conditions are met:  
  1. the banking entity provides bona fide trust, fiduciary or investment advisory services;  
  2. the fund is organized and offered only in connection with the provision of such services and is only offered to customers of such services of the banking entity;  
  3. the banking entity does not have an equity or other ownership interest in the fund except for the following de minimis investments:  
  • seed investments to establish the fund and provide the fund with sufficient initial equity for investment to attract unaffiliated investors; and  
  • other de minimis investments;  

provided that, in making either of the above investments, (x) the banking entity must actively seek unaffiliated investors to reduce its ownership interest to not more than 3% of the total ownership interest of the fund within one year of the establishment of the fund (which period of time may be extended for up to two additional years upon application to the Federal Reserve); and (y) the banking entity's aggregate interests in all funds in which it is permitted to invest may not exceed 3% of its Tier 1 capital;  

  1. the banking entity does not enter into covered transactions (as defined in Section 23A of the Federal Reserve Act, these transactions generally include providing loans or guarantees to funds and purchasing fund assets or securities) with the funds it organizes and offers and complies with the requirements of Section 23B of the Federal Reserve Act, which imposes restrictions on transactions between banks and their affiliates;  
  2. the banking entity does not guarantee, assume or otherwise insure the obligations or performance of the fund or any other hedge fund or private equity fund in which the fund invests;  
  3. the banking entity does not share the same name or a variation of the same name with the fund;  
  4. no director or employee of the banking entity takes or retains an equity or other ownership interest in the fund, except for any director or employee who is directly engaged in providing investment advisory or other services to the fund; and  
  5. the banking entity discloses to prospective and actual investors that the fund's losses are borne by the fund's investors and not by the banking entity;  
  • investing in small business investment companies or certain other investments that are designed to promote the "public welfare" or that are qualified rehabilitation expenditures;  
  • investing in or sponsoring a hedge fund or private equity fund solely outside the United States, provided that the banking entity is not directly or indirectly controlled by a banking entity organized in the United States and the interests in the fund are not offered or sold to a resident of the United States; and  
  • engaging in such other activities as the appropriate federal banking agencies, the SEC and the Commodity Futures Trading Commission determine, by rule, would "promote and protect" the safety and soundness of the banking entity and the financial stability of the United States.  

These exceptions for permitted activities are subject to the same limitations contained in the Volcker Rule with respect to proprietary trading, i.e., such transactions must not give rise to material conflicts of interest, involve high-risk assets or strategies or pose a threat to the banking entity or the U.S. financial system.  

The Dodd-Frank Act also requires the Federal Reserve to adopt rules imposing additional capital requirements and quantitative limits on systemically important nonbank financial companies that engage in proprietary trading or sponsor or invest in hedge funds or private equity funds.

Please see our July 14, 2010 client memorandum entitled "The Volcker Rule" for further information on this topic.

  • Reg D Offerings

Rule 506 of Regulation D of the Securities Act creates a safe harbor allowing issuers to make private placements under Section 4(2) without the offering being deemed "public" and without having to comply with the securities laws of each specific state in which they offer or sell securities. Section 926 of the Dodd-Frank Act requires the SEC to adopt rules by July 21, 2011, that will disqualify offerings from the protections of Regulation D under the Securities Act if such offerings are made by certain "bad actors." The Dodd-Frank Act requires that these new rules must be substantially similar to Rule 262 of the Securities Act. The Dodd- Frank Act specifies that the new rules must disqualify an offering or sale of securities as a Regulation D offering where the person offering the securities: (i) is subject to a final order by a state securities, banking or insurance authority, a federal banking agency or the National Credit Union Administration that (a) bars the person from (1) association with any entity regulated by such authority, (2) engaging in the business of securities, insurance or banking, or (3) engaging in savings association or credit union activities, or (b) constitutes a final order based on a violation of any law or regulation that prohibits fraudulent, manipulative or deceptive conduct within the 10-year period ending on the date of the filing of the Form D; or (ii) has been convicted of any felony or misdemeanor in connection with the purchase or sale of any security or involving the making of any false filing with the SEC.  

  • Incentive-Based Compensation

Section 956 of the Dodd-Frank Act directs federal regulators, including the SEC, by April 2011, to jointly prescribe regulations that would require "covered financial institutions," including investment advisers, to disclose to the appropriate regulator the structures of their incentive-based compensation arrangements. No reporting of the actual compensation of particular individuals would be required. Further, such regulators must jointly issue rules to prohibit any incentive-based payment arrangement that they determine will encourage inappropriate risks by the covered financial institutions by providing their executive officers, employees, directors or principal shareholders with excessive compensation, fees or benefits or that could lead to material financial loss to the institution. Covered financial institutions with assets of less than $1 billion are excluded from these provisions.  

  • SEC Adopts Pay to Play Rule

On June 30, 2010, the SEC adopted a new rule under the Advisers Act to curb "pay to play" practices by certain investment advisers. Pay to play refers to the practice of making campaign contributions to elected officials in an attempt to influence the awarding of contracts for the management of public pension plan assets and similar government investment accounts. Newly adopted Rule 206(4)-5 entitled "Political Contributions by Certain Investment Advisers" (the "Pay Rule") prohibits an investment adviser from:  

  • providing advisory services for compensation to a government entity for two years after the adviser, or certain of its executives or employees, makes a contribution to certain elected officials or candidates who are in a position to influence the selection of the adviser;  
  • providing or agreeing to provide, directly or indirectly, payment to any third party (i.e., a placement agent) for solicitation of advisory business from any government entity on behalf of such adviser, unless the third party is an SEC-registered investment adviser or an SEC-registered broker-dealer, in each case, subject to similar pay to play restrictions; and  
  • coordinating or soliciting from others (a practice known as "bundling") campaign contributions to certain elected officials who are in a position to influence the selection of the adviser or payments to certain political parties in the state or locality where the adviser is seeking government business.

The Pay Rule becomes effective September 12, 2010; however, the restrictions on political contributions will only apply to contributions made after March 12, 2011. Compliance with the ban on the use of unregulated placement agents is required by September 12, 2011. The SEC is providing time for the Financial Industry Regulatory Authority to propose a similar rule covering broker-dealers. Please see our July 9, 2010 client memorandum entitled "SEC Adopts Rule Regarding Political Contributions by Investment Advisers" for further information on this topic.  

  • SEC Adopts Amendments to Form ADV, Part 2

On July 28, 2010, the SEC published its release1 discussing amendments recently adopted by the SEC to Part 2 of Form ADV, and related rules under the Advisers Act, which require registered investment advisers to provide clients and prospective clients with a brochure and brochure supplements written in plain English, including clearly written, meaningful, current disclosure of the business practices, conflicts of interest and background of the investment adviser and its advisory personnel. The brochures must be filed electronically with the SEC and will be made available to the public through the SEC's website.

Currently, Part 2 requires investment advisers to respond to a series of multiple-choice and fillin- the-blank questions organized in a "checkthe- box" format. Unfortunately, that format frequently does not correspond well to an investment adviser's business. And, in some cases, the required disclosure may not describe the investment adviser's business or conflicts in a user-friendly manner.

Under the new rules, investment advisers are required to prepare a narrative, plain English, brochure, presented in a consistent, uniform manner that will make it easier for clients to compare different investment advisers' disclosures. Investment advisers must deliver the brochure to a client before or at the time the investment adviser enters into an advisory contract with the client. In addition, investment advisers must provide each client an annual summary of material changes to the brochure and either deliver a complete updated brochure or offer to provide the client with the updated brochure. The new brochure addresses those topics the SEC believes are most relevant to clients, including (i) advisory business; (ii) fees and compensation; (iii) performance-based fees and side-by-side management; (iv) methods of analysis, investment strategies and risk of loss; (v) disciplinary information; (vi) code of ethics, participation or interest in client transactions and personal trading; and (vii) brokerage practices. An investment adviser is also required to deliver brochure supplements to clients and prospective clients providing them with information about the specific individuals who will provide services to the clients. The supplement will contain brief résumé-like disclosure about the educational background, business experience, other business activities and disciplinary history of the individual, so that the client can assess the person's background and qualifications. It will also include contact information for the person's supervisor in case the client has a concern about the person.

Investment advisers that are currently registered, with fiscal years ending on or after December 31, 2010, must file a brochure that complies with the new rules by March 31, 2011. New investment advisers filing for registration after January 1, 2011 must file a brochure that complies with the new requirements with their application for registration.


  • New York City Adopts Additional Pay to Play Policies

On June 22, 2010, New York City Comptroller John Liu announced additional transparency and disclosure initiatives implemented by his office relating to money managers seeking to do business with the Teachers' Retirement System ("TRS"), the New York City Employees' Retirement System ("NYCERS") and the Board of Education Retirement System ("BERS"). Comptroller Liu also announced that the current ban on the use of placement agents will remain in place. Effective July 1, 2010 (Fiscal Year 2011), there will be new policies relating to disclosure in the due diligence investment process at TRS, NYCERS and BERS (collectively, the "Systems"):


  • Investment managers must certify in writing that they have not given any gifts to any employee in the Comptroller's Office, and have complied with NYC Conflict of Interest Board gift restrictions for the Systems and their respective Boards of Trustees;  
  • Investment managers must disclose all contacts with employees of the Comptroller's Office regarding new investments as well as contacts with other individuals, such as members of the Boards of Trustees, involved in the investment decision-making process;  
  • Investment managers must certify/agree to the following:
    • No placement agent was used in connection with securing the Systems' commitment to any private equity investment transaction;  
    • Full disclosure of all fees and terms relating to any firm retained to provide marketing or placement services for transactions that are not covered by the placement agent ban;  
    • Marketing/placement fees, if any, shall be fully borne by the investment manager;  
    • They have read and complied with Chapter 68 of the NYC Conflict of Interest Board rules and have not caused any employee of the Comptroller's Office or any member of the Boards of Trustees or employee of NYCERS or TRS to breach them in any way; and  
    • Agree that Systems may terminate an investment commitment or contract, and any obligations to pay future management or performance fees, for violation of the Systems' placement agent policy and related disclosure requirements.  
  • Comptroller Liu has voluntarily agreed not to accept any campaign contributions from investment managers and their agents doing business with, or seeking to do business with, the New York City pension systems.