• Political Contributions by Certain Investment Advisers

On August 3, 2009, the SEC published proposed Rule 206(4)-5 under the Advisers Act that would prohibit an investment adviser from providing advisory services for compensation to a government client for two years after the adviser or certain of its executives or employees make a contribution to certain elected officials or candidates. The new rule would also prohibit an adviser from providing or agreeing to provide, directly or indirectly, payment to any third party for a solicitation of advisory business from any government entity on behalf of such adviser. Additionally, the new rule would prevent an adviser from soliciting from others, or coordinating, contributions to certain elected officials or candidates or payments to political parties where the adviser is providing or seeking government business. The SEC also is proposing rule amendments to Rules 204-2 and 206(4)-3 under the Advisers Act that would require a registered adviser to maintain certain records of the political contributions made by the adviser or certain of its executives or employees. The SEC is seeking public comment on the proposed rule and rule amendments; comments must be received by the SEC by October 6, 2009. Please see our August 11, 2009 client alert entitled "SEC Proposes ‘Pay to Play’ Rule Regarding Political Contributions by Certain Investment Advisers" for further information on this topic.  

  • Private Fund Investment Advisers Registration Act of 2009

The U.S. Department of the Treasury, on behalf of President Barack Obama, recently introduced legislation entitled the "Private Fund Investment Advisers Registration Act of 2009," which would require all investment advisers to "private funds" (including hedge funds and private equity funds) with more than $30 million of assets under management to register with the SEC. A "private fund" is defined as any investment company relying on the exceptions from registration provided by Section 3(c)(1) or Section 3(c)(7) of the U.S. Investment Company Act of 1940, as amended (the "Investment Company Act") that is either organized under the laws of the United States or that has 10% or more of its securities owned by U.S. persons. Any such registered investment adviser would be required to submit to the SEC such reports regarding each private fund it advises as are "necessary or appropriate in the public interest and for the assessment of systemic risk" by the Board of Governors of the Federal Reserve System (the "Board") and the Financial Services Oversight Council (the "Council"), including the amount of assets under management, use of leverage (including off-balance sheet leverage), counterparty credit risk exposures, trading and investment positions, and trading practices. Such reports may also include "such other information" as the SEC, in consultation with the Board determines "necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk." The records of each private fund advised by the investment adviser - which would be "deemed to be the records and reports of the investment adviser" - would be subject at any time to periodic, "special" and other examinations by the SEC. The SEC would make available to the Board and the Council copies of all reports and documents filed with the SEC as the Board or the Council may consider necessary to assess the systemic risk of a private fund and determine whether a private fund should be designated a "Tier 1 Financial Holding Company." A fund designated a Tier 1 Financial Holding Company would be subject to the Board's jurisdiction and subject to the prudential standards for such holding companies, which include strict capital, liquidity and risk management standards. All such reports obtained by the Board or the Council from the SEC would be kept confidential; however, the proposed legislation also provides that the SEC would not be authorized to withhold such information from Congress or any other federal department or agency. In addition to providing reports to the SEC, a registered adviser would be required to provide such reports, records and other documents to investors, prospective investors, counterparties and creditors of any private fund advised by such registered adviser as the SEC "may prescribe as necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk." The proposed Act would also eliminate the current "private adviser" exemption from registration available to advisers with fewer than 15 clients in the preceding 12 months, and, in lieu thereof, would provide for a "foreign private adviser" exemption that would be available to an adviser that (i) has no place of business in the United States; (ii) during the preceding 12 months has had (a) fewer than 15 clients in the United States and (b) assets under management attributable to clients in the United States of less than $25 million; and (iii) neither holds itself out generally to the public in the United States as an investment adviser, nor acts as an adviser to any investment company registered under the Investment Company Act. Please see our July 20, 2009 client alert entitled "Obama Administration Proposes Legislation Requiring Registration of All Private Fund Advisers" for further information on this topic.

  • Investor Protection Act of 2009

The U.S. Department of the Treasury, on behalf of President Obama, recently introduced legislation entitled the "Investor Protection Act of 2009." Specifically, the legislation proposes: (i) establishing consistent standards of conduct for broker-dealers and investment advisers (namely, to act solely in the interest of the customer or client); (ii) giving the SEC authority to prohibit mandatory arbitration clauses in broker-dealer, municipal securities dealer and investment advisory agreements; (iii) giving the SEC authority to regulate the quality and timing of disclosure documents and prospectuses with respect to registered investment companies; (iv) clarifying the SEC's authority to conduct consumer testing and encourage it to do so, in order to create more effective and clearer disclosures and to better assess its rules and programs; (v) expanding the SEC's whistleblower program by establishing a fund to pay whistleblowers for information that leads to enforcement actions resulting in significant financial awards; (vi) harmonizing liability standards so that the SEC can pursue those who aid and abet securities fraud; (vii) requiring accountability of securities professionals throughout the financial services industry; and (viii) establishing a permanent SEC Investor Advisory Committee. Please see our July 14, 2009 client alert entitled "Obama Administration Releases Proposed Legislation to Strengthen the SEC's Authority to Protect Investors" for further information on this topic.

  • Private Fund Transparency Act of 2009

Senator Jack Reed has introduced legislation entitled the "Private Fund Transparency Act of 2009" which eliminates the "private adviser exemption" under Section 203(b)(3) of the Advisers Act. The bill would (i) require all private fund advisers that manage more than $30 million in assets to register as investment advisers with the SEC; (ii) provide the SEC with the authority to collect information from private funds, including the risks they may pose to the financial system; (iii) authorize the SEC to require private funds to maintain and share with other federal agencies any information necessary for the calculation of systemic risk; and (iv) clarify other aspects of SEC's authority in order to strengthen its ability to oversee registered investment advisers.

  • Amendments to Rule 206(4)-2 Under the Advisers Act

The SEC recently published proposed amendments to the rules governing the custody of client funds and securities by registered investment advisers. The proposed amendments enhance and expand on existing requirements for registered investment advisers under Rule 206(4)-2 (Custody of Funds or Securities of Clients by Investment Advisers) of the Advisers Act, which requires advisers who have custody of client assets to implement controls to protect such assets from being lost, misused, misappropriated or subject to the adviser's financial problems (such as insolvency). One proposed amendment would require all registered investment advisers that have custody of client funds or securities to undergo an annual surprise examination by an independent public accountant to verify that those client assets exist. (Particularly important to pooled investment vehicles, the proposed amendments would eliminate the exemption from the surprise examination requirement for a pooled investment vehicle that is audited at least annually and distributes audited financial statements to investors within 120 days of the end of its fiscal year.) Another proposed amendment would apply to advisers whose client assets are held or controlled by the adviser or a related person acting as a qualified custodian and would require such advisers to obtain a written "SAS-70" report from an independent public accountant registered with and inspected by the PCAOB that, among other things, describes the controls in place, tests the operating effectiveness of those controls and provides the results of those tests, and includes an opinion regarding the custodian's controls relating to custody of client assets. The proposed amendments also would include reporting requirements designed to alert the SEC staff and investors to potential problems at an adviser, and provide the SEC with important information for risk assessment purposes. An adviser would be required to disclose in public filings with the SEC, among other things, the identity of the independent public accountant that performs its surprise examination and amend its filings to report if it changes accountants. The accountant would have to report the termination of its engagement with the adviser and, if applicable, any problems with the examination that led to the termination of its engagement. If the accountants find any material discrepancies during the surprise examination, they would have to report them to the SEC. Under the proposed amendments, an adviser would be deemed to have custody of any client assets that are directly or indirectly held by a related person in connection with advisory services provided by the adviser to its clients. The proposed amendments would also include several changes to Form ADV that would make certain currently permitted disclosures mandatory and would require additional details relating to topics already covered in the Form ADV.

  • Corporate and Financial Institution Compensation Fairness Act of 2009

The U.S. House of Representatives recently approved the "Corporate and Financial Institution Compensation Fairness Act of 2009." Although much of the bill applies only to public companies and deals with giving shareholders a "say on pay" for top executives, the bill would also require certain investment advisers to disclose incentive based compensation structures. Specifically, the bill requires "covered financial institutions," which includes investment advisers whether they are registered with the SEC or not, with "assets" of at least $1 billion to disclose to the appropriate federal regulator (i.e., the SEC) the "structures of all incentive-based compensation arrangements offered by such covered financial institutions sufficient to determine whether the compensation structure: (a) is aligned with sound risk management; (b) is structured to account for the time horizon of risks; and (c) meets such other criteria as the appropriate federal regulators jointly may determine to be appropriate to reduce unreasonable incentives offered by such institutions for employees to take undue risks that (i) could threaten the safety and soundness of covered financial institutions or (ii) could have serious adverse effects on economic conditions or financial stability." The bill would give federal regulators the power to prescribe regulations that prohibit any incentive-based payment arrangements, or any feature of any such arrangement, that regulators determine encourages inappropriate risk by covered financial institutions.

  • European Commission’s Draft Directive on Alternative Investment Fund Managers

The European Commission recently released a Proposal for a Directive of the European Parliament and of the Council on Alternative Investment Fund Managers (the "Directive"). The Directive aims to create a comprehensive and effective regulatory and supervisory framework for managers of hedge funds and private equity funds in the European Union. The Directive applies to managers and administrators established in the EU who manage alternative investment funds that are not regulated under the UCITS Directive, including hedge funds, private equity funds, commodity funds, real estate funds, infrastructure funds and other types of institutional funds (such managers, "AIF Managers" and such funds, "AIFs"). The Directive would only apply to:  

  • Leveraged AIF Managers - AIF Managers with assets under management (including any assets acquired through the use of leverage) equal to or greater than €100 million; and  
  • Non-Leveraged AIF Managers - AIF Managers with assets under management equal to or greater than €500 million, where the portfolio of AIFs consists of AIFs that are not leveraged and have no redemption rights exercisable during a period of five years following the date of constitution of each AIF.  

To operate in the EU, regulated AIF Managers would be required to obtain authorization from the competent authority of their home Member State and would be subject to ongoing requirements. Among other requirements, these AIF Managers would be required to demonstrate that they are suitably qualified to provide AIF management services and would be required to provide detailed information on their planned activities, the identity and characteristics of the AIFs managed, the governance of the AIF Managers (including any delegation arrangements), internal arrangements with respect to risk management, arrangements for the valuation and safe-keeping of assets and the systems of regulatory reporting. Regulated AIF Managers would be required to report on a regular basis to their home Member State's competent authority on the principal markets and instruments in which they trade, their principal exposures, performance data and concentrations of risk. These AIF Managers would also be required to notify the competent authority of the identity of the AIFs managed, the markets and assets in which the AIFs invest, and the organizational and risk management arrangements established in relation to the AIFs. The Directive also contains a number of common disclosure requirements that would be applicable to all regulated AIF Managers, such as risk, return and liquidity characteristics, identity of service providers, risk management systems, percentage of an AIF's assets that are subject to special arrangements (e.g., side pockets), fees and charges that are directly or indirectly borne by investors and preferential treatment provided to other investors by the AIF Managers. Regulated AIF Managers would be required to hold and retain a minimum level of capital of at least €125,000, plus 0.02% of the amount by which the value of an AIF Manager's portfolios exceeds €250 million. An AIF Manager authorized in its home Member State would be entitled to provide management services and/or market AIFs to "professional investors" in any country within the EU (subject to a notification procedure under which relevant information is provided to the home and host Member State). AIF Managers would be permitted to continue marketing to retail investors in those Member States that allow such marketing, and those Member States may impose additional regulatory requirements on the AIF Managers or the AIFs. However, marketing to retail investors would only be permitted where a Member State expressly grants that right and such right may not be "passported" to any other Member State. The Directive also contemplates "passporting rules" applicable to AIF Managers established in a third country who offer interests in an AIF to professional investors in the EU; however, due to the complexity of creating such a system, passporting rules would only come into force three years after the Directive becomes effective. The Directive now passes to the European Parliament and then the European Council for further debate and consideration. Following adoption, the Directive would be complemented by implementing measures adopted by the European Commission and would then need to be transposed into national law by the Member States. Member States would have flexibility in incorporating the Directive into national law. The Directive is not expected to come into force until 2011. Please see our May 5, 2009 client alert entitled "European Commission Publishes Draft Directive on Alternative Investment Fund Managers" for further information on this topic.

Levin Bill to Tax Carried Interest as Ordinary Income

Representative Sander Levin has reintroduced legislation to tax carried interest capital gains at ordinary income rates. This bill is substantially similar to a version proposed by Representative Levin in June 2007, although it goes further than the prior proposals in some important respects; the Obama Administration 2010 budget proposes similar legislation. As with the prior proposals, this bill would tax any income from an "investment services partnership interest" at ordinary rather than capital gains rates. It would also tax gains from the dispositions of such interests at ordinary rates. Going beyond earlier proposals, gains realized in transactions that would otherwise be tax-deferred (including, it appears, gifts) are also subject to tax at ordinary rates. As written, the bill would cover both carried interests and so-called "fee waiver" or "MPI" interests. "Investment services partnership interests" are interests in a partnership held by a person if it was reasonably expected at the time the person acquired the interest that the person or a related party would provide a substantial quantity of advisory or management services, directly or indirectly, to the partnership with respect to "specified assets." Specified assets generally consist of securities, rental and investment real estate, partnership interests, and commodities, as well as options and derivatives with respect to those assets. Income and gain from a "disqualified interest" is also treated as ordinary income. A disqualified interest is, in general, an interest in an entity the value of which is substantially related to the amount of income or gain generated by assets with respect to which investment management services are performed. Exceptions are provided for, among other things, interests in a taxable C corporation. Thus "founders stock" and similar interests would appear not to be covered. However, an interest in a non-U.S. corporation the income of which is not effectively connected with a U.S. trade or business or subject to a comprehensive income tax is a disqualified interest. The effect of this provision appears to be to shut down a PFIC-based structure that has been discussed in the press to substitute for partnership carried interests in offshore corporations not themselves subject to tax. As with the earlier versions of the legislation, there is an exception from ordinary income treatment for reasonable returns on "qualified capital interests." Under this rule, the serviceprovider partner would receive capital gains treatment on returns on capital to the extent of the similar returns received by non-service provider, unrelated limited partners. In addition, the rule characterizing gains from dispositions of investment service partnership interests as ordinary income would not apply to any portion of the gain attributable to a qualified capital interest. The proposal defines a qualified capital interest as the portion of a partner's interest in the capital of a partnership attributable to the amount of money or the fair market value of property contributed to the partnership in exchange for the interest. Expanding on the prior proposals, (i) any amounts the partner included in gross income with respect to the transfer of the interest and (ii) cumulative net income and gain taken into account with respect to the interest for years to which the new law applies would also be treated as capital investments, but such amounts would be reduced by losses and distributions. A qualified capital interest does not include a capital interest acquired with the proceeds of a loan from or guaranteed by the partnership or a partner, thus cutting off another "work around" discussed in the press. As with the prior carried interest proposals, this bill would clearly apply to managers of traditional buyout funds, real estate funds, and hedge funds that rely on carried interest allocation. Profits interests issued to employees in other kinds of businesses may not be caught by this legislation (largely because of the limiting definition of "specified assets"). Please see our April 6, 2009 client alert entitled "Levin Reintroduces Bill That Would Tax Carried Interest as Ordinary Income" for further information on this topic.