Regulation, licensing and registrationPrincipal regulatory bodies
What are the principal regulatory bodies that would have authority over a private equity fund and its manager in your jurisdiction, and what are the regulators’ audit and inspection rights and managers’ regulatory reporting requirements to investors or regulators?
Advisers Act registration requirements and exemptions
The SEC has the authority to regulate investment advisers pursuant to the Advisers Act. Investment advisers may also be subject to regulatory requirements at the state level. Under the Advisers Act, all investment advisers to private equity funds are generally required to be registered with the SEC under the Advisers Act unless they meet one of the following limited exemptions from such registration:
- the venture capital fund adviser exemption - investment advisers solely to venture capital funds (private funds that represent themselves to their investors and prospective investors as pursuing a venture capital strategy and that comply with other significant requirements, including limitations of the amount of leverage they may incur and type of assets in which they may invest);
- the foreign private adviser exemption - investment advisers who are not holding themselves out to the public in the US as an investment adviser or advising registered funds, have no US place of business, have fewer than 15 US clients and US investors in total in private funds, and have assets under management (AUM) (as discussed below) from such US clients and US investors of less than US$25 million; and
- the private fund adviser exemption - investment advisers solely to private funds with AUM of less than US$150 million (discussed further below). However, for non-US investment advisers, the private fund adviser exemption provides that a non-US investment adviser would not be required to register as long as the following is true:
- it has no client that is a US person except for qualifying private funds; and
- any assets managed by such adviser at a place of business in the US are solely attributable to private fund assets the total value of which is less than US$150 million.
AUM includes 100 per cent of any securities portfolios or private funds for which an investment adviser provides continuous and regular supervisory or management services, regardless of the nature of the assets held by the portfolio or the private fund. In addition, AUM includes 100 per cent of any proprietary assets, assets managed without receiving compensation and any uncalled capital commitments to private funds.
In determining whether an investment adviser can rely on the private fund adviser exemption, the SEC considers an investment adviser’s principal office and place of business as the location where the investment adviser controls the management of private fund assets, although day-to-day management of certain assets may take place at another location. An investment adviser with its principal office and place of business in the US must count all private fund assets, including those from non-US clients toward the US$150 million limit in calculating AUM. An investment adviser with its principal office and place of business outside of the US need only count private fund assets it manages at a place of business in the US toward the US$150 million limit. An investment adviser provides ‘continuous and regular supervisory or management services’ with respect to a private equity fund from a place of business in the US if its US place of business has ‘ongoing responsibility to select or make recommendations’ as to specific securities or other investments the fund may purchase or sell and, if such recommendations are accepted by the fund, the investment adviser’s US place of business is responsible for arranging or effecting the purchase or sale. However, the SEC does not view merely providing research or conducting due diligence to be continuous and regular supervisory or management services at a US place of business if a person outside of the US makes independent investment decisions and implements those decisions. Therefore, a private fund adviser with its principal office and place of business outside of the US that cannot meet the terms of the foreign private adviser exemption because it has raised more than US$25 million from US investors can often rely on the private fund adviser exemption because the type or number of non-US clients or the amount of assets managed outside of the US are not taken into account when calculating the AUM of an investment adviser with its principal office and place of business outside the US.
Investment advisers relying on the venture capital fund exemption or the private fund adviser exemption are considered to be exempt reporting advisers (ERAs) and are required to report with the SEC by filing certain portions of Form ADV, Part 1 within 60 days of relying on the exemption. These portions require disclosure of certain basic information with respect to the investment adviser, its activities and the private funds that it advises. An adviser’s Form ADV filing must be amended at least annually, within 90 days of the end of the investment adviser’s fiscal year, and more frequently for certain specific changes. The SEC is authorised to require an ERA to maintain records and provide reports, and to examine such ERA’s records, which means an ERA’s books and records are subject to SEC inspection. The SEC has in the past indicated that it intends to examine ERAs as a part of the SEC’s routine examination programme. ERAs are not required to file Form PF described below. Investment advisers relying on the foreign private adviser exemption are not required to file reports with the SEC.
In addition to the exemptions described above, certain investment advisers are excluded from the definition of ‘investment adviser’ and thus are not required to register under the Advisers Act. For example, a ‘family office’, which is generally a company owned and controlled by family members that provides investment advice only to family clients and does not hold itself out to the public as an investment adviser, is so excluded from the definition.
On the other hand, subject to certain exceptions, investment advisers with less than US$100 million in AUM are generally prohibited from registering with the SEC under the Advisers Act and must instead register as an investment adviser in the state in which they maintain a principal office and place of business and be subject to examination as an investment adviser by the applicable securities commissioner, agency or office.
A registered investment adviser with at least US$150 million of ‘private fund’ (ie, a fund relying on 3(c)(1) or 3(c)(7)) AUM is required to file Form PF with the SEC, which requires disclosure of certain information regarding each private fund an investment adviser advises, including gross and net asset value, gross and net performance, use of leverage, aggregate value of derivatives, a breakdown of the fund’s investors by category (eg, individuals, pension funds, governmental entities, sovereign wealth funds), a breakdown of the fund’s equity held by the five largest investors and a summary of fund assets and liabilities. Registered investment advisers to hedge funds are also required to report additional information about the hedge funds they advise, including fund strategy, counterparty credit risk and use of trading and clearing mechanisms. Large private fund advisers are required to report more extensive information, with the nature of the information dependent upon their strategy. Additional disclosure requirements apply to registered investment advisers to private equity funds with at least US$2 billion in AUM (ie, large private equity advisers). Such disclosure requirements focus on fund guarantees of controlled portfolio company obligations, leverage of controlled portfolio companies and use of bridge financing for controlled portfolio companies. In addition, registered investment advisers to hedge funds with at least US$1.5 billion in AUM (ie, large hedge fund advisers) must report on an aggregated basis information regarding exposures by asset class, geographical concentration and turnover, and for hedge funds with a net asset value of at least US$500 million, they must also report certain information relating to such fund’s investments, leverage, risk profile and liquidity. For registered investment advisers that manage only private equity funds, real estate funds and venture capital funds (as well as registered investment advisers to hedge funds that have a smaller AUM), the form has to be filed annually within 120 days of the fiscal year-end. Large hedge fund advisers must file Form PF on a quarterly basis within 60 days of the end of each fiscal quarter. Unlike Form ADV filings, which are available on the SEC’s website, Form PF filings are confidential and such information is exempt from requests for information under FOIA. However, the SEC is required to share information included in Form PF filings with the Financial Stability Oversight Council and in certain circumstances US Congress and other federal departments, agencies and self-regulatory organisations (in each case, subject to confidentiality restrictions). We note that, for purposes of Form PF, a private fund that is required to pay a performance fee based on unrealised gains to its investment adviser or has the ability to borrow in excess of certain thresholds or sell assets short is deemed to be a per se hedge fund.
Regulation applicable to unregistered advisers
Even unregistered investment advisers (whether ERAs or not) are subject to the general anti-fraud provisions of the Exchange Act, the Advisers Act (see question 6), state laws and, if required to register as a broker-dealer with the Financial Industry Regulatory Authority (FINRA) (see question 11), similar rules promulgated by FINRA, and the SEC and many of the analogous state regulatory agencies retain statutory power to bring actions against a private equity fund sponsor under these provisions.
US Commodity Futures Trading Commission (CFTC) regulation
The CFTC has the authority to regulate commodity pool operators (CPOs) and commodity trading advisers (CTAs) under the US Commodity Exchange Act. CFTC regulations broadly include most derivatives as ‘commodity interests’ that cause a private equity fund holding such instruments to be deemed a ‘commodity pool’ and its operator (typically the general partner, in the case of a limited partnership) to be subject to CFTC jurisdiction as a CPO and/or its adviser (typically the investment adviser) to be subject to CFTC jurisdiction as a CTA, and, unless an exemption is available, to become a member of the National Futures Association (NFA), the self-regulatory organisation for the commodities and derivatives market. The CFTC regulations will generally apply on the basis of holding any commodity interest, directly or indirectly and, as such, CPO and CTA status should be considered with respect to all investment activities and products, including, for example, private funds, real estate investment trusts, business development companies, separate managed account arrangements and any subsidiary entities, alternative investment vehicles and other related entities and accounts. CPOs managing private equity funds may claim certain exemptions from registration with the CFTC, which may include no-action relief (including for CPOs of ‘funds of funds’, real estate investment trusts and business development companies), the ‘de minimis’ exemption under CFTC Rule 4.13(a)(3) (providing relief for CPOs that engage in limited trading of commodity interests on behalf of a commodity pool) and ‘registration lite’ under CFTC Rule 4.7 (providing relief from certain reporting and record-keeping requirements otherwise applicable to a registered CPO if the interests in such pool are offered only to ‘qualified eligible persons’ (which includes a ‘qualified purchaser’ described in question 24 and ‘non-United States persons’) in a private offering of securities (including an offering that complies with Rule 506(c) under the Securities Act, as described in question 24)), and corresponding exemptions are available to CTAs of private equity funds. The confluence of regulatory measures taken in the post-financial crisis period, including the expansion of the meaning of commodity interests to include most swaps and the repeal of the broad exemption under CFTC Rule 4.13(a)(4), which was commonly relied upon by CPOs of private equity funds that rely on the 3(c)(7) exemption from registration under the Investment Company Act (ie, the qualified purchaser exemption described in question 24) placed additional regulatory pressure on private equity fund sponsors to monitor whether their activities will deem their private equity funds to be commodity pools (eg, because the funds hedge their currency or interest rate exposure by acquiring swaps), and to appropriately assess the registration requirements for CPOs and determine whether they meet the de minimis exemption from such registration, which requires consideration of a number of factors early in the process of structuring a fund and throughout its term. If an exemption or other relief is not available, a sponsor of a fund that invests in commodity interests (including derivatives) may be required to register with the CFTC and NFA, in which case it will become subject to reporting, record-keeping, advertising, ethics training, supervisory and other ongoing compliance obligations and certain of its personnel will become subject to certain proficiency requirements (eg, the Series 3 exam) and standards of conduct.Governmental requirements
What are the governmental approval, licensing or registration requirements applicable to a private equity fund in your jurisdiction? Does it make a difference whether there are significant investment activities in your jurisdiction?
The offering and sale of interests in a private equity fund are typically conducted as ‘private placements’ exempt from the securities registration requirements imposed by the Securities Act, the regulations thereunder and applicable state law. In addition, most private equity funds require their investors to meet certain eligibility requirements so as to enable the funds to qualify for exemption from regulation as investment companies under the Investment Company Act. Accordingly, there are no approval, licensing or registration requirements applicable to a private equity fund that offers its interests in a valid private placement and qualifies for an exemption from registration under the Investment Company Act.
As a general matter, if 25 per cent or more of the total value of any class of equity interests in a private equity fund is held by ‘benefit plan investors’ (disregarding the value of interests held by the sponsor and its affiliates, and anyone providing investment advice to the private equity fund and its affiliates, unless they themselves are ‘benefit plan investors’), the private equity fund must be operated to qualify as an ‘operating company’ such as a ‘venture capital operating company’ (VCOC) or a ‘real estate operating company’ (REOC). In general, for purposes of applying the 25 per cent test, the term ‘benefit plan investors’ includes only those plans and arrangements that are subject to fiduciary responsibility standard of care under Title I of the Employee Retirement Income Security Act of 1974 (ERISA) and prohibited transaction rules under Title I of ERISA and section 4975 of the Internal Revenue Code of 1986 (the Code), such as US corporate pension plans and individual retirement accounts as well as entities whose assets include plan assets (such as a fund of funds). Plans that are not subject to the fiduciary responsibility standard of care under ERISA or prohibited transaction rules under ERISA and section 4975 of the Code, such as US governmental pension plans and pension plans maintained by non-US corporations, are not counted for purposes of the 25 per cent test. Qualification as a VCOC generally entails the private equity fund having on its initial investment date and annually thereafter at least 50 per cent of the private equity fund’s assets, valued at cost, invested in operating companies as to which the private equity fund obtains direct contractual management rights. The private equity fund must exercise such management rights with respect to one or more of such operating companies during the course of each year in the ordinary course of business.
The sponsor of a private equity fund engaging in certain types of corporate finance or financial advisory services may be required to register as a broker-dealer with FINRA and be subject to similar audit and regulation.Registration of investment adviser
Is a private equity fund’s manager, or any of its officers, directors or control persons, required to register as an investment adviser in your jurisdiction?
In the absence of an applicable exemption, exception or prohibition, a private equity fund’s manager will be subject to registration as an investment adviser under the Advisers Act. (See question 10.)
Those investment advisers registered under the Advisers Act (whether voluntarily or because an exemption, exception or prohibition is not available) are subject to a number of substantive reporting and record-keeping requirements and rules of conduct that shape the management and operation of their business, as well as periodic compliance inspections conducted by the SEC.
As part of the shift towards more systematic regulation and increased scrutiny of the private equity industry, the SEC continues to focus on the examination of private equity firms. Certain private equity industry practices have received significant attention from the SEC and have led to a number of enforcement actions against private equity fund advisers in recent years. Areas that the SEC has highlighted to be of particular concern include, among others, the following:
- allocation of expenses to funds or portfolio companies, or both, without pre-commitment disclosure and agreement from investors (including for the compensation of operating partners, senior advisers, consultants and seconded and other in-house employees of private equity fund advisers or their affiliates for providing services (other than advisory services) to funds or portfolio companies or both);
- full allocation of broken deal expenses to funds instead of separate accounts, co-investors or co-investment vehicles without pre-commitment disclosure and agreement from investors;
- marketing presentations, and the presentation of performance information generally;
- receipt by private equity firms of compensation from funds or portfolio companies, or both, which is outside the typical management fee or carried interest structure without a corresponding management fee offset, without pre-commitment disclosure and agreement from investors as well as an acceleration of monitoring fees;
- receipt by private equity firms of transaction-based or other compensation for the provision of brokerage services in connection with the acquisition and disposition of portfolio companies without being registered as a broker-dealer;
- allocation of investment opportunities among investment vehicles they manage and between such funds and the private equity fund advisers, affiliates or employees;
- allocation of co-investment opportunities;
- disclosure of other conflicts of interests to investors, including those arising out of the outside business activities of a private equity sponsor’s employees and directors;
- valuation methods;
- receipt of service provider discounts by private equity firms that are not given to the funds or portfolio companies without pre-commitment disclosure and agreement from investors;
- plans to mitigate or respond to cybersecurity events;
- failure to fully allocate fees from portfolio companies to management fee paying funds to offset such management fees without pre-commitment disclosure and agreement from investors;
- allocation of interest from a loan to the private equity fund adviser only to the adviser or its affiliates without pre-commitment disclosure and agreement from investors;
- pay to play violations; and
- late filing of required filings (eg, Form PF).
Are there any specific qualifications or other requirements imposed on a private equity fund’s manager, or any of its officers, directors or control persons, in your jurisdiction?
There are no particular educational or experience requirements imposed by law on investment advisers, although the education and experience of certain of an investment adviser’s personnel are disclosable items in the Form ADV. As a matter of market practice, the required experience level of an investment adviser’s management team will be dictated by the demands of investors. If required to register as a broker-dealer with FINRA, a private equity fund sponsor would need to satisfy certain standards in connection with obtaining a registration (eg, no prior criminal acts, minimum capital, testing, etc). Also, a private equity fund’s sponsor is typically expected to make a capital investment either directly in or on a side-by-side basis with the private equity fund (but see question 16 with respect to limitations on sponsor commitments in bank-sponsored private equity funds). Investors will expect that a significant portion of this investment be funded in cash, as opposed to deferred-fee or other arrangements.Political contributions
Describe any rules - or policies of public pension plans or other governmental entities - in your jurisdiction that restrict, or require disclosure of, political contributions by a private equity fund’s manager or investment adviser or their employees.
The SEC has adopted Rule 206(4)-5, a broad set of rules aimed at curtailing ‘pay-to-play’ scandals in the investment management industry. The rules, subject to certain de minimis exceptions, prohibit a registered investment adviser, as well as an ERA and a foreign private adviser (covered advisers), from providing advice for compensation to any US government entity within two years after the covered adviser or certain of its executives or employees (covered associates) has made a political contribution to an elected official or candidate who is in a position to influence an investment by the government entity in a fund advised by such investment adviser. The rules also make it illegal for the covered adviser itself, or through a covered associate, to solicit or coordinate contributions for any government official (or political party) where the investment adviser is providing or seeking to provide investment advisory services for compensation to a government entity in the applicable state or locality. Investment advisers are also required to monitor and maintain records relating to political contributions made by their employees.
In addition to the SEC rule, certain US states (including California, New Mexico, New Jersey and New York) have enacted legislation and certain US public pension plans (including the California Public Employees’ Retirement System (CalPERS), the California State Teachers’ Retirement System (CalSTRS), the New Mexico State Investment Council and the New York State Common Retirement Fund) have established policies that impose similar restrictions on political contributions to state officials by investment advisers and covered associates.Use of intermediaries and lobbyist registration
Describe any rules - or policies of public pension plans or other governmental entities - in your jurisdiction that restrict, or require disclosure by a private equity fund’s manager or investment adviser of, the engagement of placement agents, lobbyists or other intermediaries in the marketing of the fund to public pension plans and other governmental entities. Describe any rules that require a fund’s investment adviser or its employees and agents to register as lobbyists in the marketing of the fund to public pension plans and governmental entities.
With effect from 20 August 2017, the SEC’s pay-to-play rules discussed above broadly prohibit a covered adviser from making any payment to a third party, including a placement agent, finder or other intermediary, for securing a capital commitment from a US government entity to a fund advised by the investment adviser unless such placement agent is registered under section 15B of the Exchange Act and subject to pay-to-play rules adopted by the Municipal Securities Rulemaking Board or FINRA. The ban does not apply to payments by the investment adviser to its employees or owners.
Certain US states have enacted legislation regulating or prohibiting the engagement or payment of placement agents by an investment adviser with respect to investment by some or all of such state’s pension systems in a fund advised by such investment adviser. Such regulations and prohibitions vary from state to state. For example, California has enacted legislation that requires placement agents, which can include third-party placement agents as well as the investment manager’s employees, officers, directors and other equity holders (unless such persons spend at least a third of their time managing the securities or assets invested by the investment adviser), to register as lobbyists before soliciting investments from its state-level public pension plans (CalPERS, CalSTRS and the University of California to the extent it is investing retirement (as opposed to endowment) assets). The California law also prohibits placement agents from receiving fees that are contingent on securing investments from the plans and requires disclosure of any fixed placement fees or other compensation paid to solicit investments from such state pension plans.
The California law requiring placement agents to register as lobbyists may also require such registration of certain of an investment adviser’s own employees and partners who are involved with the solicitation of investments from the California state pension plans, such as marketing or investor relations personnel. The compensation paid to such employees and partners of the investment adviser who directly solicit the plan is also required to be disclosed. In addition, investment advisers who retain third-party placement agents to solicit the California state pension plans or whose employees and partners are covered by the lobbyist-registration law are considered ‘lobbyist employers’ under California law and are required to make certain public filings in addition to such placement agents and employees. Kentucky has also recently adopted registration requirements with respect to placement agents soliciting investments from Kentucky state pension plans that are similar to those applicable to California state public pension plans. Various other states may also have lobbying laws that effectively require investment advisers and their employees who solicit state and local pension plans to register as lobbyists. Counties, cities or other municipal jurisdictions may require lobbyist registration or disclosure or both. For example, in New York City, local rules effectively require investment advisers and their employees who solicit local pension plans to register as lobbyists.
In addition, public pension plans may have their own additional requirements. In states where state law does not ban placement agent fees or require disclosure, the public pension plans themselves may have such bans or requirements.Bank participation
Describe any legal or regulatory developments emerging from the recent global financial crisis that specifically affect banks with respect to investing in or sponsoring private equity funds.
In 2013, the five US regulatory agencies responsible for implementing the ‘Volcker Rule’ provisions of Dodd-Frank approved final rules (the ‘Final Rules’) that generally prohibit ‘banking entities’ from acquiring or retaining any ownership in, or sponsoring, a private equity fund (and engaging in proprietary trading). On 24 May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the Reform Act) was enacted and, among other financial regulatory changes, modified the Volcker Rule’s ‘banking entity’ definition. For purposes of the Volcker Rule, as implemented by the Final Rules and as amended by the Reform Act, the term ‘banking entity’ means any insured depository institution (other than certain limited-purpose trust institutions and insured depository institutions that do not have, and are not controlled by a company that has, more than US$10 billion in total consolidated assets and total trading assets and trading liabilities that are more than 5 per cent of total consolidated assets), any company that controls such an insured depository institution, any company that is treated as a bank holding company for purposes of the International Banking Act (such as a foreign bank that has a US branch, agency or commercial lending subsidiary) and any affiliate or subsidiary of such entities.
There are a number of exceptions to the basic prohibition on banking entities investing in or sponsoring private equity funds. In particular, banking entities are permitted to invest in covered private funds that they sponsor, provided that the investment does not exceed 3 per cent of the fund’s total ownership interest on a per-fund basis, or 3 per cent of the banking entity’s ‘Tier 1 capital’ on an aggregate basis, and provided that certain other conditions are met. For these purposes, covered funds generally include funds that would be investment companies but for the exemptions provided by section 3(c)(1) or section 3(c)(7) of the Investment Company Act.
In June 2018, the five US regulatory agencies responsible for implementing the Volcker Rule proposed certain limited modifications to the Final Rules, but whether such administrative modifications will be adopted (or in what ultimate form) is uncertain.