On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). This alert summarizes noteworthy impacts of the Act on the investment management community in general. However, each client should review the Act as a whole, and Holland & Knight can help you to identify aspects of the legislation, including those not discussed here, that may be relevant to your specific business.
Unless otherwise stated, any changes in law discussed here are generally not effective until July 21, 2011.
1. Exemptions Under the Act
You will no longer be exempt from registration under the Advisers Act simply by means of having, inter alia, fewer than 15 clients (i.e., the federal de minimis exemption has been eliminated).2
The Act now provides only much narrower registration exemptions (as discussed below).
If you previously relied on the de minimis exemption, you may need to register with your home state(s) or the SEC.
Advisers in states such as Connecticut, which currently exempts advisers from Connecticut registration that were eligible for SEC registration (but claimed the federal de minimis exemption), must now re-evaluate their exemption status in such states to the extent they are not required to register with the SEC under the new thresholds. (For more information on SEC or state registration, including the new thresholds, see section 2 below.)
Advisers with aggregate assets under management (AUM) of less than $150M in the United States, whose sole clients are private funds, may remain exempt from SEC registration.
If you manage any separate accounts in addition to private funds, you are not eligible for this exemption.
Once your aggregate AUM is greater than or equal to $150M, you must register with the SEC. (See section 2 below).
Advisers not required to register pursuant to this exemption are still subject to certain record keeping and filing obligations to be determined by the SEC.
Exempt advisers must continue to evaluate the registration laws of any state where they have a place of business to ensure compliance with, or exemption from, such state laws.
Non-U.S. advisers will generally be required to register with the SEC unless they qualify for a very narrow “Foreign Private Advisers” exemption.
A “foreign private adviser” means any adviser that: (1) has no place of business in the United States; (2) has less than $25M in assets under management3 “attributable” to U.S. clients and to investors in such adviser’s private funds; (3) has fewer than 15 clients and investors in the U.S.4; and (4) does not hold itself out generally to the public in the United States as an investment adviser nor act as an adviser to any registered investment company or business development company (BDC).
Non-U.S. advisers solely to private funds with aggregate AUM of less than $150M may still claim that registration exemption (discussed more fully above).
“Family offices” or advisers solely to one or more “venture capital funds” are exempted from SEC registration.5
The SEC is required to develop definitions for “venture capital funds” and “family offices” through rulemaking within a year of the Act’s adoption; very narrow definitions are expected.
Advisers solely to one or more “venture capital funds” will still be subject to certain record keeping and filing obligations to be determined by the SEC.
2. New AUM Thresholds for SEC/State Registration6
U.S. Advisers That Do Not Solely Advise Private Funds. If you are an adviser to at least one separately managed account (i.e., if you are not an adviser solely to “private funds”), the following new registration requirements and thresholds apply:7
If you have AUM in excess of $100M, then you must register with the SEC (even if you only have one account/client).
If you have AUM of $25M to $100M8 and are not required to be registered, or, if registered, would not be subject to examination in your home state(s), then you: (i) may register with the SEC if your AUM is at least $25M; and (ii) must register with the SEC if your AUM is $30M or more.
If you have AUM of $25M to $100M and are required to be registered, and, if registered, would be subject to examination, in your home state(s), then you must: (i) deregister with the SEC (to the extent applicable); and (ii) register in your home state(s).9
If you have AUM of less than $25M, then you are not eligible for SEC registration and must either be: (i) registered in any state where you have a place of business; or (ii) able to claim an exemption in each state where you have a place of business.
U.S. Advisers Solely to Private Funds. If you are an adviser solely to private funds (i.e., hedge funds, real estate funds that hold securities, private equity funds, etc.) and are not an adviser solely to “venture capital funds,”10 then the following new registration requirements and thresholds apply:
If you are an adviser solely to “private funds” and your aggregate AUM is equal to or greater than $150M, then you must register with the SEC (even if you advise only one fund).
If you are an adviser solely to “private funds” and your aggregate AUM is less than $150M, then you are not required to register with the SEC.11 It is currently unclear whether such advisers may optionally elect to register, or stay registered, with the SEC even if their AUMs exceed certain threshold levels (e.g., a private fund adviser that has an aggregate AUM in excess of $100M). Additionally, the following apply to private fund advisers with AUMs less than $150M: (1) they must continue to evaluate registration laws of any state where they have a place of business to ensure compliance with, or exemption from, such state laws; and (2) they are still subject to certain record keeping and filing obligations to be determined by the SEC. Such recordkeeping and filing obligations may be applicable to all advisers exempt from SEC registration hereunder, including advisers solely to private funds with aggregate AUMs of less than $25M.
Non-U.S. Advisers. If you are a non-U.S. adviser, you must register with the SEC (even if you have only one U.S. client or investor) unless you satisfy the “foreign private adviser” exemption,12 which means, inter alia, you have less than $25M in assets under management “attributable” to U.S. clients and to U.S. investors in any private funds, whether domiciled inside or outside the United States.
Important Note on When to Begin Implementing. If, as a result of the unavailability of any registration exemptions or any of the new AUM registration thresholds discussed herein, any adviser needs to: (1) register with the SEC; (2) register with any state(s); and/or (3) de-register with the SEC, such adviser should seek to implement any of the foregoing actions well in advance of the July 21, 2011, effective date, preferably beginning in the fall of 2010.
3. Investor/Client Certifications
If you advise a private fund exempt under Regulation D of the Securities Act of 1933,13 you need to amend immediately the “accredited investor” certification/description in the fund’s offering documents.
The Act now requires that the value of a natural person’s primary residence be excluded when determining such person’s net worth under the “Accredited Investor” determination.
For now, this change seems to apply prospectively (e.g., only to new investors or additional subscriptions from existing investors) and not retroactively (e.g., no need to analyze and expel any existing investors).
There is no grandfathering provision for funds formed prior to the Act.
This change is effective immediately and requires your prompt attention.14
If you are a registered investment adviser and charge performance fees/allocations to any client (i.e., a private fund), you will need to amend the “qualified client” certification obtained from each client/fund investor.15
The Act requires the SEC to adjust the “qualified client” dollar thresholds for inflation within a year of the Act’s adoption and every five years thereafter.
Registered advisers charging performance fees to private funds exempt under Section 3(c)(7) of the Investment Company Act of 1940 generally need not amend their subscription agreements.16
4. Miscellaneous Impacts on Certain Advisers
Additional Reporting Requirements for Registered Investment Advisers
The Act provides the SEC with authority to require registered advisers to maintain records and file reports to the SEC (and to provide certain regulatory bodies the contents of such reports).17
Such reports will include a description of the amount of AUM; the use of leverage, including off-balance sheet leverage; counterparty credit risk exposure; trading and investment positions; valuation policies and procedures; types of assets held; side letters; trading practices; and any other information that the SEC deems to be “necessary or appropriate.”
Custody. The Act will also require registered investment advisers to take steps to safeguard client assets, including verification with an independent public accountant.18
The “Volcker” Rule. The Act substantially restricts proprietary trading activities by “banking entities”19 and generally prohibits such entities from sponsoring or acquiring any equity, partnership or other ownership interest in a hedge fund, private equity fund or similar entity.
“Bad Boy” Provisions. The “Bad Boy” (issuer disqualification) provisions,20 which previously only applied to Rule 505 Regulation D offerings, will likely now also apply to Regulation D Rule 506 offerings. The SEC has one year from the Act’s enactment date to issue rules regarding such Bad Boy provisions and their applicability to Rule 506 private offerings.
Potential Limitations on Mandatory Arbitration. The SEC may adopt rules and regulations restricting or prohibiting the use of mandatory arbitration agreements by advisers.
5. Impacts on Funds/Advisers as Participants in Certain Financial Instruments
If you buy commodities and are subject to percentage limitations, you will need to include any swaps (i.e., non-securities-based swaps, including interest rate swaps) that now must be registered and/or regulated under the Commodity Exchange Act when determining compliance with such limitations.21
If you are involved with swaps in the OTC derivatives markets,22 you may be subject to new regulations under the Act as a “major swap participant” (e.g., over-the-counter (OTC) swap dealers and certain large OTC swap participants); and/or certain of your OTC derivative transactions may be subject to federal regulation.
The Act appears to require applicable regulators to issue interim rules, within 90 days after the Act’s enactment, regarding the reporting of pre-enactment swaps, which were not accepted for clearing.
Any swap entered into before the Act’s enactment date that has not expired after July 21, 2010, must be reported by a date not later than 30 days after the of such interim final rules or such other period as may be determined by the relevant regulator.
Asset-Backed Securities. Within 270 days, certain federal agencies (e.g., the SEC) are required to jointly issue regulations requiring the person securitizing an asset-backed security to retain (without hedging) 5 percent or more of the credit risk of the securitized assets collateralizing the asset backed security that are not qualified residential mortgages.
Municipal Securities. Advisers to municipalities must generally be registered under the Securities Exchange Act of 1934 to solicit services or provide advice. Registered investment advisers that provide advice to municipalities or on municipal securities won’t need to register, but certain of their activities will be subject to regulation.
Securities Lending. The Act makes it unlawful to effect, accept or facilitate a transaction involving a loan or borrowing of securities in contravention of SEC rules. Within two years, the Act requires the SEC to promulgate rules designed to raise the transparency of information available to investors with respect to the loan or borrowing of securities.
Shorting and Arbitrage. The SEC may adopt further reporting rules and restrictions on such activities pursuant to the Act.