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Unlikely Coalition Comes Together in Opposition to the Creation of an SRO for Investment Advisers

August 6, 2012 By Leave a Comment

As part of the Dodd-Frank Act, Congress directed the SEC to review whether a so-called “self-regulatory organization” (or “SRO”) should be created to regulate investment advisers. Doing so would make investment adviser regulation more akin to the way broker-dealers are regulated.

Under securities laws, broker-dealers must register with the SEC by filing Form BD.  But Form BD is a relatively minor step in the process of registering a broker-dealer, because broker-dealers are also required to become a member of the Financial Industry Regulatory Authority (“FINRA”).  The membership application for FINRA is the most time-consuming step in creating a new broker-dealer.  After a broker-dealer is registered, FINRA also takes the primary role in regulating the activities of the broker-dealer.

After the SEC issued its report on an SRO for investment advisers, House Financial Services Committee Chairman Spencer Bachus (R-LA) and Rep. Carolyn McCarthy (D-NY) introduced the Investment Adviser Oversight Act of 2012. The bill is an amendment to the Investment Advisers Act of 1940 which requires investment advisers to join a new SRO that would be funded by membership fees. Though not explicitly set forth in the bill, FINRA (or another organization affiliated with FINRA) would be expected to be that SRO.

However, the North American Securities Administrators Association (“NASAA”), which is the association that represents the state securities regulators, has taken the position that an SRO is neither necessary nor a good idea because they believe that the state securities regulators and the SEC can collectively regulate the investment adviser industry in a more efficient manner than an SRO.  In its opposition to an SRO, NASAA has argued that an SRO would not be an effective regulator because an SRO, being a membership based organization, is beholden to the same members it is required to regulate. In addition, the Investment Advisers Association (“IAA”), a lobbying group for investment advisers, opposes the creation of an SRO for investment advisers as a heavy, unnecessary burden for the investment advisory industry.

In June, after the Government Accountability Office issued a report which criticized the SEC’s oversight of FINRA, Rep. Maxine Waters (D-CA) introduced the Investment Advisor Examination Improvement Act of 2012, which keeps oversight of investment advisors with the SEC, and pays for the SEC’s review with user fees charged to investment advisers. This user fee model is supported by both the NASAA and industry groups, like the IAA, which have argued that not only is it cheaper to fund SEC oversight (rather than create a new SRO), but that the SEC will be  more effective at protecting the public from investment advisors than FINRA.

Momentum seems to be moving away from the creation of an SRO for investment advisers. It isn’t very often that you will see the NASAA (which generally lobbies for the most restrictive securities regulation) on the same side as the securities industry itself.  In addition, Rep. Waters is not exactly known as a particularly pro-business congresswoman, so it’s difficult to argue that she is beholden to industry.  While you’d think that industry would prefer to be regulated by the private sector, the reality is that broker-dealers’ experience with FINRA has led industry players to believe that a government regulator may actually be more preferable than the ones at FINRA, which charges expensive membership fees and issues extensive regulation which broker-dealers must follow in addition to SEC rules.  The result has made for some strange bedfellows.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Filed Under: Investment Management Tagged With: , , , , , ,

Maryland Securities Commissioner Issues New Order Adopting a Private Fund Exemption Based on Model NASAA Rule

June 22, 2012 By 2 Comments

On June 15, 2012, the Maryland Securities Commissioner issued an order adopting the NASAA model rule exemption for investment advisers to private funds.

Like the model rule, the new order issued by the Maryland Securities Commissioner, provides for an exemption from registration for “private fund advisers”, which is any investment adviser who provides advice solely to one or more private funds (i.e. a 3(c)(1) fund or a 3(c)(7) fund).   A private fund adviser must not be subject to disqualification from prior bad acts such as fraud or other securities law violations.  The private fund adviser must also make the same Form ADV filings as an exempt reporting adviser would.

Any private fund adviser that advises one or more 3(c)(1) funds (other than venture capital funds, as defined under federal regulations) must also comply with additional restrictions.  All investors in these funds must be “qualified clients.” [1]  The fund manager must also disclose in writing all services that are provided to individual owners (if any), all duties owed to individual owners (if any), and any other material information affecting the rights or responsibilities of owners.  Finally, the fund manager must provide audited financial statements to each investor.

Fund managers registered with the SEC will be required to make applicable notice filings to the Maryland Securities Commissioner even if they would otherwise qualify for the private fund adviser exemption.

The new rule also provides grandfathering provisions for fund managers of 3(c)(1) funds that existed before June 15, 2012 but cease accepting non-qualified clients after the date, as long as the fund manager does comply with the disclosure and audit requirements of the new exemption.

This order continues the trend of an increasing number of states adopting the NASAA model rule, or something substantially similar.  So far California, Indiana, Maine, Virginia, Massachusetts, Michigan, Wisconsin, Missouri, Rhode Island (proposed but not yet adopted), and Maryland have adopted some form of the NASAA model rule.

Footnotes

[1] A “qualified client” is defined as an individual or company that has at least $1 Million under the management with the investment adviser or has a net worth (together with assets held jointly with a spouse) of more than $2 Million, not counting an individual’s primary residence.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Filed Under: Investment Management Tagged With: , , , , , , ,

Missouri Commissioner of Securities Proposes New Private Fund Exemption Based on Model NASAA Rule

May 9, 2012 By Leave a Comment

On April 26, 2012, the Missouri Commissioner of Securities proposed revised regulations exempting certain private fund managers from investment adviser registration with the State of Missouri.

Background

Prior to the repeal of the federal 15-client exemption, Missouri had an exemption for fund managers who were exempt under the old federal 15-client exemption and who managed investments solely for private funds with at least $5 million under management.  After the repeal of the federal 15-client exemption, fund managers have relied on a No-Action Determination by the Missouri Commissioner of Securities dated July 20, 2011, which allowed private fund managers in Missouri to continue to rely on Missouri’s old exemption, until the earlier of June 28, 2012 or the promulgation of a new exemption, notwithstanding the repeal of the federal 15-client exemption.  Now, it appears that the Missouri Commissioner of Securities is ready to adopt that new exemption.

The New Proposed Regulations

The new proposed regulations are based upon the NASAA model rule exemption for investment advisers to private funds.    They provide for an exemption from registration for “private fund advisers.” A private fund adviser is any investment adviser who provides advice solely to one or more private funds (i.e. a 3(c)(1) fund or a 3(c)(7) fund).[1]   A private fund adviser must not be subject to disqualification from prior bad acts such as fraud or other securities law violations.  The private fund adviser must also make the same Form ADV filings as an exempt reporting adviser would.

Any private fund adviser that advises one or more 3(c)(1) funds (other than venture capital funds, as defined under federal regulations) must also comply with additional restrictions.  All investors in these funds must be (i) an accredited investor, as defined in Regulation D  or (ii) a qualified client, as defined in federal regulations. [2]  However, the exemption does not allow private fund managers that advise a 3(c)(1) fund to accept accredited investors who are individuals that qualify solely by the income test.[3]    The inclusion of certain categories of accredited investors within 3(c)(1) funds is a significant departure from the model NASAA rule, which requires that all investors in a 3(c)(1) fund at least be a qualified client (at least for the fund manager to be exempt from registration).  The fund manager must also disclose in writing all services that are provided to individual owners (if any), all duties owed to individual owners (if any), and any other material information affecting the rights or responsibilities of owners.  Finally, the fund manager must provide financial statements to each investor.  This is also a departure from the NASAA model rule, which requires that such financial statements be audited.

The new rule also provides grandfathering provisions for fund managers of 3(c)(1) funds that existed before the effective date of the new regulations but cease accepting, after the effective date, accredited investors that are individuals that meet the income test but don’t meet the net worth test, as long as the fund manager does comply with the disclosure and audit requirements of the new exemption.

The Commissioner of Securities did not state in their announcement when they expect the new exemption to take effect, but we can expect that to occur on or prior to June 28, 2012.

Footnotes

[1] A 3(c)(1) fund is a fund which has not more than 100 investors.  A 3(c)(7) fund is a fund which is limited to qualified purchasers, which are defined roughly as a person with at least $5 Million in investment assets or a company with at least $25 Million in investment assets.

[2] A “qualified client” is defined as an individual or company that has at least $1 Million under the management with the investment adviser or has a net worth (together with assets held jointly with a spouse, but not including the value of the individual’s primary residence) of more than $2 Million.

[3] Rule 501 of Regulation D allows an investor to qualify as an accredited investor if such investor has income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Filed Under: Investment Management Tagged With: , , , , , , ,

Massachusetts Securities Division Adopts Final Private Fund Adviser Exemption Based Upon NASAA Model Rule

April 19, 2012 By Leave a Comment

Previously, I reported that the Massachusetts Securities Division had proposed an exemption from investment adviser registration for advisers to private funds.  In late winter, the division adopted these regulations as final (with small changes).  They are, more or less, identical to the NASAA model rule and include the model rule’s grandfathering provisions.

As part of the rule, advisers to 3(c)(1) private funds (that are not venture capital funds) must, among other requirements, accept only qualified clients (as defined in SEC regulations) as investors.  However, under the grandfathering provision, an adviser to a 3(c)(1) private fund may have non-qualified clients as investors only if the fund ceased to accept non-qualified clients as of February 3, 2012.  (In the previous proposed rule, this date was March 30, 2012).

The new exemption takes effect August 3, 2012.  Prior to that, private fund managers can continue to make use of “institutional buyer” exemption, which exempts any adviser that only advises entities (i) whose investors are solely accredited investors each of which has invested a minimum of $50,000, (ii) existed prior to February 3, 2012, and (iii) ceased accepting new investors or new capital from existing investors after February 3, 2012.  If a fund manager does keep accepting new investments, then it must comply with the requirements of the new exemption.

Massachusetts joins several other states in adopting (or proposing to adopt) some form of the NASAA model rule, including California, Virginia, and Rhode Island.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Filed Under: Investment Management Tagged With: , , , , ,

U.S. House Votes to Adopt Six Measures Loosening Securities Regulation for Smaller Companies; Provisions Include Crowdfunding and “IPO On Ramp”

March 8, 2012 By Leave a Comment

The U.S. House of Representatives voted earlier today (March 8, 2012) to pass the Jumpstart Our Business Startups (JOBS) Act.  The bill is actually a compilation of six separate measures that have been proposed in Congress (and in some instances already passed in the House) which loosen securities restrictions on smaller companies.  Here are brief summaries of each measure:

The Reopening American Capital Markets to Emerging Growth Companies Act (H.R. 3606; the rest of the bills were added to this one).  This bill is also known as the “IPO On Ramp” and it creates a new category of company called an “emerging growth company,” which is defined roughly as a public company with less than $1 Billion in revenue.  An issuer that is an emerging growth company as of the first day of a fiscal year will continue to be one until the earliest of (i) the last day of the fiscal year during which the issuer had $1 billion in annual gross revenues or more; (ii) the last day of the fiscal year following the fifth anniversary of the issuer’s IPO date; or (iii) the date in which the issuer is deemed to be a large accelerated filer, defined by the SEC as an issuer with more than $700 million in public float. In addition, a company would not be considered an emerging growth company if it has issued more than $1 billion in non-convertible debt over the prior three years.  An emerging growth company would enjoy more lax regulation by the SEC.  For instance, the bill would allow emerging growth companies to defer compliance with Section 404(b) of the Sarbanes-Oxley Act until the company is no longer considered an emerging growth company.  Section 404(b) requires the company’s auditor to report on and attest to management’s assessment of the company’s internal controls, a requirement that carries high compliance costs. In addition, the bill would only require emerging growth companies to provide audited financial statements for the two years prior to their IPO rather than three years. The bill also exempts emerging growth companies from new corporate governance requirements within the Dodd-Frank Act, namely the so-called “say on pay” requirement and the requirement that public companies calculate and disclose the median compensation of all employees compared to the CEO.  The bill would remove restrictions prohibiting investment banks that underwrite a company’s IPO from publishing research on emerging growth companies and would  expand the range of permissible pre-filing communications to “qualified institutional buyers” or “accredited investors.”

The Access to Capital for Job Creators Act (formerly H.R. 2940).  As discussed in a previous post, this bill essentially removes the general solicitation prohibition on offerings made under Rule 506 of Regulation D.

The Entrepreneur Access to Capital Act (formerly H. R. 2930).  This is the “crowdfunding” bill, which I’ve discussed at length in the following posts: Is action forthcoming on a crowdfunding exemption to Federal securities laws?; Bill Creating Crowdfunding Exemption from Securities Registration Passes U.S. House of Representatives; What does the future hold for crowdfunding legislation?; Implications of the Pending Startup Crowdfunding Bill.

The Small Company Formation Act (formerly H. R. 1070).  This bill would increase the offering threshold for companies exempted from SEC registration under Regulation A from $5 million to $50 million. It would also preempt state blue sky laws with regards to such offerings if they are traded on a national exchange.   Regulation A is a little used exemption from registration that permits an exempt public offering using a type of “short form” registration.  It is rarely used for two reasons: (i) it has a limit of $5 million and (ii) there is no preemption and so the offerings are subject to blue sky laws.  This bill would eliminate both of these obstacles.

The Private Company Flexibility and Growth Act (formerly H.R. 2167).  This bill raises the number of shareholders a company can have before it is forced to go public from 500 to 1,000.  In addition, it also excludes employees from counting against this limit.  More details can be found on a previous post on this topic: Bill Introduced in Congress to Permit Private Companies to Stay Private for Longer.

The Capital Expansion Act (formerly H.R. 4088).  This bill raises the number of shareholders permitted to invest in a community bank from 500 to 2,000.  The issue here is that community banks are often forced to engage in expensive Exchange Act reporting because they have over 499 shareholders.  This bill would remove this expense for many of them.

The vote was lopsided and the White House has indicated that it is supportive, so the bill has a decent chance of become law.  That said, don’t let the lopsidedness of the vote fool you.  There is genuine opposition to these bills in the Senate that has been building for some time.  There are some significant concern that the legislation will increase the incidence of securities fraud, particularly for senior citizens.  Therefore, stay tuned.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Filed Under: Startups and Venture Capital Tagged With: , , , , , , , , , , , , ,
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