You are here: Home / Archives for Dodd-Frank

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.

———————————–

© 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.

———————————–

© 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.

———————————–

© 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.

———————————–

© 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: , , , , ,

Does a negative “Say on Pay” vote trigger a breach of fiduciary duty claim?

March 15, 2012 By Leave a Comment

The Dodd-Frank Act, passed in 2010, includes the so-called “Say on Pay” provision for publicly traded companies. This provision requires that, at least once every three years, the shareholders of a publicly traded company must vote on its executive compensation arrangements. In addition, the shareholders also vote at least once every six years on the frequency of the “say on pay” vote.  Shareholders are able to elect whether the vote will happen once every one, two, or three years.  In most companies, the shareholders have chosen to have the “say on pay” vote conducted annually.  Publicly traded companies are also required  to disclose, in any proxy solicitation asking for the approval of a merger, acquisition, or other sale of the company, any compensation from “golden parachutes” that would be triggered.  Shareholders also have a chance to “approve” (or not approve) such golden parachute payments.

However, except for the vote on the frequency of “say on pay” votes, none of these votes are actually binding.  They are simply there to provide an outlet for the shareholders to express their views on management’s compensation.  In addition, the law specifically states that the vote doesn’t create any new or alter existing fiduciary duties of the company’s board of directors.  To date, only 37 companies’ boards have received a negative “say on pay” vote.

However, a number of creative plaintiff’s lawyers have tried to use a negative “say on pay” vote as evidence of a breach of fiduciary duty.  How have these claims fared?  Not very well.  Below is a quick summary of the cases where this line of reasoning has been used and the results thus far:

Teamsters Local 237 Additional Security Benefit Fund, derivatively on behalf of Beazer Homes USA, Inc. v. McCarthy (Georgia Superior Court; decided September 16, 2011).  This case, litigated in Georgia Superior Court applying Delaware corporate law, arose out of a negative “say on pay” vote that occurred after the board voted to increase executive compensation.  The court reasoned that because the negative vote occurred after the board’s action, the negative vote could not be used to prove a breach of fiduciary duty by the board.  In addition, the court ruled that, under Delaware law, the negative vote of the shareholders could not be used as evidence to rebut the business judgment rule presumption.[1] (Unfortunately, the ruling was given orally and no written opinion was issued to date, limiting its precedential value).

NECA-IBEW Pension Fund, derivatively on behalf of Cincinnati Bell, Inc. v. Cox (Southern District of Ohio; decided September 20, 2011).  Here, a federal court applying Ohio corporate law, refused to dismiss a similar case prior to discovery and trial.  The basis used is that Ohio law differs from Delaware law.  While Ohio has its own version of the business judgment rule, according to the court, it “imposes a burden of proof, not a burden of pleading” which effectively means a board can’t have the case dismissed prior to discovery (or even trial).  Thus Ohio corporate law would seem to be more friendly territory for plaintiff’s attorneys in “say on pay” suits.

Plumbers Local No. 137 Pension Fund v. Davis (U.S. Federal Court, District of Oregon; decided January 11, 2012).  This case is another “say on pay” suit involving a company called Umpqua Holdings Corporation.  In this case, a magistrate judge recommended that the case be dismissed.  The court applied Oregon corporate law, though the court noted that Delaware law often provides guidance for Oregon courts in areas of corporate law that are undeveloped.  The court adopted the holding of Beazer and criticized the holding of Cincinnati Bell, rejecting the notion that a negative “say on pay” vote can rebut the presumption of the business judgment rule.

Laborers’ Local v. Intersil (Northern District of California; decided March 7, 2012).  Here, a federal court applied Delaware law and dismissed a derivative claim against a board of directors based on a negative “say on pay” vote.  The court held that a “say on pay” vote “alone is not enough to rebut the presumption of the business judgment rule.”  The opinion also criticized the Cincinnati Bell decision.

The Cincinnati Bell decision has caused great concern within corporate America.  It has the possibility of encouraging further lawsuits each and every time the shareholders of a corporation vote against the company’s compensation package.  That said, other courts appear to be rejecting its holding, which may in the long run establish a firm rule that negative “say on pay” votes may not be used as evidence of a breach of fiduciary duty by a board.

Footnotes

[1] Essentially, the business judgment rule, under Delaware corporate law provides that a court will not substitute its own notions of what is or is not sound business judgment if the directors of a corporation “acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”

———————————–

© 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: General Business Law Tagged With: , , , , , , ,
«Older Posts