Since the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") was passed, the Securities and Exchange Commission (the "SEC") and various other regulatory agencies, including the Commodity Futures Trading Commission (the "CFTC"), the Federal Reserve Board (the "Federal Reserve"), and the Department of the Treasury (the "Treasury"), have been busy proposing and finalizing rules to implement provisions of the Dodd-Frank Act. There have also been a number of significant developments in the hedge fund tax area, and the SEC and private plaintiffs have continued at a fast pace in bringing enforcement actions and litigation involving private funds and fund managers. Additionally, Bruce Karpati, co-chief of the SEC Division of Enforcement's Asset Management Unit, announced the Asset Management Unit's priority areas of focus for 20121 at HedgeWorld's 2011 Fund Services Conference & Expo held on October 26, 2011.
This Report provides an update since our last Hedge Fund Report in April 2011 and highlights recent regulatory and tax developments, as well as recent civil litigation and enforcement actions as they relate to the hedge fund industry. Paul Hastings attorneys are available to answer your questions on these and any other developments affecting hedge funds and their investors and advisers.
CONTENTS
- I. SECURITIES-RELATED LEGISLATION AND
REGULATION
A. The Dodd-Frank
B. Other New and Proposed Securities-Related Legislation and Regulation
C. Other Updates - II. TAXATION
A. Carried Interest under the American Jobs Act of 2011
B. Recent FBAR Developments
C. Recent Foreign Account Tax Compliance Act Developments
D. Tax Court Denies Petitioner was a Trader in Securities - III. CIVIL LITIGATION
A. New Developments in Securities - IV. REGULATORY ENFORCEMENT
A. Insider Trading
B. Fraudulent Misrepresentations to
C. Side Pockets and Valuations of Illiquid Assets
D. Ponzi Schemes
E. PIPE Transactions
I. SECURITIES-RELATED LEGISLATION AND REGULATION
A. Dodd-Frank Rulemaking
In the wake of the unprecedented financial crisis that caused a significant downturn in the global economy in 2008 and 2009, President Obama on July 21, 2010 signed the Dodd-Frank Act into law. Since then, various agencies have been focusing on the rulemaking process to implement provisions of the Dodd-Frank Act. In recent months, these agencies have begun issuing final rules while continuing to issue proposals of other rules necessary to put Dodd-Frank into effect. Accordingly, although the regulatory framework imposed by the Dodd-Frank Act is becoming more clear, the precise impact of the Dodd-Frank Act on the hedge fund industry remains uncertain. The following summarizes the status of various proposed and finalized rules implementing the Dodd-Frank Act that are most relevant to the hedge fund industry.
1. SEC's Final Rules on Private Investment Fund Adviser Registration and Exemptions
On June 22, 2011, the SEC adopted final rules to implement three new exemptions from registration under the Investment Advisers Act of 1940 (the "Advisers Act") as amended by the Dodd-Frank Act. These are the "venture capital fund exemption" for investment advisers who solely advise "venture capital funds,"2 the "private fund adviser exemption" for investment advisers who solely advise "private funds"3 that have less than $150 million in assets under management in the United States, and the "foreign private adviser exemption" for investment advisers who are "foreign private advisers."4 The final rules are substantially in the form originally proposed on November 19, 2010. The most notable changes include: (i) with respect to the venture capital exemption, the final rule revises the definition of venture capital fund to include funds that invest up to 20% in "non-qualifying investments" rather than requiring funds to invest 100% in qualifying investments as proposed; (ii) with respect to the private fund adviser exemption, the final rule requires an adviser seeking to rely on this exemption to calculate and report its assets under management on an annual basis rather than quarterly as proposed; and (iii) with respect to the foreign private adviser exemption, the final rule does not require non-U.S. advisers to count investors who are "knowledgeable persons" toward the "fewer than fifteen" investor limit as originally proposed, and also expands the definition of "place of business" for the purposes of the requirement that non-U.S. advisers have no "place of business" in the United States.
Also on the same date, the SEC adopted final rules implementing various other provisions of the Dodd-Frank Act related to investment adviser registration. The final rules, among other things, (i) extend the compliance date for an investment adviser that becomes subject to registration under the Advisers Act due to the elimination of the "private adviser" exemption5 from July 22, 2011 to March 30, 2012; (ii) clarify that advisers with assets under management in excess of $25 million and who have their principal office and place of business in New York, Minnesota or Wyoming are required to register with the SEC (unless an exemption is available); and (iii) amend Form ADV to require advisers to provide additional information to improve the SEC's ability to assess compliance risks and to identify advisers that are subject to the Dodd-Frank Act's requirements concerning certain incentive-based compensation arrangements.
Additional information on the final rules on private fund adviser registration and exemptions is available here.
2. SEC's Approval of Form PF
On October 26, 2011, the SEC, by a unanimous vote, adopted new Rule 204(b)-1 and Form PF under the Advisers Act to implement certain provisions of Title IV of the Dodd-Frank Act. These provisions require certain advisers to hedge funds and other private funds to report, among other things, risk, leverage, and financial information. The new rule applies to SEC-registered advisers with at least $150 million in private fund assets under management and features "tiered" reporting requirements for private fund advisers. "Large private fund advisers" (i.e., hedge fund advisers with at least $1.5 billion in assets under management, liquidity fund advisers with at least $1 billion in combined assets under management in liquidity funds and registered money market funds, and private equity fund advisers with at least $2 billion in assets under management) must submit more detailed reports and provide additional information for each managed hedge fund valued at $500 million or more. "Small private fund advisers" (i.e., those who do not meet the threshold levels of large private fund advisers) must submit less detailed reports.
The final rule extends the submission deadlines from those in the proposed rule. Large hedge fund advisers must file Form PF within 60 days of the end of each fiscal quarter, while smaller hedge fund advisers have until 120 days from the end of each fiscal year. Most advisers must begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, ending on or after December 15, 2012. However, very large fund advisers (including hedge fund advisers with at least $5 billion in assets under management) have until the end of the first fiscal quarter ending on or after June 15, 2012. Additional information regarding Form PF is available here.
3. SEC's Approval of Filing Fees for Exempt Reporting Advisers Filing Form ADV and Private Fund Advisers Filing Form PF
On September 30, 2011, the SEC issued a notice of intent to approve filing fees for exempt reporting advisers6 filing Form ADV and private fund advisers filing Form PF. The notice proposed filing fees for exempt reporting advisers of $150 for each initial and annual report. With respect to Form PF, the SEC determined that the Financial Industry Regulatory Authority ("FINRA") will develop and maintain the filing system for Form PF, and proposed that fees be set at $150 for the proposed quarterly filings and $150 for the proposed annual filings.7 On October 24, 2011, the SEC issued an order approving the filing fees as set forth in the earlier notice. The filing fees for exempt reporting advisers became effective on October 28, 2011 when the SEC order was published in the Federal Register, and the filing fees for Form PF will become effective on the effective date of Rule 204(b)-1 under the Advisers Act. Additional information on SEC's approval regarding filing fees for exempted reporting advisers and for Form PF is available here.
4. SEC's Order and Proposed Rule Amending Definition of "Qualified Client"
On May 10, 2011, the SEC published a notice of intent to issue an order increasing the dollar thresholds of the assets under management and net worth tests in the definition of "qualified client" in Rule 205-3 under the Advisers Act. At the same time, the SEC also proposed to amend Rule 205-3 to (i) provide that the SEC will adjust the dollar amount tests for inflation on a five-year basis (as required by the Dodd-Frank Act), (ii) exclude the value of a person's primary residence from the net worth test, and (iii) add certain transition provisions to Rule 205-3. The proposed primary residence exclusion will harmonize the threshold calculation for "qualified client" under the Advisers Act with similar standards under the Securities Act of 1933, as amended (the "Securities Act"), and the Securities Exchange Act of 1934, as amended (the "Exchange Act"),8 while the transition provisions are intended to prevent retroactive application of amended Rule 205-3 to minimize disruption to existing investments. Comments on the proposed amendments to Rule 205-3 were due on or before July 11, 2011. On July 12, 2011, the SEC published its final order increasing the dollar amount thresholds in the definition of "qualified client" in Rule 205-3 from $750,000 to $1 million for the assets under management test and from $1.5 million to $2 million for the net worth test. The revised dollar amounts reflect inflation from 1998 to the end of 2010. The final order took effect on September 19, 2011. Additional information on the proposed amendments to Rule 205-3 and the revised dollar amount thresholds in the definition of "qualified client" is available here.
5. SEC and other Financial Regulators' Joint Proposal to Implement the Volcker Rule
On October 12, 2011 the SEC, by unanimous vote, jointly proposed a rule implementing Section 619 of the Dodd-Frank Act, also known as the "Volcker Rule," with the Federal Reserve, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.9 The Volcker Rule generally prohibits a banking entity from (i) engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for the banking entity's own account; or (ii) owning, sponsoring, or having certain relationships with a hedge fund or private equity fund. The proposed rule would clarify the scope of the prohibitions and provide certain exemptions.
Specifically, the proposed rule defines various relevant terms, including "proprietary trading," "trading account," "covered financial position," "covered fund," and "ownership interest," and provides various exemptions, including exemptions for underwriting and market making-related activity, an exemption for risk-mitigating hedging, and exemptions for trading in certain government obligations, trading on behalf of customers, trading by a regulated insurance company, and trading by certain foreign banking entities outside of the U.S. The proposed rule would also exempt, among other activities, organizing and offering hedge funds or private equity funds under certain conditions, including limiting investments in such funds to a de minimus amount, and making risk-mitigating hedging investments. Banking entities may also own or sponsor a covered fund if done in the ordinary course of collecting a previously contracted for debt or pursuant to, and in compliance with, the statutory transition periods, both subject to certain back-stop provisions. In order to rely on some of these exemptions, a banking entity may be required to establish an internal compliance program and satisfy certain other requirements. Additionally, under the proposed rule, certain banking entities with significant covered trading activities would be required to furnish periodic reports to a specified relevant agency regarding a variety of quantitative measurements of its covered trading activities and maintain records documenting the preparation and content of these reports.
The public comment period for the proposed rule closes on January 13, 2012. Additional information on the proposed rule implementing the Volcker Rule is available here.
6. SEC's Proposed Rule on Registration of Security-Based Swap Dealers and Major Security- Based Swap Participants
On October 12, 2011, pursuant to Title VII of the Dodd-Frank Act, the SEC proposed new Rules 15Fb1-1 through 15b6-1 under the Exchange Act to provide for the registration of security-based swap dealers and major security-based swap participants ("SBS Entities").10 The proposed rules establish procedures for registration, as well as amendment, withdrawal, and cancellation of such registrations. The proposed registration regime closely mirrors that already in place for brokerdealers.
Under the proposed rules, to register, an SBS Entity must electronically submit the required registration form (Form SBSE) to the SEC. SBS Entities registered or registering with the SEC as broker-dealers or with the CFTC as swap dealers or major swap participants need only submit a shorter registration form (Form SBSE-BD or SBSE-A, respectively). The proposed rules would also require an SBS Entity to certify on Schedule G of Form SBSE, Form SBSE-A, or Form SBSE-BD, as appropriate, that no person associated with it who effects or is involved in effecting security-based swaps on its behalf is subject to statutory disqualification. To avoid potential business disruptions, the proposed rules provide that an SBS Entity seeking SEC registration would first apply for conditional registration by submitting a complete application to the SEC, and then convert its conditional registration to ongoing registration by submitting a certification on Form SBSE-C signed by one of its knowledgeable senior officers (the "Senior Officer Certification").
The Senior Officer Certification must state that, after due inquiry, the senior officer has reasonably determined that the SBS Entity has the operational, financial, and compliance capabilities necessary to act as an SBS Entity and has documented the process by which he or she reached such determination.
Comments on the proposed rule on registration of SBS entities should be received on or before December 19, 2011. Additional information on the proposed rule on registration of SBS Entities is available here.
7. Department of the Treasury's Mandatory Cross-Border Ownership Reporting on Form SLT
On June 27, 2011, the Treasury published its notice of mandatory monthly reporting of information on cross-border ownership by U.S. and foreign residents of long-term (i.e., original maturity of more than one year or no contractual maturity) securities for portfolio investment purposes on Form SLT in the Federal Register. The notice imposes reporting requirements on all U.S. persons (i) who are U.S.- resident custodians, U.S.-resident issuers or U.S.-resident end-investors, and (ii) whose consolidated total of all reportable long-term securities has an aggregate fair market value of at least $1 billion on the last business day of the reporting month (the "as-of date").
Reportable securities include certain long-term (i) securities issued by U.S. residents that are held directly by foreign residents, (ii) foreign securities that are held directly by U.S. residents, (iii) U.S. securities managed by U.S.-resident custodians on behalf of foreign residents, and (iv) foreign securities managed by U.S.-resident custodians on behalf of U.S. residents. Such reportable long-term securities include equity interests, such as common stock, preferred stock, restricted stock, and limited partnership interests, and long-term debt securities, such as bonds, notes, convertible bonds and debt with attached warrants, asset-based securities, and floating rate notes. Various types of securities are specifically excluded from the reporting requirement, including short-term securities, derivative contracts, loans and loan participation certificates, and letters of credit. Certain direct investments are also excluded.
Investment advisers generally would report as representatives of U.S.-resident issuers or U.S.- resident end-investors, and should file one consolidated report of the holdings and issuances for all U.S.-resident parts of their own organizations and for all U.S.-resident entities that they advise or manage. Investment advisers who create master-feeder funds with entities both outside and inside the U.S. should report any investments between the U.S. and foreign-resident affiliate funds that the investment adviser sets up.
Form SLT must be submitted quarterly as of September 30 and December 30 in 2011, and monthly beginning with the report as of January 31, 2012. The form must be submitted to the Federal Reserve Bank no later than the 23rd calendar day of the month following the report as-of date. Additional information on Form SLT is available here.
B. Other New and Proposed Securities-Related Legislation and Regulation
1. SEC's Final Rule Regarding Large Trader Reporting Requirements
On July 26, 2011, the SEC, by a unanimous vote, adopted Rule 13h-1 and Form 13H under Section 13(h) of the Exchange Act establishing large trader reporting requirements. Rule 13h-1 is intended to, among other things, help the SEC to reconstruct events following market disruptions by identifying significant market participants and to assess the impact of large trader activity on the securities markets. Rule 13h-1 targets "large traders," which are defined as persons (firms or individuals) who effect transactions in NMS securities11 of at least (i) 2 million shares or shares with a fair market value of at least $20 million during any calendar day or (ii) 20 million shares or shares with a fair market value of at least $200 million during any calendar month.
Specifically, large traders must register with the SEC by making an initial filing on Form 13H by December 1, 2011 and annually within 45 days after the end of each full calendar year thereafter.12 The information requested by Form 13H includes, without limitation, (i) basic identifying information, (ii) a list of business affiliates, (iii) disclosure of registration status with the CFTC or regulation by any foreign regulators, (iv) an organizational chart, (v) the names of all general and limited partners and (vi) a list of all broker-dealers at which the large trader has accounts. The SEC will keep Form 13H confidential and exempt from Freedom of Information Act requests.13 Following initial registration, the SEC will issue each large trader a unique identification number, which it must disclose to its registered broker-dealers with whom it has accounts. Rule 13h-1 also imposes certain recordkeeping and reporting requirements on broker-dealers.
Additional information on the SEC's final rule regarding large trader reporting requirements is available here.
2. Anti-Spinning Provisions of FINRA's New Rule 5131
On September 26, 2011, the "anti-spinning" provisions in new FINRA Rule 5131(b) went into effect.14 These provisions restrict "spinning," which refers to the allocation of new issues (i.e., any initial public offering of any equity security as defined in Section 3(a)(11) of the Exchange Act made pursuant to a registration statement or offering circular) by FINRA members to certain accounts. Specifically, Rule 5131(b) prohibits FINRA members from allocating new issues to certain accounts in which a beneficial interest in excess of 25 percent is held by (i) an executive officer or director of a public company or a covered non-public company15 or (ii) a person materially supported16 by such executive officer or director (a "Covered Person"). The Rule 5131(b) applies if (i) the company is currently an investment banking client of the FINRA member; (ii) the FINRA member received compensation from the company for investment banking services in the past 12 months; (iii) the person making the allocation decision knows or has reason to know that the FINRA member expects to provide or to be retained for investment services within the next 3 months; or (iv) the allocation was made on the condition that such executive officer or director, on behalf of the company, retain the FINRA member for future investment banking services. The anti-spinning provisions exempt allocations of new issues to certain types of accounts and permit allocations of new issues to an account, including a collective investment vehicle such as a hedge fund, in which the beneficial interests of Covered Persons do not exceed 25 percent in the aggregate. As a result of Rule 5131(b), hedge fund managers may need to obtain additional information from their investors to ascertain whether the investors are Covered Persons. Additional information on the anti-spinning provisions is available here.
3. DOL's Withdrawal of Proposed Rule Expanding the Definition of "Fiduciary"
On October 21, 2010, the Department of Labor (the "DOL") issued a proposed rule that would amend a 1975 regulation to define a "fiduciary" for the purposes of the Employee Retirement Income Security Act of 1974, as amended, more broadly as a person who provides investment advice to plans for a fee or other compensation. The DOL received more than 260 comments on the controversial proposed rule, many of which opposed the expansion of the definition. On September 19, 2011, the DOL announced its withdrawal of the proposed rule in its current form and its intention to re-propose the rule in early 2012. The re-proposed rule is expected to contain provisions, among others, (i) limiting the definition of fiduciary advice to individualized advice directed to specific parties; (ii) prohibiting the application of the rule to routine appraisals; (iii) clarifying the limits of the rule's application to arm's length commercial transactions; and (iv) setting forth new or amended exemptions that best preserve beneficial fee practices, while offering protection to plan participants and individual retirement account owners. Additional information on the DOL's withdrawal of its current proposal to expand the definition of a fiduciary and the expected re-proposed rule is available here.
4. House Subcommittee's Approval of H.R. 2940 (Access to Capital for Job Creators Act)
On October 26, 2011, the House Financial Services Committee approved H.R. 2940, the Access to Capital for Job Creators Act. The bill, introduced on September 15, 2011, would require the SEC to eliminate the prohibition on general solicitation or general advertising under Rule 506 of Regulation D under the Securities Act, provided that all purchasers of the securities are accredited investors. Rule 506 is utilized by many private funds as a "safe harbor" from the registration requirements of Section 5 of the Securities Act, and allows a private fund to sell an unlimited dollar amount of interests if the conditions to the rule are satisfied. Rule 506 currently prevents companies utilizing the rule from using advertisements or general solicitation activities to market securities to investors. According to Representative Kevin McCarthy (R-CA and House Majority Whip), the bill's sponsor, the removal of this restriction would allow small businesses (including private fund managers) "to widely seek funds from the entire pool of wealthy SEC accredited investors without requiring them to go through the full SEC registration process." The bill was reported to the whole House with an amendment on October 31, 2011. The full text of H.R. 2940 with the amendment is available here.
C. Other Updates
1. California Publishes Invitation for Comments on Proposed Changes to Custody Rules
On July 8, 2011, the California Department of Corporations (the "CA DOC") published an invitation for comments on a proposal to amend its investment adviser rules pertaining to custody or possession of funds or securities of clients.17 The proposed amendments incorporate the proposed North American Securities Administrators Association Model Rule on investment adviser custody and recent changes to federal custody rules under the Advisers Act. Among other things, the proposed amendments (i) define "custody" as holding or having authority to possess or appropriate client funds or assets; (ii) subject to certain limited exceptions, require that advisers with custody of an account maintain the assets with a "qualified custodian," which would include certain (a) banks or savings associations, (b) California- or SEC-registered broker-dealers, (c) CFTC-registered futures commission merchants, and (d) foreign financial institutions; and (iii) specify certain audits or independent verifications respecting custody accounts that must be performed by certified public accountants registered with the Public Company Accounting Oversight Board. The comment period for the proposed amendments closed on August 5, 2011. Additional information on the CA DOC's proposed amendments to the custody rules is available here, and the full text of the proposed amendments is available here.
2. California Publishes Invitation for Comments on Proposed Private Fund Registration Exemption
On March 15, 2011, the CA DOC published an invitation for comments on a proposal to amend Section 260.204.9 of Title 10 of the California Code of Regulations in response to the elimination of the federal "private adviser" exemption under the Advisers Act. The proposal would exempt from California's registration requirements any private fund adviser that is exempted from registration with the SEC under Section 203(l) (i.e., the venture capital fund exemption) or Section 203(m) (i.e., the private fund adviser exemption) of the Advisers Act, as enacted by the Dodd-Frank Act, and that (i) is not subject to disqualification by the SEC, (ii) acts as an adviser solely to private funds, (iii) files with the CA DOC a copy of each report that an exempt reporting adviser under the Advisers Act would be required to file with the SEC pursuant to Rule 204-4 under the Advisers Act, (iv) pays a $125 application fee, and (v) has assets under management of not less than $100 million or provides investment advice only to venture capital companies. Comments on the proposal were due by March 28, 2011. On July 7, 2011, the CA DOC issued an emergency order effectively extending the former federal private adviser exemption in California through January 17, 2012, in light of a delay in the adoption of successor federal rules. The full text of the invitation for comments on the proposed new California investment adviser regulations is available here, and the full text of the emergency order extending the former federal private adviser exemption is available here.
3. Massachusetts Security Division's Final Regulation on the Use of Expert Network Services by Hedge Fund Managers
On August 8, 2011, the Massachusetts Security Division adopted a final regulation addressing the rising use of expert network firms by investment advisers and concerns about the potential misuse of inside information improperly obtained by these firms. In doing so, Massachusetts became the first state to enact such a regulation. The regulation appends 950 CMR 12.205(9)(c) (a non-exclusive list of investment adviser practices deemed to be "dishonest or unethical conduct or practices in the securities business") to require an investment adviser, prior to retaining investment consulting services for compensation that is provided directly by a consultant or indirectly through an expert network service, to obtain a written certification from the consultant. The certification must (i) describe confidentiality restrictions relevant to the potential consultation, (ii) affirmatively state that no confidential information will be provided to the investment adviser, and (iii) be signed and dated by the consultant and be accurate as of the date of the initial and any subsequent consultation(s). The regulation further prohibits an investment adviser that comes into possession of material confidential information through a consultation from trading in the relevant security until the confidential information is made public. In response to concerns about the potential breadth of the regulation, "investment consulting services" covered by the regulation are limited to those obtained "for the purpose of assisting the investment adviser's decision as to whether to buy, sell, or abstain from buying or selling, positions in client accounts." In a policy statement issued on September 8, 2011, the Massachusetts Security Division clarified that the regulation is not applicable to investment advisers who register with the SEC under the Advisers Act. The final regulation will become effective on December 1, 2011. The full text of the regulation is available here, and the policy statement is available here.
4. SEBI's Draft AIF Regulations
On August 1, 2011, the Securities Exchange Board of India ("SEBI") proposed draft regulations for Alternative Investment Funds ("AIFs"), including, without limitation, private equity funds, venture capital funds, and strategy funds (including hedge funds). These draft regulations would supplant the existing regulatory framework centered on the voluntary Venture Capital Funds ("VCF") registration system. The draft regulations, among other things, (i) establish mandatory registration for all new and existing AIFs (not currently registered as VCFs) and define eligibility criteria for such funds; (ii) impose certain structural requirements on AIFs; (iii) outline certain obligations for the fund sponsor, designated partner, or board of directors; (iv) set guidelines restricting solicitation and requiring certain disclosures to investors; (v) require investor consent before an AIF can change its investment strategy; (vi) dictate termination standards for AIFs; (vii) impose general investment restrictions; and (viii) establish reporting and transparency requirements. The draft regulations also contain grandfather provisions for existing AIFs currently registered as VCFs, which would continue under the terms of the existing framework for the duration of their tenure. The comment period for the draft regulations ended on August 30, 2011. The full text of SEBI's draft regulations for AIFs is available here.
Footnotes
1 These priority areas (in order of priority) are: (1) Valuation/Performance Issues (aberrational performance; fraudulent or weak valuation procedures or practices; lax valuation committees; the use of side pockets to conceal losing or illiquid positions); (2) Conflicts of Interest (commonly managed accounts (e.g., side-by-side management of separate accounts with fund accounts); allocation practices; undisclosed compensation arrangements/loans; use of affiliated brokerdealers; soft dollar/best execution violations; preferential treatment/redemptions (including side letters that give investors preferential treatment); and private equity fund fees, deal allocations, cross-fund investing, capital deployment, and relationships with potential deal sources); (3) Compliance/Controls (managers with a weak compliance and control environment; controls around "quant" funds; controls around insider trading, particularly use of expert networks); (4) Offering Issues (unregistered broker-dealers that sell fund interests; offering fraud and misappropriation of client assets); and (5) Third-Parties/Service Providers (e.g., deficient auditors, administrators, and fund boards of directors).
2 New Rule 203(l)-1 under the Advisers Act defines a "venture capital fund" as a private fund that: (i) holds no more than 20 percent of the fund's capital commitments in non-qualifying investments (other than short-term holdings); (ii) does not borrow or otherwise incur leverage, other than certain limited short-term borrowing; (iii) does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances; (iv) represents itself as pursuing a venture capital strategy to its investors and prospective investors; and (v) is not registered under the 1940 Act, and has not elected to be treated as a business development company. Rule 203(l)-1 also contains a grandfathering provision for pre-existing funds that satisfy certain criteria.
3 A "private fund" includes any issuer that would be an investment company as defined in Section 3 of the 1940 Act but for Sections 3(c)(1) or 3(c)(7) of that act. The definition includes hedge funds, private equity funds, certain real estate funds, and venture funds.
4 New Section 202(a)(30) of the Advisers Act, as added by the Dodd-Frank Act, defines a "foreign private adviser" as any investment adviser that: (i) has no place of business in the United States; (ii) has, in total, fewer than 15 clients and investors in the United States in private funds advised by the investment adviser; (iii) has aggregate assets under management attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser of less than $25 million, or such higher amount the SEC may, by rule, deem appropriate; and (iv) neither holds itself out generally to the public in the United States as an investment adviser nor acts as (I) an investment adviser to any investment company registered under the 1940 Act; or (II) a company that has elected to be a business development company pursuant to Section 54 of the 1940 Act, and has not withdrawn its election.
5 The "private adviser" exemption set forth in the now repealed Section 203(b)(3) of the Advisers Act exempted any investment adviser from registration if the investment adviser (i) had fewer than 15 clients in the preceding 12 months, (ii) did not hold itself out to the public as an investment adviser, and (iii) did not act as an investment adviser to a registered investment company or a company that has elected to be a business development company.
6 Exempt reporting advisers are those investment advisers exempted from registration under Section 203(l) or 203(m) of the Advisers Act.
7 The quarterly filing fees only apply to private fund advisers managing $1 billion or more in hedge fund assets, combined liquidity fund and registered money market fund assets or private equity fund assets.
8 Specifically, the Dodd-Frank Act requires the SEC to exclude a natural person's primary residence from the threshold net worth calculation for "accredited investor" under the Securities Act, and Regulation R under the Exchange Act excludes a natural person's primary residence from the threshold calculation for "high net worth customers."
9 The Commodity Futures Trading Commission is working on its own "Volcker Rule" which it plans to propose shortly
10. The Exchange Act defines "security-based swap dealers" as ones who (i) hold themselves out as a dealer in securitybased swaps; (ii) make a market in security-based swaps; (iii) regularly enter into security-based swaps with counterparties as an ordinary course of business for its own account; or (iv) engage in any activity causing them to be commonly known in the trade as a dealer or market maker in security-based swaps. "Major security-based swap participants" are defined by the Exchange Act as any person who is not a security-based swap dealer and (i) who maintains a substantial position in security-based swaps for certain major security-based swap categories, (ii) whose outstanding security-based swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets, or (iii) who is a financial entity that is highly leveraged relative to the amount of capital such entity holds, is not subject to Federal capital requirements, and maintains a substantial position in outstanding security-based swaps in any major security-based swap category. Sections 721(b) and 761(b) of the Dodd-Frank Act provide that the SEC may further define the terms "security-based swap dealer," and "major security-based swap participant," to include transactions and entities that have been structured to evade the requirements of subtitles A and B, respectively, of Title VII of the Dodd-Frank Act.
11 An "NMS security" is any security or class of securities for which transaction reports are collected, processed, and made available pursuant to an effective transaction reporting plan, or an effective national market system plan for reporting transactions in listed options. The term refers generally to exchange-listed securities, including equities and options.
12 If a person becomes a large trader after December 1, 2011, such person must register "promptly" (i.e., within 10 days) after satisfying the threshold activity level.
13 However, the SEC is still required to share the information if requested by Congress or by any other federal department or agency requesting information for purposes within the scope of its jurisdiction, or to comply with federal court orders in actions brought by the United States or the SEC.
14 The other provisions of Rule 5131 became effective on May 27, 2011.
15 A "covered non-public company" means any non-public company with: (i) income of at least $1 million in the last fiscal year or in two of the last three fiscal years and shareholders' equity of at least $15 million; (ii) shareholders' equity of at least $30 million and a two-year operating history or (iii) total assets and total revenue of at least $75 million in the last fiscal year or in two of the last three fiscal years.
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