United States: The SEC Expands The Types Of Employees Of Fund Managers Who Can Invest In Private Funds

The SEC has issued an interpretive letter to the Managed Funds Association (MFA) providing favorable interpretations of the concept of a knowledgeable employee. Knowledgeable employees can invest in qualified purchaser (QP) funds without meeting the QP financial requirements (generally $5 million in investments). In addition, knowledgeable employees do not count against the 100-holder limit in a C1 fund.

The MFA letter expands the number of situations where employees of private fund managers will be considered to be knowledgeable employees.

Executive Summary

Knowledgeable employee status generally depends on

  • being an executive officer of a principal business unit;
  • performing policymaking functions; or
  • participating in the investment activities of the fund.

Executive Officers of a Principal Business Unit

The SEC’s usual definition of “executive officer” has created uncertainty when applied to fund managers because that definition is based on an operating company concept.

The MFA letter expands the concept of a principal business unit to include departments not traditionally considered principal business units (such as information technology and investor relations) under certain circumstances discussed in more detail below.

Employees Who Perform Policymaking Functions

These types of employees generally are considered to be knowledgeable employees. The MFA letter confirms that this status does not depend on any particular title and that this status can result from participation in a group (typically a committee) that performs policymaking functions.

Participation in Investment Activities

Employees who participate in investment activities are generally considered to be knowledgeable employees. The MFA letter discusses several situations which have created uncertainty under current interpretations of the concept, including research analysts, risk analysts, tax professionals and lawyers.

Separate Accounts

The MFA letter confirms that the knowledgeable employee status of persons involved in managing separate accounts will be analyzed in a manner similar to that of employees involved in managing private funds.

Affiliated Funds

The MFA letter confirms that employees who are knowledgeable employees for a fund which is part of a controlled fund complex using the ABA letter dated Jan. 18, 2012, combined IA registration format would generally be considered to be knowledgeable employees for all funds in the controlled fund complex.

Documentation

Private fund managers should document the basis for any decision to treat an employee as a knowledgeable employee and should retain that documentation in their books and records.

Qualified Clients

Rule 205-3 of the Advisers Act also contains provisions which are intended to permit knowledgeable employees to invest in funds which involve “performance fees,” such as the typical carried interest. The language in the applicable Investment Company Act rule, Rule 205-3, is slightly different from the language in Rule 3c-5. The MFA letter does not state whether the interpretations in the MFA letter also apply to Rule 205-3. However, the logic behind the interpretations in the MFA letter should also apply to 205-3, or else the MFA letters would have little practical effect, because so many funds have performance fees. The SEC staff has confirmed by phone that the analysis in the MFA letter should also apply in determining qualified client status in Rule 205-3.

Accredited Investor Issue Not Resolved

The MFA letter does not resolve a second issue that the MFA has also advocated: whether knowledgeable employees should automatically be treated as accredited investors or have to meet the financial tests in Regulation D. So far, the SEC has not taken this position, and the MFA letter does not deal with this issue.

Detailed Analysis

Executive Officers and Policymaking Employees

“Knowledgeable employee” includes any natural person who is an executive officer of a private fund or an affiliated manager of a private fund (“Affiliated Management Person”). The term “executive officer” means

  • the president, any vice president in charge of a principal business unit, division or function (such as sales, administration or finance);
  • any other officer who performs a policymaking function; or
  • any other person who performs similar policymaking functions for a private fund or for an Affiliated Management Person.

The application of these concepts to investment managers has generated uncertainty in a number of situations. One of these uncertainties has been whether various functions associated with private investment vehicles would be considered to be principal business units for the purpose of this definition.

Principal Business Unit

The MFA letter confirms that

  • the principal business unit status of a division or function depends on the relevant facts and circumstances of a particular investment manager’s business operations;
  • whether a business unit, division or function qualifies as a principal business unit, division or function should be determined through an analysis by the investment manager of the relevant facts and circumstances regarding the investment manager’s business operations;
  • several business units, divisions or functions within an investment manager’s business operations may each be considered a principal unit, division or function;
  • while not all business units, divisions or functions are necessarily principal, it is possible that several business units, divisions or functions could each be principal units, divisions or functions, depending on the facts and circumstances;
  • the unit, division or function need not be part of the investment activities of a prviate fund to be considered a principal unit, division or function; and
  • the size of a particular department is not determinative as to whether a function should be considered principal.

The IT Department Can Be a Principal Business Unit

The MFA letter confirms that an information technology (IT) department may be considered to be a principal business unit where

  • an investment manager employs one or more technologically driven trading models, and the IT professionals are charged with building the models and systems that translate certain quantitative signals into trade orders; and
  • an investment manager employs technology professionals to build performance and risk monitoring systems that interact with the investment program.

The Investor Relations Department Can Be a Principal Business Unit

The MFA letter also confirms that the investor relations department could be considered to be a principal business unit where an investment manager relies on investor relations personnel to

  • conduct substantive portfolio reviews with investors, and
  • respond to substantive due-diligence inquiries from institutional investors and consultants.

However, an investor relations function would not have principal business unit status where the department merely assists in arranging meetings between an investment manager’s investment staff and prospective investors, disseminates investor communications written by senior executives outside of the investor relations department, or performs administrative tasks.

Policymaking Employees

The concept of a knowledgeable employee includes any officer who performs a policymaking function and any other person who performs similar policymaking functions on behalf of an investment manager. A policymaking individual does not need to have a specific title, and the concept of a knowledgeable employee includes all employees who have the power to make and do make policy on behalf of the investment manager, the private fund or an Affiliated Management Person.

The MFA letter confirms that an employee who does not have a senior manager title, depending on the facts and circumstances, may still be considered an executive officer under the rule if he or she makes policy through day-to-day involvement in the development and adoption of an investment manager’s policies.

Significantly, the MFA letter also confirms that the policymaking function need not be concentrated in one individual and that employees serving as active members of a group or committee who develop and adopt an investment manager’s policies, such as the valuation committee, could be executive officers under the rule.

However, individuals who merely observe committee meetings or simply provide information or analysis to the decision makers of a committee or group would not be engaged in making policy and therefore generally would not be executive officers.

Employees Who Participate in the Investment Activities of a Private Fund

The concept of a knowledgeable employee includes any employee of a private fund or an Affiliated Management Person who, in connection with his or her regular function or duties, participates in the investment activities of the private fund, other private funds or investment companies whose investment activities are managed by the Affiliated Management Person, provided that such employee has been performing such functions and duties for or on behalf of the private fund or the Affiliated Management Person of the private fund, or substantially similar functions or duties for or on behalf of another company for at least 12 months (“Participating Employee”).

Previously, while stating that certain types of nonexecutive employees would not generally be knowledgeable employees because they were not participating in investment activities, the SEC staff stated that some research analysts (e.g., a research analyst who researches all potential portfolio investments and provides recommendations to the portfolio manager) would be knowledgeable employees.

The MFA letter confirms that a research analyst who researches only a portion of the portfolio of a private fund and provides analysis or advice to the portfolio manager with respect to that portion of the private fund’s portfolio is participating in the investment activities of the private fund and could be a knowledgeable employee.

The MFA letter also confirms that individuals in the following factual scenarios could be considered Participating Employees because they participate in investment activities (provided they regularly perform those functions or duties and have been doing so for at least 12 months):

  • a member of the analytical or risk team who regularly develops models and systems to implement the private fund’s trading strategies by translating quantitative signals into trade orders or providing analysis or advice that is material to the investment decisions of a portfolio manager (in contrast to someone who merely writes the code to a program used by the portfolio manager);
  • a trader who regularly is consulted for analysis or advice by a portfolio manager during the investment process and whose analysis or advice is material to the portfolio manager’s investment decisions based on the trader’s market knowledge and expertise (in contrast to a trader who simply executes investment decisions made by the portfolio manager);
  • a tax professional who is regularly consulted for analysis or advice by a portfolio manager, typically before the portfolio manager makes investment decisions, and whose analysis or advice is material to the portfolio manager’s investment decisions, such as when a tax professional’s analysis of whether income from an offshore fund’s investment may be considered “effectively connected income” and is material to a portfolio manager’s decision to invest in certain debt instruments (in contrast to a tax professional who merely prepares tax filings); and
  • an attorney who regularly analyzes legal terms and provisions of investments and whose analysis or advice is material to the portfolio manager’s investment decisions, such as where the attorney’s legal analysis of tranches of a distressed debt investment is material to a portfolio manager’s decision to invest in the loan (in contrast to an attorney who negotiates agreements that effectuate transactions evidencing the investment decisions of the portfolio manager or an attorney or compliance officer who evaluates whether an investment is permitted under the fund’s governing documents).

Treatment of Separate Accounts

In some cases, employees of an Affiliated Management Person also participate in the investment activities of separate accounts (or a portfolio, or a part of a portfolio, of a separate account) for clients that are “qualified clients” and are otherwise eligible to invest in private funds advised by the Affiliated Management Person and whose accounts pursue investment objectives and strategies that are substantially similar to those pursued by one or more of those private funds (“Covered Separate Accounts”).

The MFA letter confirms that an employee of an Affiliated Management Person who participates in the activities of Covered Separate Accounts (or a portfolio, or a part of a portfolio, of a Covered Separate Account) can also be treated as a knowledgeable employee.

Employees of Related Advisers in Control Relationships

In a letter to the American Bar Association Section of Business Law dated Jan. 18, 2012 (“ABA letter”), the SEC permitted the managers of affiliated private fund complexes to file a single Form ADV to register all affiliated managers under specified circumstances which involve a single advisory business.

The MFA letter applies the same analysis to the concept of knowledgeable employee.

The ABA letter procedure involves the filing of an ADV by one of the fund managers in the complex, and the other fund managers in the fund complex are described in the ADV. The fund manager who files the ADV is known as the filing adviser, and the other managers included in the ADV are known as relying advisers. This procedure eliminates the need for all fund managers in a controlled fund complex to file separate ADVs.

Accordingly, the MFA letter confirms that if a filing adviser and its relying adviser(s) collectively conduct a single advisory business as described in the ABA letter, then the filing adviser and each of the relying adviser(s) may be an Affiliated Management Person of a private fund.

As a result, knowledgeable employees of a filing adviser or any of its relying advisers may be treated as knowledgeable employees with respect to any private fund managed by the filing adviser or its relying advisers, provided that the employees meet the other conditions of the rule.

To view the SEC's letter, please click here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions