Investment Funds Regulatory Update
June 17, 2009
White & Case's Investment Funds Regulatory Update provides a brief overview of some of the latest legislative, regulatory and judicial actions, policy statements and decisions affecting investment funds.
SEC to Propose Investment Adviser Pay-to-Play Rules; NYC Comptroller Urges Implementation Alongside Placement Agent Regulation Reform
In response to a flurry of recent enforcement actions and investigations of "pay-to-play" practices involving pension funds and placement agents in a number of jurisdictions, the Securities and Exchange Commission (the "SEC") has announced that it expects to propose certain pay-to-play rules sometime in July.
SEC spokesman John Nester said the SEC is "seriously considering" reintroducing a 1999 proposal under the Investment Advisers Act of 1940 (the "Advisers Act") that would have required an investment adviser to give up any compensation received for managing public funds for two years after making a campaign contribution to a state official or candidate who could have influenced the selection of the adviser. The 1999 proposal would have also required registered investment advisers with government clients to keep records of their political contributions.
Some industry participants believe, however, that the pay-to-play concerns would be better addressed through disclosure, particularly given that Rule 206(4)-3 of the Advisers Act requires all registered investment advisers to disclose to clients any compensation paid in exchange for solicitation activity. In light of pending legislation, it is expected that most investment advisers will be required to register with the SEC in the near future and will therefore be subject to these disclosure requirements.
In a letter to SEC Chairman Mary Schapiro dated May 13, New York City Comptroller William C. Thompson Jr. urged the SEC to reintroduce the 1999 proposal, as well as to tighten federal regulation of entities or individuals acting as placement agents in connection with investments by public pension funds. Thompson noted that many placement agents are not registered with any federal agency and engage in fee-splitting arrangements with undisclosed parties. He stated that this, along with recent SEC and other governmental pay-to-play related enforcement actions, underscores the need for additional transparency in the activities of public pension funds.
The SEC is currently engaged in a massive investigation into pay-to-play practices involving pension funds in New York, California and New Mexico. The SEC filed civil charges in late April against Aldus Equity Partners LP and one of its founding partners, Saul Meyer, over an alleged kickback scheme involving New York state's largest pension fund. The SEC also charged Julio Ramirez Jr., a former affiliate of DAV/Wetherly Financial LP, on May 12 with involvement in the scheme.
The New York state government is conducting parallel investigations. As part of the settlements with New York Attorney General Andrew Cuomo to resolve their respective roles in the investigation, The Carlyle Group agreed on May 14 to pay a US$20 million penalty and Riverstone Holdings, a private equity firm and Carlyle's joint venture partner, agreed on June 11 to pay a US$30 million penalty. Both firms also agreed to enact a code of conduct that bars their employees from making campaign contributions to pension officers and prohibits the use of middlemen to win business from public pensions. In addition, New York is implementing regulations that bar the involvement of paid intermediaries in state pension fund decisions.
Regulators disagree over whether placement agents should be registered as lobbyists or with the SEC as broker-dealers. According to New York Attorney General Cuomo, between 40 and 50 percent of all placement agents and other intermediaries involved in transactions with New York pension funds are neither registered as broker-dealers nor as lobbyists. The current investigations place great scrutiny on any such unregistered intermediaries.
We will continue to monitor these developments.
Proposed 1999 Rule: Political Contributions by Certain Investment Advisers, SEC Rel. No. IA-1812 (Aug. 4, 1999)
Press Release: Cuomo Announces Landmark Agreement with The Carlyle Group to Eliminate Pay-to-Play in Public Pension Funds Nationwide (May 14, 2009)
Thompson Letter: available here (PDF)
SEC Approves FINRA Rule Governing Private Placement Proceeds
Effective June 17, 2009, the Financial Industry Regulatory Authority ("FINRA") Rule 5122 requires FINRA member firms, and associated persons that engage in a private placement of such firm's securities or those of a control entity, to comply with certain disclosure and filing requirements and limitations on the use of proceeds.
Rule 5122 requires such members or associated persons to:
(1) disclose to investors in a private placement memorandum, term sheet or other offering document the intended use of offering proceeds and offering expenses;
(2) file the offering document with FINRA; and
(3) commit that at least 85 percent of the offering proceeds will be used for business purposes, that will not include offering costs, discounts, commissions and any other cash or non-cash sales incentives.
Rule 5122 provides a number of exemptions to the rule, including private offerings sold only to the following:
(1) institutional accounts, as defined in NASD Rule 3110(c)(4);
(2) qualified purchasers, as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940;
(3) qualified institutional buyers, as defined in Rule 144A of the Securities Act of 1933;
(4) investment companies, as defined in Section 3 of the Investment Company Act of 1940;
(5) an entity composed exclusively of qualified institutional buyers, as defined in Rule 144A of the Securities Act of 1933;
(6) banks, as defined in Section 3(a)(2) of the Securities Act of 1933; or
(7) employees and affiliates of the issuer or its control entities.
Rule 5122 also excludes a variety of offerings from the rule, including offerings of exempted securities, as defined by Section 3(a)(12) of the Securities Exchange Act of 1934, offerings made pursuant to Rule 144A or Regulation S, offerings in which the member acts primarily in a wholesaling capacity, and offerings of equity and credit derivatives, including OTC options, provided that the derivative is not based principally on the member or any of its control entities.
The rule will not apply retroactively to any offerings that have already commenced selling efforts as of the effective date, June 17, 2009.
FINRA Regulatory Notice: available here (PDF)
Proposed Investment Adviser Custody Rules Would Require Nearly All Registered Investment Advisers to Pay for Annual Surprise Exams; Independent Public Accountants to Play Watchdog Role
On May 20, 2009, the SEC issued a release proposing amendments to Rule 206(4)-2 of the Advisers Act to improve the safekeeping of client assets. The proposed rule would require a yearly "surprise exam" of investment advisers deemed to have custody of client assets, to be performed by an independent public accountant, to verify the integrity of client assets. In addition, when an adviser or an affiliate directly holds client assets, the proposed rule would require that in addition to a surprise exam, a custody control review be conducted by a PCAOB-registered and inspected accountant. The proposed rule would also require qualified custodians to deliver periodic account statements to clients of an investment adviser, or to the underlying investors in the case of advisers to pooled investment vehicles such as private equity funds and hedge funds that do not distribute annual audited financial statements to investors.
The proposed rule would apply to any SEC-registered investment adviser deemed to have custody of client assets, either directly or through an affiliate, and to those registered investment advisers with authority to access client funds, to deduct advisory fees for example. This would place 9,600 of the approximately 11,000 currently registered advisers within the scope of the proposed rule, a number that will rise dramatically if pending federal legislation requiring the registration of most investment advisers, specifically the Hedge Fund Transparency Act or the Hedge Fund Adviser Registration Act, becomes law.
The SEC is seeking comments on the proposed rule by July 28, 2009. We expect many industry participants to suggest that the rule not apply to advisers deemed to have custody solely as a result of their ability to withdraw advisory fees directly from client accounts (nearly two-thirds of all advisers subject to the proposed rule), given that such limited access to client assets is less likely to be subject to abuse and misappropriation.
Proposed Rule: Custody of Funds or Securities of Clients by Investment Advisers, SEC Rel. No. IA-2876 (May 20, 2009)
Related Client Alert: Available here (PDF)
Connecticut Bill to Regulate Hedge Funds Shelved
A Connecticut bill that sought to impose transparency regulations on hedge funds in the state has effectively died for the time being as the state House of Representatives failed to hold a vote on the measure before the end of the 2009 normal legislative session on June 3. The proposed bill, "An Act Concerning Hedge Funds," passed the Connecticut Senate on May 26 by a 24-12 vote and would have required fund managers and other investment advisers that have not registered with the SEC to alert investors to any material conflicts of interest. SEC-registered advisers are already required to disclose
such conflicts.
State Representative Ryan Barry (D), co-chairman of the Joint Committee on Banking and the bill's co-sponsor, said in an interview that he had the requisite votes for passage but could not bring the bill to the floor before the session concluded. Although the clerk's office said on June 4 that it remained unclear whether the measure could be taken up in special sessions, lawmakers stated that the bill would not be revived in special sessions because it is not related to the state budget. Rep. Barry noted that he expects to bring the bill up again next year. It is possible that, absent the passage of any federal regulation of private funds or their advisors in the intervening time, any future versions of the bill may include more aggressive provisions.
Text of the Bill Passed in Connecticut's Senate: Available here (HTML)
Related Story: Hedge-Fund Measure Dies in Connecticut, Wall Street Journal (June 6, 2009)
IASB Publishes Draft Guidance on Fair Value Measurement
On May 28, the International Accounting Standards Board (the "IASB") published for public comment an exposure draft of guidance on fair value measurement, which borrows heavily from FAS 157. If adopted, the proposal would replace fair value measurement guidance contained in individual International Financial Reporting Standards ("IFRS") with a unified definition of fair value and authoritative guidance on the application of fair value measurement in inactive markets. The proposal reflects a long-term goal to achieve convergence between IFRS and US generally accepted accounting principles.
The IASB's starting point in developing the draft was FAS 157, and the proposals incorporate recent guidance on fair value measurement published by the Financial Accounting Standards Board (the "FASB"). The proposed definition of fair value is identical to the definition in FAS 157. Also, the IASB proposal applies the FAS 157 hierarchy and both FAS 157 and the IASB proposal explain how to measure fair value but do not tell financial statement preparers when it should be applied.
There are, however, differences between the IASB proposal and FAS 157. For example, unlike FAS 157, the IFRS standard would apply to leasing arrangements, and it addresses how to apply the exit price to equity instruments measured at fair value.
The four-month comment period ends September 28, 2009.
Press Release: IASB Publishes Draft Guidance on Fair Value Measurement (May 28, 2009)
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