An SEC Valentine: Many offshore advisers must be registered


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An SEC Valentine: Many offshore advisers must be registered

  1. 1. An SEC Valentine: Many offshore advisers must be registered Dec 27 2011 Mark Berman and Philip Thomas recommended This Valentine’s Day, the U.S. Securities and Exchange Commission (SEC) has a gift for advisers to hedge funds around the world that, if not necessarily welcome, at least has the benefit of not going straight to the hips. February 14, 2012, will mark the day by which many advisers who do business connected with the United States will have to submit their applications for registration as investment advisers. Many other money managers must tender their initial Report of Exempt Reporting Adviser as Private Fund Advisers on Form ADV Part 1 by March 30, which is also just around the corner. This latter filing will serve as the application for a new status of quasi-registration under which managers will have reporting and other responsibilities, and be subject to SEC inspection. The hour is late. Managers who have procrastinated or been in denial are apt to find the considerable task of completing registration or exemption by the cutoff date to be a challenge. Here’s how the math works for registration applicants. The SEC will begin enforcing the Dodd-Frank Act amendments to the Investment Advisers of Act of 1940 on March 30. The SEC has up to 45 days to approve or deny initial applications for registration, meaning that affected managers must have their paperwork filed 45 days prior to this deadline. Other money managers need to do nothing on this day, although we recommend they not forget to send their mothers a card. If advisers can satisfy the requirements to claim Foreign Private Adviser status—a category of true exemption from registration for firms whose contacts with the United States are glancing at most—no action is required. However, for advisers who must register, or who will become Exempt Reporting Advisers, including hedge fund managers who will claim the Private Fund Adviser exemption, a lengthy application process is ahead. What am I? Much has been written about the Dodd-Frank amendments, so this article will not focus on the nuances of these. Importantly, a long-standing exemption from registration was eliminated that had allowed some of the largest advisers to remain unregistered. Many substantial offshore advisers can remain unregistered, while their U.S. counterparts are likely to require registration. A key provision of the Private Fund Adviser exemption permits an unlimited amount of U.S. assets to be managed offshore by non-U.S. advisers, as long as these managers have no clients in the United States apart from private funds. A Private Fund is a pooled investment vehicle exempt from registration under the Investment Company Act of 1940; for the most part, it means a hedge fund or private equity fund. A single managed account or pension-plan client blows the deal.1 of 6 1/5/2012 10:42 PM
  2. 2. Other important exemptions are available to advisers to venture capital funds and to single family offices. Understanding these requirements requires a solid grasp of the difference in this context between a “client” and an “investor.” Here, a client is the direct recipient of investment advice. Examples include an investment fund or a managed account. An investor is someone who places his or her money with a fund. Also, when considering just who is a U.S. client, keep in mind the following rules based on residence: Individuals: where they reside; Companies: where incorporated; Trusts, estates, etc: the location of trustees, executors; and Investment managers: where the clients reside. If in doubt, use the definition of "U.S. Person" in Regulation S adopted under the Securities Act of 1933. I have to register. What do I do? Registration as an investment adviser with the SEC calls for an eruption of activity. Rule 206(4)-7 under the Advisers Act (usually called the “Compliance Rule”) mandates that a registered investment adviser have a compliance program with policies and procedures “reasonably designed” to prevent violations of the U.S. securities laws. This means that risks and conflicts must be uncovered and analyzed, and mapped to policies and procedures which address them. The inventories the2 of 6 1/5/2012 10:42 PM
  3. 3. adviser creates during this process will themselves become key documents. Quality and fullness of disclosure is a cornerstone of the investment adviser regulatory scheme, so many of these same risks and conflicts—unless they can be eliminated—must be aired in an adviser’s Form ADV Part 2, a long-form narrative document that bears strong resemblance to a prospectus. The ADV Part 2, or “Brochure,” must be written in a clear, comprehensible manner that the SEC calls “Plain English.” In broad terms, it must convey all the information necessary for a potential client to make a decision whether to place his or her assets with the adviser. As a rough guide, it seems that advisers are falling largely within a range of about 15-30 pages for their Brochures, although big firms are producing documents of twice that length or more. Also required for registration is the Form ADV Part 1, a “check-the-box” and short-answer form that in itself is no small burden. Form ADV 1 calls for analysis and disclosure of affiliates, information about the adviser’s service providers, employee and client composition, indentifying information and a raft of details about any private funds the firm advises. Rounding out the documents a firm needs when registering is its code of ethics. This lays out the general standards of the firm’s professional conduct and sets out the rules concerning some important activities, like trading in employees’ personal accounts. Finally, a registered firm needs to appoint a chief compliance officer who is “competent and knowledgeable” about the Advisers Act, and empowered with sufficient authority to discharge the firm’s compliance program. Advisers Act regulation is a maze of law, rules, SEC Staff no-action letters and interpretations. In summary, these are the key controls in a sound compliance program: board-level and management buy-in: “tone at the top”; the CCO; a log of compliance risks and conflicts; disclosure: Form ADV Parts 1 and 2; written policies and procedures reasonably designed; code of ethics; annual review; monitoring and forensic testing; business continuity plan; and3 of 6 1/5/2012 10:42 PM
  4. 4. Regulation S-P (data protection) – if applicable. Private Fund Advisers are “exempt” Private Fund Advisers (and other so-called “exempt reporting advisers,” such as venture capital funds) are subject to a state of pseudo-registration, under which they must in some ways act like fully registered advisers. The application for exemption is even a subset of ordinary registration. As is the case with prospective registrants, the path to becoming a Private Fund Adviser begins with the applicant firm obtaining an Investment Adviser Registration Depository account from FINRA, the self-regulatory-organization for broker- dealers, and the body who runs this computer system on behalf of the SEC. The filing process calls for would-be Private Fund Advisers to provide identifying information and to disclose their financial industry affiliations. Of particular interest are other advisers or broker-dealer firms to whom the applicant is related through common ownership or other ties. Extensive information about private funds, including the service providers to each fund and its regulatory assets under management, is required. It is probably fair to view the process of obtaining an exemption as being 20-30 percent of the work that goes into registering with the SEC … and registration is a lot of work. Affiliates In a small irony, firms that register as investment advisers with the SEC may have a more convenient means of bringing along their affiliates than do managers that file for an exemption. In many corporate structures, it may be appropriate to register one advisory entity with the SEC, then set-up a Participating Affiliate Agreement (PAA) allowing the other adviser firms under the same corporate umbrella to avoid registration. A PAA requires, among other things, that the firm that is registered with the SEC supervise the employees at affiliated advisers that are providing advisory services to U.S. persons. No such handy mechanism has presented itself in the case of advisers seeking exemptions. Each separately-organized advisory business in a financial services company will have to determine whether it is eligible for an exemption. If the adviser may claim ERA status, it must file the complete Report with the SEC. It may not “tag along” with other adviser firms in the organization. Two scenarios may occur where a filing is not necessary. Analysis may show that the firm is a Foreign Private Adviser, or remote locations may simply be branch offices, requiring a mention on the Report, but no filing on their own. It is frequently the case, however, that the Singapore “office” or Hong Kong “office” is a separately organized business, and not a branch. As a result, very large global adviser firms without a registered adviser in the structure may be required to seek exemptions for several advisory divisions. The SEC inspection program4 of 6 1/5/2012 10:42 PM
  5. 5. There are three primary forms of SEC inspections that affect registered investment advisers, and one that applies to Exempt Reporting Advisers. Sometimes informally called “audits,” these are the reviews that the SEC’s Office of Compliance Inspections and Examinations (OCIE) makes of the operations of advisers. The first type is the routine inspection. This is a periodic examination whose frequency will be determined according to the riskiness the SEC perceives at the target firm. A “sweep” examination focuses on one particular area or concern and recent examples include sweeps intended to detect insider trading or market manipulation. A “for cause” examination is prompted by suspected violations at a firm. Exempt Reporting Advisers are subject to “for cause” reviews. Do ERAs require policies and procedures? Exempt Reporting Advisers are not subject to the Compliance Rule and thus are not obligated to institute a compliance program or appoint a Chief Compliance Officer. However, this is not to say that ERAs aren’t subject to a slew of requirements by dint of their status. Important among these, ERAs must: Know what actions (e.g., taking on a U.S.-managed account) will instantly require them to register Maintain their Report of Exempt Reporting Adviser and know when annual updates are due, and when to amend the document between updates Understand the activities that will bring them under the authority of the securities regulators of the states in which they do business in the United States Know their responsibilities for filing other U.S. securities reports, if applicable, such as Form 13F Remain prepared for a possible SEC inspection For these reasons, it may be advisable to maintain written policies and procedures relating to ERA obligations. A recap for Exempt Reporting Advisers: Reasons why you should prepare now The filing is probably harder than you think; ERAs must perform much of the same work to file as applicants who are registering; It will take you longer than you expect; and Firms that are not in status by March 30 may be subject to SEC sanction.5 of 6 1/5/2012 10:42 PM
  6. 6. Mark Berman, the founder and CEO of CompliGlobe, advises and conducts training programs for hedge funds, investment managers, issuers, regulators and multi-national banks and brokers in Europe and Asia on SEC practice outside the United States, UK and EU issues and cross-border regulatory, compliance and AML matters. Mark was also a lawyer with the SECs Division of Corporation Finance and the Division of Market Regulation. He was a lawyer with the London Stock Exchange. He wrote "An Introduction to Hedge Funds" (2007 Risk Books) and has edited and contributed to others. Philip Thomas is the managing director, Asia, of CompliGlobe Limited, the regulatory advisory provider to a range of financial services firms and foreign private issuers. He is based in Hong Kong. At CompliGlobe, Philip focuses on the creation and maintenance of compliance programs and systems at market participants in Europe, Asia and the US. He also assists overseas companies in addressing their US filing requirements, and in negotiating ISDA agreements and managing the risk associated with OTC derivatives. Philip is a securities and regulatory attorney with both in-house and law firm experience. He has also served as the chief compliance officer to several money management concerns. THOMSON REUTERS GRC | © 2011 THOMSON REUTERS. ALL RIGHTS RESERVED CONTACT US DISCLAIMER TERMS & CONDITIONS PRIVACY STATEMENT ACCESSIBILITY RSS TWITTER GRC CONNECTS LINKEDIN6 of 6 1/5/2012 10:42 PM