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Advisers Act Alert Part 10: Other Matters

Amendments to Form ADV

As discussed above, the SEC adopted several amendments to Form ADV (the “ADV Amendments”). While the ADV Amendments focus to a significant extent on ERAs, the changes to Form ADV Part 1A also apply to registered investment advisers, and, significantly, set forth, new detailed reporting requirements regarding private funds managed by an adviser. A general description of the ADV Amendments, as well as more detailed information on private fund reporting requirements and ERAs’ reporting obligations, follows. A more detailed description of all of the ADV Amendments is set forth in Goodwin Procter’s June 28, 2011 Financial Services Alert.

As a general matter, the ADV Amendments are designed to provide the SEC with additional information about three areas of an adviser’s operations. First, the ADV Amendments require advisers to provide additional information about the private funds that they advise. Second, the ADV Amendments require advisers to provide additional data regarding their advisory business (including data about the types of clients they advise, their employees and their advisory activities), as well as their business practices that may present significant conflicts of interest (such as the use of affiliated brokers, soft dollar arrangements and compensation for client referrals). Third, the ADV Amendments require advisers to report on certain non-advisory activities and their financial industry affiliates.

Private Fund Information

The ADV Amendments significantly increase the amount of information that an adviser is required to report on its private fund(s) under Item 7.B of Form ADV Part 1A. Under the ADV Amendments, both registered advisers and ERAs are required to complete Item 7.B and the related portions of Schedule D, which require an adviser to provide a separate Section 7.B of Schedule D for each private fund that it advises. A brief overview of certain of the information that an adviser will be required to provide about each private fund, including, as applicable, distinctions from the SEC’s initial rule proposals and interpretive matters, follows:

  • The name and size of the fund, whether it is part of a master-feeder arrangement or is a fund of funds and the securities law exemptions on which it relies. The ADV Amendments modify the proposed rules in certain respects. Specifically, under the proposed rules, an adviser would have been required to report both the gross and net asset values of each private fund and the assets and liabilities of each fund broken down by class and categorization in the fair value hierarchy established under GAAP. In light of commenters’ concerns regarding, among other things, the disclosure of competitively sensitive information, under the ADV Amendments, an adviser is not required to report a private fund’s “net” asset value or the breakdown of assets and liabilities by class and categorization.
  • The fund’s investment strategy (selected from one of seven broad categories described in the ADV Amendments) and whether it invests in shares of registered investment companies. The ADV Amendments include definitions, certain of which have been modified from the proposed rules to provide enhanced clarity as to the appropriate classification. In this regard, the ADV Amendments include, among other things, a clarification for categorizing securitized asset funds and funds that engage in short selling activities for hedging currency exposure or managing duration. While the ADV Amendments include some guidance on the appropriate classification, advisers may experience some level of uncertainty on the appropriate classification of a private fund, particularly when the fund’s structure lends itself to more than one category.
  • The minimum amount that investors are required to invest, the approximate number of beneficial owners of the fund and the approximate percentage of the fund owned by the adviser and related persons and the extent to which clients of the advisers are solicited to invest, and have, invested in the fund. The ADV Amendments remove the aspect of the Proposed Rules that would have required disclosure regarding the types of investors in the fund. Certain information needed to respond to these questions may not be readily available. For example, the ADV Amendments require an adviser to provide information regarding the percentage of the private fund beneficially owned by funds-of-funds. Many private fund advisers may not be able to answer this question without reaching out to their investors or using a reasonable estimation. The level of precision or due diligence required is not specified. In addition, as a general matter, the concept of “beneficial ownership” is somewhat ambiguous as it applies to private funds.
  • Information regarding the five specific types of service providers to the fund (auditors, prime brokers, custodians, administrators and marketers).

In addition, under the ADV Amendments, the SEC will no longer require an adviser to report funds that are advised by affiliates, and will allow a sub-adviser to exclude private funds for which an adviser is already reporting on Schedule D to Form ADV Part 1A. An adviser sponsoring a master-feeder arrangement may submit information on an aggregate basis for the master fund and all of the feeder funds that would otherwise be submitting substantially identical data.

ERA Obligations under the Form ADV Amendments .

As discussed in Part 5 of this Alert, the SEC has imposed on ERAs certain reporting and other obligations. While an ERA will not be required to file a full Form ADV, it will be required to respond to certain items to allow the SEC to gather certain basic information about the adviser, details about the private funds it advises (see above), other business interests of the adviser and its affiliates and disciplinary history of the adviser and its employees.

As discussed above, the SEC staff will reconsider the information the SEC collects from ERAs after the SEC receives and assesses the information gathered during the first year’s filings. During last week’s SEC open meeting, Commissioners Troy Paredes and Kathleen Casey objected to the level of reporting required of ERAs and highlighted the critical importance of the SEC staff’s analysis after the first year’s filings. It will be important for ERAs to consider, as they go through the reporting process, which aspects were particularly burdensome or otherwise objectionable.

Changes to Pay-to-Play Rule

The SEC also amended the “pay-to-play” rule in response to changes made by the Dodd-Frank Act. These amendments broaden the scope of the rule to confirm that its requirements apply to both ERAs and foreign private advisers. In addition, the amendments add regulated municipal advisors to the list of “regulated persons” that advisers may pay to solicit government entities’ advisory business. The amendments include additional guidance on qualifying as a “municipal advisor”, noting that a solicitor must be registered under Section 15B of the Exchange Act and be subject to “pay-to-play” rules adopted by the MSRB. In this regard, the MSRB has issued a proposed draft of a “pay-to play” rule and requested comment. In the Proposed Rules, the SEC had proposed to limit the exception to the third-party solicitation ban to municipal advisors but, in response to certain comments, has retained the approach of the current rule permitting advisers to compensate persons that are “regulated persons” (which could also include FINRA registered broker-dealers). The SEC also extended the compliance date for the ban on third-party solicitation from September 13, 2011 to June 13, 2012 in order to allow for FINRA and MSRB to adopt “pay-to-play” rules and to allow for solicitors to come into compliance.

Form PF

The SEC has also proposed creating a new reporting form (Form PF) to be filed periodically by registered investment advisers who manage one or more private funds. The SEC indicated that Form PF will be finalized later this year.

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