On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") became law and eliminated the exemption from registration with the Securities and Exchange Commission (the "SEC") under the Investment Advisers Act of 1940 (the "Advisers Act") for private advisers with fewer than 15 clients effective July 21, 2011. Under the Dodd-Frank Act and new rules proposed by the SEC, foreign private advisers who do not fall within two narrowly drawn exemptions will be required to register under the Advisers Act. In this client alert, we briefly address regulatory issues related to foreign advisers and foreign funds.
Exemption 1: Foreign Private Adviser Exemption
The Dodd-Frank Act exempts from registration "foreign private advisers," or an investment adviser that (i) has no place of business in the U.S., (ii) has, in total, fewer than 15 clients in the U.S. and investors in the U.S. in private funds advised by the adviser, (iii) has aggregate assets under management attributable to such clients and investors of less than $25 million (or such higher amount as determined by the SEC), and (iv) neither holds itself out generally to the public in the U.S. as an investment adviser nor acts as an investment adviser to any registered investment company or business development company.
On November 19, 2010, the SEC proposed new rule 202(a)(30)-1 to define certain terms in the foreign private adviser exemption as follows:
- Clients: The SEC proposal retains certain safe harbors in counting clients which the Dodd-Frank Act would otherwise eliminate. Generally, an adviser may count as one client (i) related natural persons sharing a principal residence (including any trusts and accounts whose only primary beneficiaries are such persons) and (ii) two or more entities with identical owners. In a departure from current legislation, the SEC proposal also counts persons advised without compensation. To avoid double-counting, an adviser need not count a private fund as a client if it counts any investor in such fund.
- Private Fund Investor: The proposed rule "looks through" nominee or other arrangements, and counts any person that is a "beneficial owner" if the fund is a Section 3(c)(1) fund or a "qualified purchaser" if the fund is a Section 3(c)(7) fund. An investor in multiple funds advised by the adviser need only be counted once. Beneficial owners who are "knowledgeable employees" and beneficial owners of "short-term paper" would also be counted, even though such persons are not beneficial owners under Section 3(c)(1) or knowledgeable employees under Section 3(c)(7).
- In the U.S.: A client or investor is "in the U.S." if it is a U.S. Person under Regulation S at the time the fund becomes a client or, for investors, when the person acquired securities in the fund. Unlike Regulation S, however, the proposed rule would deem to be "in the U.S." an offshore discretionary account held for the benefit of a person "in the U.S." by a non-U.S. affiliate of an adviser.
- Place of Business: The proposed rule defines "place of business" as "any office where the investment adviser regularly provides advisory services, solicits, meets with, or otherwise communicates with clients, and any location held out to the public as a place where the adviser conducts any such activities."
- Assets Under Management: Assets under management would be calculated following the proposed instructions to Form ADV and would include securities portfolios to which the adviser provides continuous and regular supervisory or management services, regardless of whether these assets are proprietary assets, assets managed without receiving compensation, or assets of foreign clients, including uncalled capital commitments. A sub-adviser would only need to count the portion of the value of the portfolio for which it has responsibility.
Exemption 2: Private Fund Adviser Exemption
Title IV of the Dodd-Frank Act requires the SEC to provide an exemption to private fund advisers with assets under management in the U.S. of under $150 million. On November 19, 2010, the SEC proposed rule 203(m)-1, which, as applicable to foreign advisers, exempts an adviser with a principal office and place of business outside the U.S. (a "non-U.S. adviser") (i) who has no client that is a U.S. person except for qualifying private funds, and (ii) whose total assets managed from a place of business in the U.S. are less than $150 million.
- Advises Solely Private Funds: Under the proposed rule, all of a non-U.S. adviser's clients that are U.S. persons must be qualifying private funds, as defined in the Advisers Act. A non-U.S. adviser may enter the U.S. market and take advantage of the exemption without regard to the type or number of its non-U.S. clients.
- Private Fund Assets: The value of private fund assets would be calculated in the same manner as assets under management under the foreign private adviser exemption described above. An adviser would be required to determine the amount of private fund assets quarterly, based on the fair value of those assets at the end of the quarter.
- Assets Managed in the U.S.: A non-U.S. adviser would only need to count private fund assets it manages from a place of business in the U.S. toward the $150 million asset limit. There is no proposed limitation on assets managed from a non-U.S. place of business.
- Principal Place of Business: The proposed rules define "principal office and place of business" as the location where the adviser controls, or has ultimate responsibility for, the management of private funds assets, and therefore as the place where all the advisers' assets are managed, although day-to-day management of certain assets may also take place at another location.
- U.S. Person: The SEC would define "U.S. person" by reference to Regulation S. Unlike Regulation S, however, the proposed rule would deem to be a "U.S. person" an offshore discretionary account held for the benefit of a U.S. person by a non-U.S. affiliate of an adviser.
- Transition Rule: An adviser that has complied with SEC reporting requirements would have one calendar quarter to register with the SEC after becoming ineligible to rely on this exemption due to an increase in the value of its private fund assets.
Registration under the Advisers Act by Foreign Broker-Dealers
The Advisers Act contains an exclusion from the requirement to register for broker-dealers whose activities would cause them to fall within the definition of an "investment adviser" if such activities are incidental to the broker-dealer's business and the broker-dealer receives no special compensation for performing such services. However, the majority of foreign broker-dealers would not be eligible for this exclusion because it requires that the broker-dealer be registered under the Securities Exchange Act of 1934, as amended (the "Act"). The SEC has stated that its staff will generally respond favorably to no-action requests where a foreign broker-dealer otherwise meets the requirements of the exclusion, and also meets certain conditions in Rule 15a-5 under the Act (exempting certain foreign broker-dealers from registration under the Act).
Recordkeeping and Other Requirements Applicable to Registered Foreign Investment Advisers
The SEC's staff has taken the position that a foreign registered investment adviser generally must comply with the Advisers Act only with respect to its clients which are U.S. persons. However, the foreign registered investment adviser must comply with the Advisers Act's recordkeeping and examination requirements with respect to all of its clients, including clients that are not U.S. persons. In addition, the foreign registered investment adviser must make its personnel available for testimony before, or questioning by, the SEC, must disclose all directors and each investment adviser that advises U.S. clients on its Form ADV, and may not hold itself out as being registered under the Advisers Act to non-U.S. clients.
In addition, the SEC's staff has taken the position that affiliates of a registered foreign investment adviser may provide advice to such registered adviser for use in advising U.S. clients without subjecting themselves to the Advisers Act as long as the advice is dispensed through the registered adviser and the affiliate is disclosed on the registered adviser's Form ADV. If an investment adviser takes advantage of this policy, then the non-registered affiliate becomes subject to certain recordkeeping and examination requirements with regard to all of its transactions (whether or not they involve U.S. persons) and submits to jurisdiction in the U.S.
Should you require any assistance in applying these new regulations to foreign advisers, please contact Stephen Cohen at 212.407.4279.
Loeb & Loeb's Financial Reform Task Force monitors key issues surrounding approval of the Dodd-Frank Wall Street Reform and Consumer Protection Act that are relevant to a broad spectrum of firm clients in the financial services industry. The multidisciplinary Task Force is comprised of attorneys across core practice areas - including general corporate, private equity, securities, mergers and acquisitions, consumer protection and banking and finance - who are focused on analyzing the historic legislation and interpreting the significant business implications for financial institutions and commercial companies nationwide.
This client alert is a publication of Loeb & Loeb LLP and is intended to provide information on recent legal developments. This client alert does not create or continue an attorney client relationship nor should it be construed as legal advice or an opinion on specific situations.
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