An SEC Valentine: Many offshore advisers must be registered
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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.
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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 the
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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; and
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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 program
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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.
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