Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

Recent SEC charges against a registered investment adviser to a private fund and one of its co-founders illustrate recurring themes in SEC enforcement actions against private equity advisers.  The enforcement action includes allegations of improper expense charges, distributions to the general partner contrary to the waterfall in the partnership agreements, misleading statements during the marketing phase, and failure to follow the custody rule.  In general terms, the SEC alleged:

  • The investment adviser misidentified some of its own expenses as “split expenses” that related to both the investment adviser and the funds.  The split expenses were allocated 70% to the advised funds and 30% to the investment adviser.  Misidentified expenses included salaries of the investment adviser’s employees, executive bonuses, health benefits, retirement benefits and rent.  The private placement memorandums, or PPMs, and limited partnership agreements for the funds did not disclose the funds would bear these expenses. Some of the PPMs specifically stated these expenses should not be paid by the funds.
  • The limited partnership agreements for the funds provided that if a fund had distributable cash it would be distributed pursuant to a waterfall provision. While the waterfall provisions varied among the funds, the provisions generally provided for a preferred return to investors, followed by a catch-up provision to the general partner, with the remainder being divided between the investor and the general partner using a disclosed ratio. Among other things, the SEC alleges instead of using catch-up amounts specified in the limited partnership agreement, the investment adviser sometimes used higher catch-up amounts without disclosure to the investors.
  • The co-founder that is charged in the SEC action told an investor he and the other co-founder were both investing $100,000 in a new fund.  However the two co-founders only invested $25,000 each.
  • The investment adviser kept stock certificates for fund investments in its office but did not follow custody rules related to surprise examinations or annual audits.

Of course, some or all of the facts alleged by the SEC may not be true.  But the action clearly demonstrates the SEC’s recent enforcement thrust.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

Fantex, offering NFL player Vernon Davis tracking stock, has taken to Twitter to promote its offering.  The required legend to use a free writing prospectus, or FWP, would exceed the character limit imposed by Twitter.  However, depending on how you view Twitter, the legend is either accessed by clicking an “expand button” or a link to a picture of the legend.  Note also the link to the prospectus and that the prospectus includes an offering price.  See Rule 433.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

 

Commissioner Luis A. Aguilar recently gave a speech in which he stated the JOBS Act will require increased scrutiny of transfer agents because of the gatekeeping function that transfer agents perform.  In his speech, Commissioner Aguilar noted:

•           Regulation A, general solicitation under Regulation D and the crowdfunding exemption will increase the amount of securities issued and potentially impact trading in shares of unregistered issuers. Any trading market that develops for these unregistered securities will almost certainly be less transparent and less liquid than the market for listed securities.  Thus, the role of transfer agents in monitoring the issuance of new shares and removing restrictions on restricted securities and control blocks may be critical in deterring and detecting fraud.

•           These new rules—enhanced Regulation A, general solicitation under Regulation D, and crowdfunding—are being proposed at the same time that other rules enable companies to remain “private” (or at least unregistered) for longer periods, even as they rely on increasing numbers of outside investors for their capital needs.  In particular, the JOBS Act raised the shareholder thresholds for when companies are required to register under the Exchange Act.  These changes, in the aggregate, will significantly impact companies and transfer agents, who in some cases may have to keep track not only of the record holders of a company’s securities, but also whether such securities were issued in a crowdfunding transaction or in a transaction exempt from the Securities Act pursuant to an employee compensation plan, and whether the record holder is an accredited investor.  All of these changes add confusion and complication to the important task of determining whether a company is required to register with the SEC.  And, although the burden of getting it right remains with the issuer, any adverse effects will fall on investors—who may be denied the information and liquidity advantages provided by Exchange Act registration.

•           The SEC needs to take a hard look at whether the current regulatory framework governing transfer agents appropriately addresses the risks associated with the anticipated increased trading in unlisted securities.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

SEC Chair Mary Jo White recently gave a speech where she discussed the SEC’s recent progress and initiatives.   For Corporation Finance she said “What is next? This year, the Corp Fin staff will focus on making specific recommendations for updating the rules that govern public company disclosure.  As part of this effort, Corp Fin will be broadly seeking input from companies and investors about how we can make our disclosure rules work better, and, specifically, investors will be asked what type of information they want, when do they want it and how companies can most meaningfully present that information.”

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The Securities and Exchange Commission has announced that its Office of Compliance Inspections and Examinations, or OCIE, is launching an initiative directed at investment advisers that have never been examined, focusing on those that have been registered with the SEC for three or more years.  OCIE previously announced that examining these advisers is a priority in 2014.

As part of the initiative, OCIE will conduct examinations of a significant percentage of advisers that have not been examined since they registered with the SEC.  These examinations will concentrate on the advisers’ compliance programs, filings and disclosure, marketing, portfolio management, and safekeeping of client assets.  Additional details on the examinations are available here.

Starting later this year, OCIE will invite SEC-registered investment advisers who have yet to be examined to attend regional meetings where they can learn more about the examination process.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The SEC staff recently issued a no-action letter stating that registration as an investment adviser was not necessary when (i) asset management services are provided only to wholly-owned subsidiaries of a parent which also owns the adviser, (ii) the adviser does not hold itself out to the public as an investment adviser and (iii) the parent beneficially owns, directly or indirectly, 100% of the assets for which the adviser provides investment advice.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

On February 7, 2014, eight United States Senators told Acting Commodity Futures Trading Commission Chairman Mark Wetjen to either (1) make the CFTC’s Large Trader Report available to the Federal Energy Regulatory Commission by the end of February or (2) tell Congress what needs to be done so that the information can be made available as quickly as possible. Senator’s Letter to Acting CFTC Chairman Mark P. Wetjen.

FERC and the CFTC have entered into a Memorandum of Understanding on sharing information, including the information contained in the CFTC Large Trader Report. Under the CFTC’s Large Trader Reporting System, clearing members, futures commission merchants and foreign brokers file daily reports with the CFTC showing futures and option positions of traders that have positions at or above specific reporting levels (ranging from 25 to over 1,000 contracts, depending on the commodity) set by the CFTC. The aggregate of all large trader positions reported to the CFTC usually represents 70% to 90% of the total open interest in any given market. Once a trader’s account reaches one of the reporting levels, the CFTC may contact the trader directly and require the trader to file a detailed identification report. CFTC staff can then use this information, including aggregation with other accounts of the trader, to assess the trader’s potential impact on markets and compliance with speculative position limits.

But the CFTC has not yet shared that information with FERC, citing technical issues. The CFTC told Congress in mid-January that “there are questions just around data transfer issues and technical personnel need to work out those things.” Testimony of Mr. Vince McGonagle, CFTC’s Market Oversight Director, Senate Banking Committee, January 15, 2014.

The eight Senators, however, oppose further delay telling Chairman Wetjen:

Information sharing between CFTC and FERC has been delayed for too long, putting our energy markets at risk of abuse unnecessarily. During the Western energy crisis, Americans learned that energy markets that lack real-time market oversight and effective regulation allow traders to rob Americans, disrupt economic activity and darken cities. The crisis cost consumers an estimated $45 billion in higher electricity rates, lost business due to blackouts, and a slowdown in economic growth. FERC investigators have explained articulately and effectively that they need access to CFTC’s Large Trader Report in order to oversee trading in fully integrated energy markets and prevent future manipulation. U. S. Senators Letter at 2

They told the Chairman to get moving and either (1) address any “technical issues and initiate information sharing no later than the end of February” or (2) tell Congress about the technical problems and they would fund any needed investments. As the letter concludes:

We ask you to provide the leadership necessary to address technical issues and initiate information sharing no later than the end of February. If the CFTC is unable to facilitate information sharing by that date, we trust that CFTC’s report to Congress [due February 17] will detail how it intends to overcome technical limitations as quickly as possible [which would include any funds needed for upgrades to information technology systems.] Id.

Check back to the blog for further developments.

 

An industry group has launched the first integrated conflict minerals database for suppliers called BOMcheck.  BOMcheck is currently used by over 560 manufacturers to gather materials declarations from over 3,500 suppliers worldwide for more than 1.6 million parts.

The platform:

  •  Provides one integrated tool for suppliers to upload their EICC GeSI Conflict Minerals Reporting Templates at the part level or company level at the same time as they publish materials declarations for RoHS, REACH and other regulated substances. There is no need to re-type data into another web tool.
  • Validates the data in the supplier’s EICC GeSI Conflict Minerals Reporting Template and provides immediate detailed feedback to help the supplier correct any data validation errors which are preventing upload.
  • Works in partnership with the Conflict-Free Sourcing Initiative to validate any new smelters which suppliers identify so that they can be added to the smelter list and invited to join the Conflict-Free Smelter Program.
  • Enables manufacturers to leverage the Conflict-Free Smelter Program and the upcoming EU Responsible Sourcing Regulations to work towards “DRC conflict free” status by 2015.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

In 2013, Minnesota enacted new regulatory statutes (prior coverage here, here, and here) that require “investment adviser representatives” to register with the department of commerce and meet certain other requirements unless an exemption is available.  However, the system of exemptions is non-intuitive and requires some background knowledge on the current state of the investment adviser regulatory framework in Minnesota.

Minnesota has for many years regulated investment advisers who do business in the state, generally requiring them to register with the department of commerce unless the investment adviser fits within a statutory exemption.  One of the major exemptions applies to “federal covered investment advisers” – that is, those investment advisers who are subject to the federal registration regime.  Aside from the registration requirement, the state imposes many other regulations on investment advisers relating to brochure contents, custody rules, financial reporting, and the like.  One of those requirements is supplied by 2876.4120 of the Minnesota Rules, which requires that every supervisory or control person of a state registered investment adviser must have passed the Uniform Investment Adviser State Law Examination (S65) or the Uniform Combined State Law Examination (S66).  However, the exam rule also contains exemptions for those persons who have a certified professional designation that is currently in good standing, such as Certified Financial Planner, Chartered Financial Consultant, Chartered Financial Analyst, Personal Financial Specialist, or Chartered Investment Counselor.

In 2013 the Minnesota legislature passed amendments to Chapter 80A of the Minnesota Statutes to require, for the first time, that “investment adviser representatives” must register with the department of commerce and comply with an exam requirement similar to the exam requirement applicable to supervisory or control persons.  See Minn. Stat. 80A.58(a).  The term “investment adviser representative,” which has been present in the Minnesota Statutes since major revisions to Chapter 80A in 2006, is broadly defined to include “an individual employed by or associated with an investment adviser or federal covered investment adviser and who makes any recommendations or otherwise gives investment advice regarding securities, manages accounts or portfolios of clients, determines which recommendation or advice regarding securities should be given, provides investment advice or holds herself or himself out as providing investment advice, receives compensation to solicit, offer, or negotiate for the sale of or for selling investment advice, or supervises employees who perform any of the foregoing.” Minn. Stat. 80A.41(17).   The new statutory provisions do include exemptions from the investment adviser representative registration requirements, but those registration exemptions do not include exemptions from the exam requirement for persons who hold financial professional certifications in good standing. 

In other words, a person who is a Certified Financial Planner but who has not passed the Series 65 or Series 66 exam would be qualified to serve as a supervisory or control person of an investment adviser under Minnesota law (by reason of the exam requirement exemption), but would not, counterintuitively, be qualified to be an “investment adviser representative” – a typical employee of an investment adviser who provides more than purely clerical services. 

Thankfully, the Minnesota Department of Commerce was receptive to the input of the investment advisory community and recognized this discrepancy in the regulatory framework.  However, rather than formally amend the statute or engage in a time consuming and resource-intensive rulemaking process, the Commissioner of Commerce instead issued an Order on October 31, 2013 that, among other things, provides exemptions from the investment adviser representative exam requirement similar to the exam requirement exemptions contained in Rule 2876.4120 applicable to supervisory or control persons.  As a result, despite the express language of the Minnesota Statutes and the absence of an applicable exemption in the Statutes or the Rules, a person who holds one of the listed professional designations in good standing need not take the Series 65 or Series 66 in order to register as an investment adviser representative in Minnesota.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The SEC has issued a no-action letter regarding Investment Company Act Rule 3c-5 which defines the term “knowledgeable employee.”  Rule 3c-5 is critical for many because it permits a knowledgeable employee of a private fund, or what the no-action letter refers to as a “Covered Fund”, or a knowledgeable employee of an affiliated person that manages the investment activities of a Covered Fund, which the no-action letter refers to as an “Affiliated Management Person”, to invest in a Covered Fund without being counted for purposes of the 100-person limit in Section 3(c)(1) or regardless of whether the knowledgeable employee is a “qualified purchaser” for purposes of Section 3(c)(7).

Some of the guidance offered includes:

  • While the ultimate determination of whether any business unit, division, or function should be deemed principal is a factual determination that must be made on a case-by-case basis, the SEC staff believes that an investment manager could determine that its IT and investor relations departments are principal business units, divisions, or functions under the circumstances described in the no-action letter and, accordingly, the individual in charge of each such department could be a knowledgeable employee.
  • The definition of executive officer in the rule encompasses any officer who performs a policy-making function or any other person who performs similar policy-making functions on behalf of an investment manager. The rule does not require policy-making individuals to have a specific title and includes all employees that have the power to make, and do make, policy on behalf of the investment manager, Covered Fund, or an Affiliated Management Person of the Covered Fund. Accordingly, the SEC staff believes that an employee who does not have a senior manager title, depending on the facts and circumstances, may still be considered an executive officer under the rule if he or she makes policy through day-to-day involvement in the development and adoption of an investment manager’s policies.
  • The SEC believes that a research analyst who researches only a portion of the portfolio of a Covered Fund and provides analysis or advice to the portfolio manager with respect to such portion of the Covered Fund’s portfolio is participating in the investment activities of the Covered Fund for purposes of the rule. Accordingly, the SEC staff believes that such a research analyst could be a knowledgeable employee under rule 3c-5(a)(4)(ii).

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.