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

There is a bill working its way through the Minnesota state legislature that amends chapter 80A of the Minnesota Statutes to, among other things, implement investment adviser registration for investment advisers whose only clients are private funds.

Minnesota law currently includes an exemption from registration as an investment adviser for investment advisers whose only clients are accredited investors.  The proposed legislation removes this exemption and includes an additional category of advisers exempt from state registration – “private fund advisers.”  Understanding this change requires knowledge of a number of new defined terms under Minnesota law, such as:

  • 3(c)(1) fund: a qualifying private fund eligible for exclusion from the definition of an “investment company” under section 3(c)(1) of the Investment Company Act of 1940.
  • Private fund: an issuer that would be an investment company as defined in Section 3 of the Investment Company Act of 1940 but for section 3(c)(1) or 3(c)(7) of that act.
  • Private fund adviser:  an investment adviser whose only clients are private funds that meet the “qualifying private fund” definition included in SEC Rule 203(m)-1.
  • Venture capital fund: a private fund that meets the definition of a venture capital fund in SEC Rule 203(1)-1.

The new legislation contains additional requirements for a subset of private fund advisers – namely, those private fund advisers who advise at least one “3(c)(1) fund that is not a venture capital fund.”   This subset of private fund advisers must:

  • Besides venture capital funds, advise only 3(c)(1) funds whose outstanding securities (other than short-term paper) are owned only by persons who would meet the definition of a qualified client under SEC Rule 205-3 at the time the securities are purchased from the issuer;
  • At the time of purchase, make additional disclosures in writing to each beneficial owner of a 3(c)(1) fund that is not a venture capital fund; and
  • Obtain annual audited financial statements of each 3(c)(1) fund that is not a venture capital fund and deliver a copy to each beneficial owner of the fund.

The new legislation also require state registered investment advisers to keep the same records that are required of exempt reporting advisers at the federal level, and to file that information with the state.  In addition, the legislation spells minimum record keeping requirements with respect to private funds.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

Swap dealers, major swap participants and private funds active in the swaps market are required to begin clearing certain index credit default swaps, or CDS, and interest rate swaps that they entered into on or after March 11, 2013. The clearing requirement determination does not apply to those who are eligible to elect an exception from clearing because they are non-financial entities hedging commercial risk.

The clearing requirement applies to newly executed swaps, as well as changes in the ownership of a swap. The five swap classes that are required to be cleared can be found here.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

Pursuant to these definitive additional materials, ISS recently changed course and recommended a vote for HP’s say-on-pay this year. HP apparently obtained ISS’ change in recommendation by the addition of a total shareholder return (“TSR”) metric to the performance metrics applicable to fiscal 2013 awards to HP Section 16 officers.

 

HP’s problems are not over however, because ISS is apparently recommending a vote against three directors.  HP filed these additional materials arguing HP is making progress in executing on its strategy and improving on its financial performance and changing the composition of the HP Board of Directors could be destabilizing to the company.

ISS is what it is, and you can think what you think, but maybe HP’s real problem is its investors are ticked off.  New York City Comptroller John C. Liu filed this notice of exempt solicitation announcing that  the New York City Pension Funds will vote against two Hewlett-Packard  directors “because of their failure to protect investors from costly, misguided acquisitions.”  According to Mr. Liu “The Autonomy debacle is the latest and most expensive in a series of ill-advised acquisitions and boardroom fiascos that have destroyed tens of billions of dollars in shareowner value.”

Mr. Liu’s tactic demonstrates the power a major shareholder can easily wield by filing a little known notice of exempt solicitation pursuant to Rule 14a-6(g) on an EDGAR form unnaturally named PX14A6G.  Personally, I like the EDGAR moniker IRANNOTICE better, because I know what I am going to see when I click on it.

The above, however, is not a complete statement of HP’s adventures this proxy season.  After mailing its proxy, HP had to correct it to clarify that the share limits in its proposed  plan apply to all awards made under the plan, not just awards intended to satisfy the “performance based compensation” exception to the deductibility limitation set forth in Section 162(m) of United States Internal Revenue Code of 1986.  It’s easier said than done, but a lesson to draft carefully the first time.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

 

Norm Champ, Director, SEC Division of Investment Management, recently noted that SEC rules prohibit certain advertisements by registered advisers.  See our analysis here of SEC guidance on advertisements by hedge fund and private equity sponsors.

Mr. Champ noted the SEC has heard from advisers to private funds, particularly advisers to private equity funds, about the difficulties of applying the specific prohibitions on testimonials and past specific recommendations to their business models.  He stated the staff is considering issues raised by private fund advisers regarding the advertising rule and considering what action, if any, should be taken or recommended to the Commission.

Mr. Champ stated “in the meantime, advisers should be sure to provide clear, complete and accurate disclosure in their advertising, particularly with respect to performance.” He also advised funds should:

  • Review marketing documents to ensure information is truthful, accurate and not misleading. 
  • Adopt, and periodically review the effectiveness of, compliance policies and procedures covering advertisements and other types of communications. 
  • Be aware that marketing is one area that the Office of Compliance, Inspections and Examinations had highlighted as a higher-risk area of the business and operations of many advisers.  It is also one of the areas of focus of OCIE’s Presence Exam initiative.

Finally, Mr. Champ discussed the JOBS Act.  He stated his staff is working closely with staff from the Division of Corporation Finance on a proposal to amend Regulation D to permit advertising and general solicitation as long as all purchasers are accredited investors and the issuer has taken reasonable steps to verify their accredited status.  According to Mr. Champ, SEC Chairman Walter has identified rulemakings required under the JOBS Act as a priority, and the staff is carefully reviewing comments and considering what recommendations to make to the Commission, taking into account Congressional intent as well as investor protection concerns.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The SEC has charged two investment advisers at Oppenheimer & Co. with misleading investors about the valuation policies and performance of a private equity fund they manage. The SEC recently hinted at potential increased actions against private equity and targeted private equity groups in its National Exam Program’s priority list.  They weren’t kidding.  The same day the Oppenheimer & Co. investment advisers were charged, the SEC brought this action against a private equity group for using an unregistered broker-dealer.

An SEC investigation found that Oppenheimer Asset Management and Oppenheimer Alternative Investment Management disseminated misleading quarterly reports and marketing materials stating that the fund’s holdings of other private equity funds were valued “based on the underlying managers’ estimated values.” However, the portfolio manager of the Oppenheimer fund actually valued the fund’s largest investment at a significant markup to the underlying manager’s estimated value, a change that made the fund’s performance appear significantly better as measured by its internal rate of return.

According to the SEC’s order, OGR’s largest investment — Cartesian Investors-A LLC — was not valued based on the underlying managers’ estimated values. OGR’s portfolio manager himself valued Cartesian at a significant markup to the underlying manager’s estimated value. OAM’s change in valuation methodology resulted in a material increase in OGR’s performance as measured by its internal rate of return, which is a metric commonly used to compare the profitability of various investments. For the quarter ended June 30, 2009, the portfolio manager’s markup of OGR’s Cartesian investment increased the internal rate of return from approximately 3.8 to 38.3 percent.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The SEC has announced charges against New York-based private equity firm Ranieri Partners, a former senior executive, and an unregistered broker who violated securities laws when soliciting more than $500 million in capital commitments for private funds managed by the firm.

According to an SEC official “Registered brokers are subject to SEC oversight and examinations in order to monitor their conduct and protect the interests of investors . . . Investors in Ranieri Partners’ funds were denied these protections because [the unregistered broker-dealer] acted outside the boundaries of the law, [and a fund official] and the firm ignored the essence of his activities.”

The SEC documents state the unregistered broker dealer engaged in the business of effecting transactions in securities in several ways despite not being registered as a broker or affiliated with a registered broker-dealer. The individual in question sent private placement memoranda, subscription documents, and due diligence materials to potential investors, and urged at least one investor to consider adjusting portfolio allocations to accommodate an investment with Ranieri Partners. The unregistered broker-dealer provided potential investors with his analysis of the strategy and performance track record for Ranieri Partners’ funds, and also provided confidential information identifying other investors and their capital commitments.

The SEC’s order against the fund official and Ranieri Partners found that the fund official aided and abetted the unregistered broker-dealers violations by providing the unregistered broker dealer with key fund documents and information while ignoring red flags indicating that the unregistered broker-dealer had gone well beyond the limited role of a finder and was actively soliciting investments. The order found that Ranieri Partners caused the unregistered broker-dealer’s violations.

The SEC apparently did not allege that receipt of transaction based compensation alone was enough to find the engagement of an unregistered broker-dealer.  If you are engaged in the somewhat risky business of using “finders,” the action teaches that you should not provide them with private placement memorandums and the like and you must monitor their activities to ensure they do not cross the line into broker-dealer territory.  For more information on finders, see Part VI of our paper here.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

 

The International Energy Credit Association (“IECA”) has released a standardized agreement titled the “Dodd-Frank Act Representations and Reporting Amending Agreement” to facilitate end user compliance with the CFTC’s swap regulations. The Amending Agreement allows non-Swap Dealers (non-SDs) and non-Major Swap Participants (non-MSPs) to amend one or more swap or master swap agreements with other non-SDs/MSPs (sometimes referred to as “end users”) to address reporting obligations for the swaps and trade options between them. Importantly, it designates which of the two end user counterparties will serve as the “reporting counterparty” for any swaps between them—a designation CFTC regulations require as a term of any swap between end users. The Amending Agreement also includes representations to confirm the trade option status of any commodity option between the counterparties and to provide information regarding the regulatory status of each counterparty that may be required for compliance in many instances (such as whether or not each counterparty is an SD, MSP, eligible contract participant, U.S. person, financial entity, or special entity).

Check dodd-frank.com frequently for updated information on the Dodd-Frank Act, the JOBS Act, and other important matters regarding regulation of derivatives and securities.

The CFTC Division of Market Oversight has issued an advisory to remind market participants of the swap reporting requirements that are now, or soon to be, in effect. End users must be in compliance with the reporting rules (swap data reporting, real time reporting of swaps, and reporting of historical swaps) beginning April 10, 2013. End users are not required to report their swaps with swap dealer or major swap participant counterparties. However, for a swap between two end user counterparties, the counterparties must agree, as a term of the swap, as to which counterparty shall be the “reporting counterparty.”

Swap dealers have been required to report interest rate and credit swaps since December 31, 2012 and equity, foreign exchange and other commodity swaps (including energy and agricultural swaps) since February 28, 2013. Swap dealers were required to report historical swaps in the same categories on January 30, 2013 and March 30, 2013, respectively. Major swap participants were required to begin reporting all such swaps on February 28, 2013.

Check dodd-frank.com frequently for updated information on the Dodd-Frank Act, the JOBS Act, and other important matters regarding regulation of derivatives and securities.

The SEC has published for comment Nasdaq’s rule proposal that Nasdaq listed companies have an internal audit function.  The rule proposal is as follows:

“Each Company must establish and maintain an internal audit function to provide management and the audit committee with ongoing assessments of the Company’s risk management processes and system of internal control. The Company may choose to outsource this function to a third party service provider other than its independent auditor. The audit committee must meet periodically with the internal auditors (or other personnel responsible for this function) and assist the Board in its oversight of the performance of this function. The audit committee should also discuss with the outside auditor the responsibilities, budget and staffing of the internal audit function.

A Company listed on Nasdaq on or before June 30, 2013, must establish an internal audit function by no later than December 31, 2013. A Company listed after June 30, 2013, must establish an internal audit function prior to listing.”

In its rule filing, Nasdaq notes the NYSE, in Listed Company Manual Section 303A.07(c), has a similar requirement.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

 

The SEC has issued a Risk Alert on compliance with its custody rule for investment.  It notes that with respect to advisers to audited pooled investment vehicles, its examinations found some failed to meet requirements to engage an independent accountant and demonstrate that financial statements were distributed to all fund investors.

 The SEC examinations found the following deficiencies with respect to pooled investment vehicles that relied on the audit approach:

  • The accountant that conducted the financial statement audit was not “independent” under Regulation S-X, as required by the custody rule.
  • The audited financial statements were not prepared in accordance with GAAP (e.g., organizational expenses were improperly amortized rather than expensed as incurred, resulting in a qualified audit opinion; financial statements were prepared on a federal income tax basis; the adviser could not substantiate fair valuations and the accountant therefore could not issue an unqualified opinion on the financial statements).
  • The adviser failed to demonstrate that the audited financial statements were distributed to all fund investors. Rather, it appeared that in many instances the statements were only made available “upon request.”
  • The audited financial statements were not sent to investors within 120 days of the private funds’ fiscal year ends (or 180 days for fund of funds).
  • The auditor was not PCAOB-registered and subject to PCAOB inspection.
  • A final audit was not performed on liquidated pooled investment vehicles.
  • The adviser requested investor approval to waive the annual financial audit of a fund—but did not obtain a surprise examination.  The adviser, therefore, failed to either undergo a surprise exam or comply with the audit approach.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.