“So you want to register with the SEC as an investment adviser …”

17 May 2011

Mark BermanCompliGlobe Limited

Relevant US laws and rules – some are changing

1933 Act Register public offers under s.5 or establish exemption from registration: Regulation D or s.4(2)

Exchange Act

Open accounts, market to or trade for individuals, US institutional investors or major US institutional investors: “broker”, “dealer”, “finder”, Rule 15a-6

1940 Act Exemptions from registration: s.3(c)(1) (max 100 US persons) or s.3(c)(7) (only Qualified Purchasers – note Exchange Act s.12(g) registration when fund/company has more than $10m assets and more than 500 shareholders (300 US persons))

Advisers Act If fewer than 14 US person clients, exempt from registration21 July 2011: Register unless you are a “Foreign Private Adviser” or a “Private Fund Adviser”

CEA re CPOs Exemptions from registration as CPO: CFTC Rules 4.13(a)(3) and 4.13(a)(4) –these parallel 1940 Act s.3(c)(1) and s.3(c)(7) exemptions, respectively the CFTC is proposing to rescind these

CEA re CTAs Exemptions from registration as CTA for advisers to commodity pools: CFTC Rule 4.14(a)(8) (for persons exempt from Advisers Act registration under s.202(a)(2) or s.202(a)(11)) or CEA s.4m(1) and CFTC Rule 4.14(a)(10) (not more than 15 persons in rolling 12 month period – tracks Advisers Act s.203(b)(3)) the SFTC is proposing to rescind these

How can we access the US markets?

1. Direct management of portfolios– Institutions– High net worth individuals– Pension funds

2. Manage funds, hedge funds and/or funds of funds3. Advise managed accounts4. Sub-adviser to an SEC registered adviser5. Participating affiliate to an SEC registered adviser

Effects of how we access the US markets

• Direct management of portfolios– If you do not satisfy the Foreign Private Issuer test, must register with

the SEC• Manage only funds, hedge funds and/or funds of funds

– If you do not satisfy the Private Fund Adviser test, must register with the SEC

• Managed accounts– SEC Staff would argue that adviser must count investors in managed

accounts, so If you do not satisfy the Foreign Private Issuer test, must register with the SEC

Not being SEC registered may require registration with one or more of the 50 US states

The US Investment Advisers Act of 1940, today

• Registration of advisers – not licensing• Deals with fiduciary duties, imposes record keeping requirements and

contains antifraud provisions• Minimal ongoing reporting• Does not touch upon “systemic risk”• The “client” of the adviser is the fund that is advised, not the underlying

investors (SEC v Goldstein)• Registration: for non-US advisers

– Not required to register if no more than 14 US person clients in 12 month period – the de minimis exemption

– Not an adviser or subadviser to a 1940 Act registered investment company (“RIC”)

– Ditto for “participating affiliates”

What happens after 21 July?

• PFIAR rescinds the 14 US person de minimis exemption• Provides these new exemptions from Advisers Act registration

1. “Foreign Private Advisers” 2. “Private Fund Advisers”3. Investment advisers that advise only “venture capital funds”4. “Family offices”

• The SEC must adopt rules to implement these exemptions• Certain banks, broker-dealers and other traditionally exempt entities

continue to be exempt• The SEC-state registration threshold increases to $100m from $25m• Under Dodd-Frank, the new exemptions come into force on 21 July• SEC must adopt rules for these exemptions by 21 July, effective Q1 2012

PFIAR changes

• The Advisers Act registration exemption for CTAs registered with the CFTC changes – CFTC proposed to rescind exemptions from the CEA for CPOs and CTAs

• “Private funds” defined as funds that are exempt from 1940 Act registration under Sections 3(c)(1) or 3(c)(7)

• Record keeping and systemic risk reporting requirements are to be imposed for Private Fund Advisers

• Key Form ADV disclosures change

Who is an investment adviser: non-US advisers

• An adviser is any person who– For compensation– Gives investment advice– About securities– To US persons

• Is an exemption available?• Is the non-US entity a participating affiliate?• If no exemption and not a participating affiliate – must register

Who is a US person?

• SEC to use the Regulation S definition of “US person” – based on residence• Individuals: where they reside

– US citizen residing in Boston? Yes– US citizen residing in Hong Kong? No– Dutch citizen residing in Chicago? Yes

• Companies and partnerships: where incorporated• Trusts, estates, etc: location of trustees, executors, etc.• Investment managers: where the underlying clients reside

Foreign Private Adviser exemption

A FPA is an adviser who

1. Has no place of business in United States; 2. Has in total fewer than 15 US clients and US investors in private funds;3. Has less than $25 million aggregate AUM attributable to US clients and

investors in private funds, or such greater amount set by the SEC in rulemaking;

4. Does not hold itself out to the public in United States; and5. Does not advise a RIC or a business development company

FPAs are exempt from Advisers Act registration

Venture Capital Fund exemption

• Fund must hold itself out as VC fund• Must get 80% of the shares directly from portfolio companies• Investments must be in a private companies (not listed)• Must have significant management involvement with (or control)

portfolio companies• Can only incur limited leverage• Redemption rights in fund interests severely restricted• A portfolio company can’t borrow in connection with fund’s investment

There is a limited grandfather clause for existing VC funds

$150m AUM private fund exemption

• Proposed Advisers Act Rule 203(m)-1 would provide an exemption from Advisers Act registration for an adviser that1. only advises private funds and2. has AUM in the United States of less than $150m

• Advisers not meeting this must register• Advisers that do meet the terms of this exemption do not register, but

become exempt reporting advisers– comply with record keeping requirements– File a Form ADV Part 1 with itemised disclosures (not as much as for

full registration)– Pay a small fee– May be subject to SEC inspection

“Participating Affiliates”

• Advice or recommendations given to SEC registered adviser or is used by it for its US clients

• Non-US non-SEC registered affiliate trades portfolio• “Participating affiliate” does not have to register with SEC

– Must sign participating affiliate agreement– Relevant personnel are “associated persons” that comply with certain

personal account dealing requirements– Must keep records and give SEC adequate access to trading and other

records of participating affiliate– Form ADV Part 2 disclosure of associated persons required

• The SEC sought comment whether it should take a new approach to participating affiliates and is seeking comment on it – would have to justify statutory authority to do this

What SEC registration involves

• This is a disclosure regime and a registration, not a licensing process

• File Form ADV Parts 1 and 2A, which become public• Provide “brochure supplement” to certain clients (Form ADV Part 2B)• Modest filing fees (initial and annual)• No capital requirement• No individual registration, testing or licensing

Action steps involved in registration*

1. Conduct gap analysis and address points raised2. Draft, verify and finalise Form ADV Part 1 and Part 23. Finalise CRI, Conflicts Log and written controls, policies and

procedures (Compliance Manual)4. implement monitoring and testing programme5. File Form ADV Part 16. Training7. When registration becomes effective, operate as a registered

adviser

* Takes two to four months. Certain steps may run concurrently.

Gap analysis

• Used to help confirm whether the adviser is operating in compliance with Advisers Act and rules thereunder

• Starts with a document request – which is what OCIE issues at the start of an inspection

• Review documents requested• Intensive, “bottom up” examination of all aspects of business,

operations, controls, policies, procedures and the compliance program– “Follow the money”– “Map disclosure” – prove the adviser is doing what it says it will do

• Interview Compliance and key staff (fund management, trading, operations, senior management, &c)

• Use independent verification

• Written reports identify– Compliance with document request– What is OK to operate as a registered adviser, no changes needed– What is missing and is required– What is present but needs to be modified

• Identify an action step and a due date to address each issue found• Review progress after agreed period of time

Areas reviewed in a gap analysis

• Compliance with document request• “Tone at the top”• Risks and conflicts arising from the business plan - CRI• Disclosure verification: Form ADV Parts I and II disclosure• Controls• Advertising and marketing• Compliance program and CCO• Monitoring and forensic testing• Interaction with affiliates and related persons• Activities from idea generation, research, recommendations and

advice/exercising discretion through trading and settlement• Best execution, allocation and aggregation (bunching)• Large position tracking and reporting

• “Leakage” into other regulated activities • PA dealing, gifts and entertainment• Measuring trading against investment objectives• Whether IMAs contain clauses required by the Advisers Act• Means to prevent misuse of inside information• Trading practices review – identify risks of market abuse (including fraud,

manipulation or deceit)• Role of compliance in the investment process• Proxy voting policies and procedures • “Change control” procedures (amended compliance materials and records)• Record retention• Financial crime: AML, sanctions/bribery, &c.• “Issues that arise ...”

Sample entries for a gap analysis

Item Findings and Source Document

Needed to Complete Due Date

Responsible

Compliance Risk Inventory

ICAAP identifies risks to the firm as a whole but not those leading to violations of the Advisers Act and rules thereunder (“AA”)

Identify and integrate into ICAAP the risks of violations of AA based on the Business Plan; use revised ICAAP as the master risk review grid

Conflicts log (with resolution procedures)

Conflicts of Interest Policy

Policies clearly stated, but this is a discussion document and does not identify material conflicts or the means to resolve/address them. Deficient for AA compliance and Form ADV Part II disclosure. Complete conflicts identification and resolution process and add to Policy, together with log to record events

The Compliance programme

• Must

– Adopt and implement written policies and procedures reasonably designed to prevent violation by the adviser and its supervised persons of the Advisers Act and the rules thereunder

– Have a Chief Compliance Officer who manages the Compliance programme and is competent, knowledgeable and empowered with full responsibility and authority

– Review “not less than annually” the adequacy and effectiveness of the Compliance programme

– Have a Code of Ethics• May use local legal and regulatory standards to satisfy Advisers Act

requirements

“Controls” in a Compliance program

• Board-level and management buy-in: “tone at the top”• CCO• Based on the written business plan

– Compliance Risk Inventory (“CRI”) – link to the firm-wide risk plan– Conflicts Log

• Disclosure: Form ADV Parts 1 and 2• Written policies and procedures reasonably designed … • Code of Ethics• Annual review• Monitoring and forensic testing• BCP• Regulation S-P (data protection)

Risk-based approach to monitoring and testing

• Compliance programme must reflect the risks in the CRI that, in turn, is based on the business plan– Monitoring and testing should

• confirm whether we have the right control• generate data to prove that a control addresses a risk• confirm whether we are monitoring for the right things or generating

wrong data– Cross monitor: PA dealing against gifts and entertainment,

recommendations, orders, trading and allocations, as well as 10 best and worst accounts and 10 best and worst trades

– Address issues when they arise– Never ignore anything– Change when required

For more information, please contact …

CompliGlobe Ltd.CompliGlobe (Asia) Ltd.

Mark Bermanberman@compliglobe.com

Philip Thomasthomas@compliglobe.com

London + 44 208 458 0152 Hong Kong + 852 8124 5181www.compliglobe.com

All materials © 2011 CompliGlobe Ltd. All rights reserved.