Memorandum
Investments by Foreign Banking Entities in Private Equity Funds
New Interpretation Says that the Marketing Restriction for SOTUS Funds Applies Only toForeign Banking Entities, Not to Third Parties
March 2, 2015

On Friday, the Federal Reserve Board and other agencies with authority under the Volcker Rule issued
guidance confirming that the marketing restriction under the so-called SOTUS (“solely outside of the UnitedStates”) exemption applies only to the activities of foreign banking entities, not to the activities of thirdparties generally. In short, this means that a foreign bank investing in a private equity fund pursuant to theSOTUS exemption may continue to rely on the exemption even if ownership interests in the fund are offeredor sold to U.S. persons by an unaffiliated sponsor or another unaffiliated third party. This should generally
allow foreign banks to invest directly in funds sponsored by private equity firms, without the need forseparate offshore parallel funds. However, if a foreign bank participates in an offer or sale of fund interests
to a U.S. person, it cannot rely on the SOTUS exemption.
The guidance, which was added to the agencies’ list of Frequently Asked Questions (“FAQs”), is appended tothis memorandum.
The Volcker Rule is a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010that generally prohibits a banking entity, when acting as principal, from sponsoring or investing in a
“covered fund” (which generally is a fund that would be an investment company but for an exemption
provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940) or engaging inproprietary trading. There are a number of important exemptions and exclusions. For foreign banks, themost important exemption is the SOTUS exemption, which applies to the acquisition or retention of anownership interest in, or sponsorship of, a covered fund “solely outside of the United States.”
For the SOTUS exemption to apply, a number of conditions must be met, including the condition that “[n]oownership interest in the covered fund is offered for sale or sold to a resident of the United States.” See 12C.F.R. § 248.13(b)(1)(iii). Until Friday, it was not entirely clear how this marketing condition applied andSimpson Thacher & Bartlett LLP

Memorandum – March 2, 2015

2

whether foreign banks could still rely on the SOTUS exemption if ownership interests in a covered fund werealso marketed to U.S. persons by unaffiliated third parties (such as the fund’s sponsor or another investor).
The new FAQ clarifies that the marketing restriction applies only to the activities of the foreign bank(including its affiliates) that seeks to rely on the SOTUS exemption; it does not encompass the activities ofthird parties that are unaffiliated with the foreign bank. As a result, if the sponsor or general partner of thecovered fund or another limited partner offers or sells ownership interests to a U.S. person, a foreign bank’sreliance on the SOTUS exemption would be unaffected.
Importantly, the new FAQ makes clear that the foreign bank may not rely on the SOTUS exemption if it“participates” in any offer or sale of covered fund interests to a U.S. person, which would presumably coversituations in which the foreign bank sells interests to U.S. persons either as principal or as a placement agent
or distributor. According to the FAQ, participation encompasses a variety of roles by the foreign bank, suchas if it acts as sponsor (e.g., serving as the general partner; controlling the general partner or fundmanagement; name sharing) or serves, directly or indirectly, as the investment manager, investment adviser,commodity pool operator or commodity trading advisor to the fund. However, participation would notinclude the role of a foreign bank as a limited partner.
The new FAQ is an important clarification and one that will have favorable implications for investments byforeign banks in covered funds. In many cases, it will obviate the need for sponsors to establish separate
parallel covered funds for foreign bank investors.

Simpson Thacher & Bartlett LLP

Memorandum – March 2, 20153

For any questions about the Volcker Rule and the recent guidance, please contact any member of the Firm’s
Financial Institutions and Private Funds practices, including those listed below.
FINANCIAL INSTITUTIONSPRIVATE FUNDS

Lee Meyerson+1-212-455-3675
lmeyerson@stblaw.com

Thomas H. Bell+1-212-455-2533
tbell@stblaw.com

Mark Chorazak+1-212-455-7613
mchorazak@stblaw.comMichael W. Wolitzer+1-212-455-7440
mwolitzer@stblaw.com
Barrie B. Covit+1-212-455-3141
bcovit@stblaw.com
Glenn R. Sarno+1-212-455-2706
gsarno@stblaw.com
Jonathan A. Karen+1-212-455-3274
jkaren@stblaw.com
Jason A. Herman+1-212-455-3697
jherman@stblaw.com

The contents of this publication are for informational purposes only. Neither this publication nor the lawyers who authoredit are rendering legal or other professional advice or opinions on specific facts or matters, nor does the distribution of thispublication to any person constitute the establishment of an attorney-client relationship. Simpson Thacher & Bartlett LLP
assumes no liability in connection with the use of this publication. Please contact your relationship partner if we can be ofassistance regarding these important developments. The names and office locations of all of our partners, as well as ourrecent memoranda, can be obtained from our website, www.simpsonthacher.com.

Simpson Thacher & Bartlett LLP

Memorandum – March 2, 2015

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Appendix
SOTUS Covered Fund Exemption – Marketing Restriction
Question – Section 13(d)(1)(I) of the Bank Holding Company Act (“BHC Act”) and section 248.13(b) of thefinal rule provide an exemption for certain covered fund activities conducted by foreign banking entities (the“SOTUS covered fund exemption”) provided that, among other conditions, “no ownership interest in suchhedge fund or private equity fund is offered for sale or sold to a resident of the United States” (the“marketing restriction”). Does the marketing restriction apply only to the activities of a foreign banking
entity that is seeking to rely on the SOTUS covered fund exemption or does it apply more generally to theactivities of any person offering for sale or selling ownership interests in the covered fund? Sponsors ofcovered funds and foreign banking entities have asked how this condition would apply to a foreign banking
entity that has made, or intends to make, an investment in a covered fund where the foreign banking entity(including its affiliates) does not sponsor, or serve, directly or indirectly, as the investment manager,
investment adviser, commodity pool operator or commodity trading advisor to, the covered fund (a “thirdparty covered fund”).
Answer – The staffs of the Agencies believe that the marketing restriction applies to the activities of theforeign banking entity that is seeking to rely on the SOTUS covered fund exemption (including its affiliates).
This is also reflected in the preamble discussion of the marketing restriction and the structure of the final
rule as discussed below.
Consistent with Section 13(d)(1)(I) of the BHC Act, the marketing restriction in the final rule provides that“no ownership interest in the covered fund is offered for sale or sold to a resident of the United States.”
Section 248.13(b)(3) of the final rule provides that an ownership interest in a covered fund is not offered forsale or sold to a resident of the United States for purposes of the marketing restriction if it is sold or has beensold pursuant to an offering that does not target residents of the United States. In describing the marketing
restriction in the preamble, the Agencies stated that the marketing restriction serves to limit the SOTUS
covered fund exemption so that it “does not advantage foreign banking entities relative to U.S. banking
entities with respect to providing their covered fund services in the United States by prohibiting the offer orsale of ownership interests in related covered funds to residents of the United States.” 1
The marketing restriction, as implemented in the final rule, constrains the foreign banking entity inconnection with its own activities with respect to covered funds rather than the activities of unaffiliated thirdparties, thereby ensuring that the foreign banking entity seeking to rely on the SOTUS covered fund
exemption does not engage in an offering of ownership interests that targets residents of the United States.
1

See Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships
With, Hedge Funds and Private Equity Funds, 79 FR 5536 at 5742 (Jan. 31, 2014) (emphasis added).
Simpson Thacher & Bartlett LLP

Memorandum – March 2, 2015

5This view is consistent with limiting the extraterritorial application of section 13 to foreign banking entities
while seeking to ensure that the risks of covered fund investments by foreign banking entities occur andremain solely outside of the United States. 2 If the marketing restriction were applied to the activities of thirdparties, such as the sponsor of a third-party covered fund (rather than the foreign banking entity investing ina third-party covered fund), the SOTUS covered fund exemption may not be available in certain
circumstances where the risks and activities of a foreign banking entity with respect to its investment in thecovered fund are solely outside the United States. 3
A foreign banking entity (including its affiliates) that seeks to rely on the SOTUS covered fund exemption
must comply with all of the conditions to that exemption, including the marketing restriction. A foreignbanking entity that participates in an offer or sale of covered fund interests to a resident of the United States
thus cannot rely on the SOTUS covered fund exemption with respect to that covered fund. Further, where abanking entity sponsors or serves, directly or indirectly, as the investment manager, investment adviser,commodity pool operator or commodity trading advisor to a covered fund, that banking entity will be viewed
by the staffs as participating in any offer or sale by the covered fund of ownership interests in the covered
fund, and therefore such foreign banking entity would not qualify for the SOTUS covered fund exemption forthat covered fund if that covered fund offers or sells covered fund ownership interests to a resident of theUnited States.
As posted on the Federal Reserve Board’s Website on February 27, 2015
http://federalreserve.gov/bankinforeg/volcker-rule/faq.htm

2See id. at 5740.

3

The staffs also note that foreign funds that sell securities to residents of the United States in an offeringthat targets residents of the United States will be covered funds under section 248.10(b)(i) of the final
rule if such funds are unable to rely on an exclusion or exemption under the Investment Company Act
other than section 3(c)(1) or 3(c)(7) of that Act. If the marketing restriction were to apply more generally
to the activities of any person (including the covered fund itself), the applicability of the SOTUS covered
fund exemption would be significantly limited because a third-party foreign fund’s offering that targets
residents of the United States would make the SOTUS covered fund exemption unavailable for all foreignbanking entity investors in the fund. The Agencies’ discussion of the SOTUS covered fund exemption inthe preamble does not suggest that the Agencies understood the SOTUS covered fund exemption to havesuch a limited application.
Simpson Thacher & Bartlett LLP

Memorandum – December 10, 2014

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