Source: https://www.gibsondunn.com/advisers-act-compliance-reminders-for-private-fund-advisers/
Timestamp: 2018-06-24 10:54:05
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Gibson Dunn | Advisers Act Compliance Reminders for Private Fund Advisers
Private fund advisers that are either registered investment advisers ("RIAs") or exempt reporting advisers ("ERAs") under the U.S. Investment Advisers Act of 1940, as amended (the "Advisers Act"), must comply with a number of regulatory reporting obligations under the Advisers Act. This memorandum provides a brief summary of those filing obligations and the applicable deadlines (assuming a fiscal year end of December 31, 2015). We also provide a brief discussion of certain annual review and other maintenance measures that private fund advisers are either required or strongly encouraged to perform with respect to their Advisers Act compliance programs.
1. Regulatory Filing Obligations
Since passage of the Dodd-Frank Act, private fund advisers have become subject to a number of new regulatory filing obligations under the Advisers Act. Chief among these are the obligations to update Form ADV and Form PF filings with the SEC on an annual basis. The following table provides a brief summary:
Each RIA and ERA has an ongoing obligation to update the information provided in its Form ADV no less frequently than annually. These annual updates must be filed within 90 days of the end of the adviser’s fiscal year end.
An RIA must update the information provided in both the "check the box" portion of its Form ADV (Part 1A) and in its "disclosure brochure" (Part 2A). An ERA is only required to update the information reported in its abbreviated Part 1A filing.
All such updates must be filed with the SEC electronically through IARD. In order to avoid last minute delays, we strongly recommend that each RIA and ERA check its IARD account early to ensure that its security access codes are up-to-date and working. We also recommend that each firm check the balance in its IARD account and wire sufficient funds to cover all Federal and state filing fees well in advance of the filing deadline.
Each RIA is also required to update the information provided in its "supplemental brochures" (Part 2B) no less frequently than annually.[1] Although an RIA is not required to publicly file its supplemental brochures with the SEC, updated supplemental brochures must be kept on file at the RIA’s offices.
Disclosure Brochure Delivery
An RIA is also required to deliver an updated version of its Part 2A disclosure brochure to all clients[2] within 120 days of the end of its fiscal year. An RIA may comply with this requirement either by mailing a complete copy of its updated brochure to its clients or by sending a letter providing a summary of any material changes that have been made to the brochure since its last annual update and offering to provide a complete copy of the updated brochure upon request free of charge.[3]
An RIA (but not an ERA) whose assets under management attributable to private funds exceed $150 million is required to provide a report on Form PF to the SEC regarding its private funds’ investment activities. For most private fund advisers, the Form PF is required to be filed once a year within 120 days of the end of the RIA’s fiscal year. However, a private fund adviser whose assets under management exceed certain thresholds may be required to file more frequently and/or on shorter deadlines. In addition, the information that such a large private fund adviser must provide to the SEC is significantly more extensive.[4]
An RIA that is also registered under the Commodity Exchange Act ("CEA") as a Commodity Pool Operator ("CPO") or Commodity Trading Adviser ("CTA") should also consider its reporting obligations under Form CPO-PQR, the Commodity Futures Trading Commission’s ("CFTC’s") version of Form PF. In theory, a dual registrant may comply with its reporting obligations under both the Advisers Act and the CEA by filing a single Form PF. However, the CFTC still requires certain information to be provided in a Form CPO-PQR filing in order to take advantage of this feature.
Rule 206(4)-7 under the Advisers Act requires an RIA (but not an ERA) to review no less frequently than annually the adequacy of its compliance policies and procedures and the effectiveness of their implementation. Although the Advisers Act rules do not require that these reviews be in writing, the SEC has a clear expectation that an RIA will appropriately document its review. SEC examiners routinely request copies of an RIA’s annual compliance program review reports as part of the examination process.
Producing an annual compliance program review report need not be as difficult or as burdensome as one might think. Although an RIA can consider engaging a third party to conduct a comprehensive audit of the firm’s compliance program, under normal circumstances an RIA can take a more risk-based approach. For example, an RIA might build a review around the following three themes where potential compliance risks may be most acute:
Compliance policies and procedures that may be affected by changes in the RIA’s business or business practices;
Changes in applicable law, regulation or regulatory priorities; and
Any other areas where SEC examiners have identified deficiencies or where the firm has experienced compliance challenges or recently changed its compliance policies and procedures.
In addition, an RIA can and should take into account and document any incremental improvements that have been made to the firm’s compliance program throughout the year, not just as part of a formal annual review process.
The past twelve months have seen a relatively low level of rule-making activity related to the Advisers Act. Nevertheless, the SEC has identified a number of current examination and enforcement priorities for the private fund industry, and a private fund adviser should take note of these priorities as part of its annual review process.
(a) Fees and Expenses. The SEC has sent clear signals that it continues to place a high priority on industry practices concerning the collection of non-investment advisory fees from portfolio companies and the allocation of firm expenses to funds. This past year, the SEC’s Enforcement Division settled a number of well publicized enforcement actions against private equity firms in which violations of fiduciary obligations were found with respect to the collection of non-advisory fees and/or the allocation of expenses.[5] In addition, the SEC’s Office of Compliance Investigations and Examinations ("OCIE") continues to identify fees and expenses as one of its top examination priorities for private fund advisers for 2016.[6] Mary Jo White, the current Chair of the SEC, also identified fees and expenses as a continuing concern of the SEC’s Staff in a speech she gave recently on the regulation of private fund advisers.[7] Examples of the types of practices that could trigger SEC scrutiny, (particularly if not the subject of clear prior disclosure and/or a contractual basis) include:
(i) re-characterizing non-investment advisory fee revenues so as to avoid triggering management fee offsets;
(ii) charging accelerated monitoring or similar fees to portfolio companies;
(iii) allocating expenses related to the adviser’s overhead and/or back-office services to its funds;
(iv) allocating broken deal expenses to funds without allocating a portion of those expenses to other potential co-investors; and
(v) negotiating discounts on service provider fees for work performed on behalf of the adviser without also making the benefit of those discounts available to the adviser’s funds.
We strongly encourage private fund advisers to review their financial controls with respect to fee collection, management fee offsets and expense allocation to ensure that their practices are consistent with their funds’ governing documents and in line with SEC expectations. We also encourage firms to review disclosure regarding fee collection and expense allocation practices to make sure that it is up to date and comprehensive.
(b) Cybersecurity. The SEC continues to make cybersecurity a high priority for the entire financial services industry. In the past two years, OCIE has published three "Risk Alerts" relating to cybersecurity and identified cybersecurity as one of its top examination priorities in both 2015 and 2016.[8] Chair White also identified cybersecurity as an "universal operational risk" in her recent speech on the regulation of the private fund industry.[9] In light of this regulatory focus, we recommend that each private fund adviser review its information security policies and practices thoroughly and implement enhancements to address any identified gaps promptly.
(c) Other Conflicts. Finally, we encourage each private fund adviser to review its operations with an eye towards identifying any potential conflicts of interest that are not being adequately addressed. For example, OCIE has indicated that it intends to take a closer look at the potential conflicts that may arise from the management of performance-based and purely asset-based fee accounts side-by-side with each other and the controls and disclosures an adviser has implemented to address these potential conflicts.[10] Likewise, Chair White emphasized in her speech the importance of adviser’s fiduciary duties as the "cornerstone" of the Advisers Act regulatory regime, and suggested that private fund advisers take a close look at their advertising materials (particularly marketing materials presenting performance data) and disclosure regarding conflicts of interest with this overriding principal in mind.[11]
3. Compliance Program Maintenance
(a) Code of Ethics Acknowledgements. Each RIA is required by Rule 204A-1 under the Advisers Act to obtain written acknowledgements from each of its "access persons" that such person has received a copy of the firm’s Code of Ethics and any amendments thereto. As a matter of best practice, many RIAs request such acknowledgements on an annual basis. In addition, each access person must provide an annual "securities holdings report" at least once every 12 months and such report must be current as of a date not more than 45 days prior to the date of such report. Each access person is also required to provide quarterly "securities transactions reports" within 30 days of the end of each calendar quarter. We recommend that each RIA review their records to ensure that each of its access persons has complied with these acknowledgement and reporting requirements, as the failure to provide such documentation on a timely basis is a frequent deficiency identified by the SEC’s examiners.
(b) Custody Rule Audits. Compliance with Rule 206(4)-2 under the Advisers Act (the "Custody Rule") generally requires a private fund adviser to prepare annual audited financial statements in accordance with US GAAP for each of its private funds and to deliver such financial statement to each fund’s investors within 120 days of the fund’s fiscal year end (180 days in the case of a fund-of-funds). The SEC’s Staff issued interpretive guidance in 2014 providing its views on the circumstances in which the annual audit requirement under the Custody Rule applies to special purpose vehicles and escrow arrangements.[12] We encourage private fund advisers to review their fund structures to ensure that every fund and special purpose vehicle that is subject to an annual audit requirement under the Custody Rule is being audited and that such audits are on schedule to be delivered to investors on a timely basis. An RIA that is relying on the alternative "surprise audit" requirements to comply with the Custody Rule for any of its funds or separately managed accounts should engage its auditing firm early in the calendar year to conduct the required surprise audits.
(c) Disclosure Documents/ Side Letter Certifications. In addition to the updates to an RIA’s disclosure and supplemental brochures on Form ADV Part 2A and 2B discussed above, private fund advisers that are in the process of raising funds should review the offering documents for their funds to ensure that the disclosure in these documents is up to date. A private fund adviser should also check to see if it has have complied with all reporting, certification or other obligations it may have under its side letters with investors.
(d) Privacy Notice. An investment adviser whose business is subject to the requirements of Regulation S-P, because it maintains records containing "nonpublic personal information" with respect to "consumers," is required to send privacy notices to its "customers" on an annual basis. As a matter of best practice, most private fund advisers simply send privacy notices to all of their clients and investors, often at the same time they distribute the annual updates to their disclosure brochures on Form ADV (see above). We recommend that each adviser review its privacy notice for any updates to reflect changes in its business practices and for compliance with the applicable safe harbor provided in Regulation S-P.
(f) Political Contributions. For a firm whose current or potential investor base includes state or local government entities (e.g., state or municipal employee retirement plans or public university endowments), we recommend that the political contributions of any of the firm’s "covered associates" be reviewed for any potential compliance issues under Advisers Act Rule 206(4)-5,the "pay-to-play" rule.
This Alert has focused primarily on the various compliance obligations a private fund adviser that is either an RIA or an ERA is subject to under the Advisers Act in the United States. Depending on the nature and scope of a private fund adviser’s business, however, numerous other regulatory reporting requirements and other compliance obligations may apply. For example:
Rule 506(d) Bad Actor Questionnaires. For a private fund adviser whose funds are either continuously raising capital (e.g., hedge funds), or where the firm anticipates raising capital in the next twelve months, we recommend that the firm ensure that it has up-to-date "Bad Actor Questionnaires" under Regulation D, Rule 506(d) on file for each of its directors, executive officers and any other personnel that are or may be involved in such capital raising efforts. Firms that are or are contemplating engaging in general solicitations under Rule 506(c) of Regulation D should also review their subscription procedures to ensure that they are in compliance with the enhanced accredited investor verification standards required under that Rule.
ERISA. A private fund adviser (particularly one whose funds are engaged in continuous offerings) should review its investor bases to make sure that none of its funds have exceeded the 25% plan asset threshold or failed to satisfy the conditions to be an exempt "venture capital operating company" or "real estate operating company" and inadvertently become subject to compliance with the requirements of ERISA. ERISA limited partners often require annual certification that the fund in which they have invested does not include ERISA "plan assets".
Exchange Act Reporting Obligations. A private fund adviser that invests in exchange-listed securities or standardized options may be subject to certain reporting requirements under the Securities Exchange Act of 1934, including Schedules 13D & 13G, Form 13F, Form 13H and Forms 3, 4 and 5 under Section 16.
State Pay-to-Play and Lobbyist Registration Laws. A private fund adviser that either has or is soliciting state or local government entities for business may be subject to registration and reporting obligations under applicable lobbyist registration or similar state or municipal statutes in the jurisdictions where the adviser is engaged in such activities.
Cross-Border Transaction Reporting Requirements. A private fund adviser that engages in cross-border transactions or which has non-US investors in its funds may be subject to various reporting requirements under the Department of Treasury’s International Capital System of the Bureau of Economic Analysis’ direct investment survey program.
European Regulatory Reporting Requirements. A private fund adviser that is either registered in Europe as an alternative investment fund manager or authorized to manage or market alternative investment funds in Europe is subject to various reporting requirements, including those under the EU’s Alternative Investment Fund Managers Directive ("AIFMD"), in each European jurisdiction in which they are so registered or authorized.
Offshore Funds. A private fund adviser that sponsors offshore funds may be subject to requirements in the jurisdiction(s) in which the firm’s offshore funds are organized.
Tax. Depending on the structure and nature of a private fund adviser’s investment activities and/or client base, certain tax filings may also be required under the U.S. Foreign Account Tax Compliance Act (FATCA), foreign bank and financial accounts reporting regime (FBAR), and other tax regulations.
[2] As a technical matter, investors in a private fund are not considered "clients" of the fund’s investment adviser. As a matter of best practice, however, most private fund advisers make updated copies of disclosure brochures available to the investors in their funds.
[3] Such letters must also provide a website address (if available), e-mail address (if available) and telephone number by which a client may obtain a copy of the RIA’s current brochure, as well as the website address through which a client may obtain information about the adviser through the SEC’s Investment Adviser Public Disclosure (IAPD) system.
[4] In particular, a hedge fund adviser with more than $1.5 billion in assets under management attributable to its hedge funds is required to report on Form PF on a quarterly basis within 60 days of the end of each calendar quarter and to complete an additional section of the Form (Section 2). A private liquidity fund adviser with more than $1.0 billion in combined assets under management attributable to both registered money market funds and private liquidity funds is required to report on Form PF on a quarterly basis within 15 days of the end of each calendar quarter and to complete an additional section of the Form (Section 3). A private equity fund adviser with more than $2.0 billion in assets under management attributable to its private equity funds is only required to file on an annual basis within 120 days of the end of its fiscal year, but is required to complete an additional section of the Form (Section 4).
[5] See, e.g., Cherokee Investment Partners, LLC, et. al., Advisers Act Release No. 4258 (Nov. 5, 2015); Fenway Partners, LLC, et. al., Advisers Act Release No. 4253 (Nov. 3, 2015), Blackstone Management Partners L.L.C., et. al., Advisers Act Release No. 4219 (Oct. 7, 2015), Kohlberg, Kravis Roberts & Co., Advisers Act Release No. 4131 (June 29, 2015); and Alpha Titans, LLC, et al., Exchange Act Release No 74828, Advisers Act Release No. 4073, Investment Company Act Release No. 31586 (Apr. 29,2015).
[6] Examination Priorities for 2016, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 11, 2016).
[7] Five Years On: Regulation of Private Fund Advisers After Dodd-Frank, Speech given by SEC Chair Mary Jo White, New York, New York (Oct 16, 2015).
[8] See, OCIE Cybersecurity Initiative, National Exam Program Risk Alert, Vol. IV, Issuer 2 (Apr. 15, 2014); Cybersecurity Examination Sweep Summary, National Exam Program Risk Alert, Vol. IV, Issue 4 (Feb. 3, 2015), and OCIE’s 2015 Cybersecurity Examination Initiative, National Examination Program Risk Alert, Vol. IV, Issue 8 (Sept. 15, 2015). See also, Examination Priorities for 2015, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 13, 2015) and Examination Priorities for 2016, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 11, 2016).
[9] See footnote 7 above.
[11] See footnote 7 above. See also Conflicts, Conflicts Everywhere – Remarks to the IA Watch 17th Annual IA Compliance Conference: The Full 360 View, Speech given by Julie M. Riewe, Co-Chief, Asset Management Unit, Division of Enforcement, Washington D.C. (Feb. 26, 2015).
[12] See Private Funds and the Application of the Custody Rule to Special Purpose Vehicles and Escrows, IM Guidance Update No. 2014-07 (June 2014).