Category Archives: Investment Advisers

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SEC Adopts Rule to Disqualify Felons and other “Bad Actors” from Using Rule 506 of Regulation D in Connection with Private Placement Offerings.

 Bad-Boys, Bad-Boys What You Going to Do?

In lieu of doing a public offering of securities, companies issuing securities can rely on an exemption from registration.  Regulation D is one of those exemptions. In 2010, Congress passed the Dodd-Frank Act.  That law specifically ordered the SEC to prohibit felons and other bad actors from utilizing Rule 506 of Reg. D to issue securities pursuant to the before-mentioned “safe harbor.”

Persons who are subject to the ban include promoters, directors, investment managers or those owning more than twenty percent (20%) of the issuer’s securities. The “bad boy” behavior that would prevent one from using Rule 506 of Reg D includes:

i)                   criminal convictions;

ii)                 injunctions and restraining orders related to securities;

iii)              final orders from other securities regulators, banking regulators and the CFTC;

iv)               SEC disciplinary orders, SEC “cease and desist” orders, and SEC “stop orders;”

v)                 suspension or expulsion of broker-dealers (B-Ds) or registered representatives from the NASD, FINRA, NYSE; and

vi)                U.S. Postal Service “false representation orders.”

The length of time for the bar on events listed above is either within five (5) or ten (10) years.

While the disqualification events listed above would have to occur after the effective date of the amended Rule 506, matters previously existing and that would otherwise fall under the rule, are subject to mandatory disclosure to investors. The amended Rule 506 becomes effective in mid-September.

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SEC Adopts Rule to Disqualify Felons and other “Bad Actors” from Using Rule 506 of Regulation D in Connection with Private Placement Offerings.

 Bad-Boys, Bad-Boys What You Going to Do? In lieu of doing a public offering of securities, funds issuing securities can rely on an exemption from registration.  Regulation D is one of those exemptions. In 2010, Congress passed the Dodd-Frank Act.  That law specifically ordered the SEC to prohibit felons and other bad actors from utilizing Rule 506 of Reg. D to issue securities pursuant to the before-mentioned “safe harbor.” Persons who are subject to the ban include promoters, directors, investment managers or those owning more than twenty percent (20%) of the issuer’s securities. The “bad boy” behavior that would prevent one from using Rule 506 of Reg D includes:

i)                   criminal convictions;

ii)                 injunctions and restraining orders related to securities;

iii)              final orders from other securities regulators, banking regulators and the CFTC;

iv)               SEC disciplinary orders, SEC “cease and desist” orders, and SEC “stop orders;”

v)                 suspension or expulsion of broker-dealers (B-Ds) or registered representatives from the NASD, FINRA, NYSE; and

vi)                U.S. Postal Service “false representation orders.”

The length of time for the bar on events listed above is either within five (5) or ten (10) years. While the disqualification events listed above would have to occur after the effective date of the amended Rule 506, matters previously existing and that would otherwise fall under the rule, are subject to mandatory disclosure to investors. The amended Rule 506 becomes effective in mid-September.

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SEC Adopts Final Rule to Allow General Solicitation and Advertising by Issuers, Private Companies and Startups.

JOBS Act and Congress Force the SEC to Go “Down the Rabbit Hole” of Mass Marketing.

The SEC’s recent vote changes the rules on the marketing of so called private placements or those securities not involved in a public offering.

This changed an 80 year prohibition on so-called general advertising or general solicitation, which generally speaking amount to broader types of marketing. So long as the investments are only sold to accredited investors, there is now no need for a pre-existing personal or business relationship between the issuer’s principals, internal marketers and broker-dealers (BDs) selling the offering of stock or debt.

Generally speaking, an accredited investor is the one with more than a one million dollar net worth, excluding home equity or one having incomes above $200,000 for individuals and $300,000 for couples. According to the SEC, 7.4% of U.S. households meet the definition of accredited investor according to the net worth definition. Under the amended Regulation D, the issuer of the private securities can no longer satisfy the accredited investor qualification by a “check the box” response. Now, issuers must take steps that amount to “reasonable verification of income and/or assets.” Companies/start-ups can review tax returns to substantiate the purchaser’s income or get confirmation of a person’s net worth or income by obtaining it from a registered broker-dealer (B-D), registered investment adviser (RIA), licensed attorney or a CPA.  

The JOBS Act itself was passed in April 2012. The Congressional deadline for the SEC to implement the JOBS Act expired more than 1 year ago. Nevertheless, the SEC has implemented the changes that will now allow for certain crowd-funding- type features to be used by issuers of securities.

Hedge funds, venture capital and private equity funds seemed to have “sneaked passed the bouncer,” as the impetus behind the change according to the JOBS Act was ease of raising capital and thus boost employment. It remains doubtful that loosening the rules on marketing by hedge funds, venture capital and private equity funds will lead to any additional hiring. The change in the marketing rules amount to a “sea change” when one considers that last year, the amount of private capital raised in the U.S. was just under 900 billion dollars.

The new rule takes effect sometime in mid-September 2013.

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SEC Adopts Final Rule to Allow General Solicitation and Advertising by Hedge Funds, Venture Capital and Private Equity Funds.

JOBS Act and Congress Force the SEC to Go “Down the Rabbit Hole” of Mass Marketing.

The SEC’s recent vote changes the rules on the marketing of so called private placements or those securities not involved in a public offering.

This changed an 80 year prohibition on so-called general advertising or general solicitation, which generally speaking amount to broader types of marketing. So long as the investments are only sold to accredited investors, there is now no need for a pre-existing personal or business relationship between the issuer’s principals, internal marketers and broker-dealers (BDs) selling the offering of the fund.

Generally speaking, an accredited investor is the one with more than a one million dollar net worth, excluding home equity or one having incomes above $200,000 for individuals and $300,000 for couples. According to the SEC, 7.4% of U.S. households meet the definition of accredited investor according to the net worth definition. Under the amended Regulation D, the issuer of the private securities can no longer satisfy the accredited investor qualification by a “check the box” response. Now, issuers must take steps that amount to “reasonable verification of income and/or assets.” Issuers/Funds can review tax returns to substantiate the purchaser’s income or get confirmation of a person’s net worth or income by obtaining it from a registered broker-dealer (B-D), registered investment adviser (RIA), licensed attorney or a CPA.

The JOBS Act itself was passed in April 2012. The Congressional deadline for the SEC to implement the JOBS Act expired more than 1 year ago.  Nevertheless, the SEC has implemented the changes that will now allow for certain crowd-funding- type features to be used by issuers of securities.

Hedge funds, venture capital and private equity funds seemed to have “sneaked passed the bouncer,” as the impetus behind the change according to the JOBS Act was ease of raising capital and thus boost employment. It remains doubtful that loosening the rules on marketing by hedge funds, venture capital and private equity funds will lead to any additional hiring. The change in the marketing rules amount to a “sea change” when one considers that last year, the amount of private capital raised in the U.S. was just under 900 billion dollars.

The new rule takes effect sometime in mid-September 2013.

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Do Registered Investment Advisors Dare Roll the Dice with the Securities and Exchange Commission and Its Office of Compliance, Investigation and Enforcement?

An Analysis of the SEC’s Examination Priorities for 2013 in light of “the odds.”

In fiscal 2012 the Securities and Exchange Commission (“SEC”) had less than 150 enforcement actions against registered investment advisers (“RIAs”), of which there are now more than 11,000 subject to SEC jurisdiction. In addition, there are almost 2,000 new advisors that have had to register due to legal changes brought about by Dodd-Frank. Those include hedge funds, venture capital funds and those involving private equity. Annually, the SEC examines approximately only eight percent (8%) of RIAs per year.

The SEC released its examination priorities for 2013 with respect to registered investment advisors. We have narrowed them down to highlight and share some of the items we feel are most likely to impact firms. Those who wish to review the entire release may do so at the SEC’s website or contact the author.

GENERAL AREAS OF RISK – FOR REGISTERED INVESTMENT ADVISORS (RIAs)

One issue the SEC will address in 2013 examinations is conflicts of interest. The SEC will examine RIA’s policies, procedures and systems in an effort to determine whether they recognize, mitigate and disclose conflicts of interest present in the investment advisors’ business.

SPECIFIC AREAS OF RISK FOR REGISTERED INVESTMENT ADVISORS (RIAs)

A)    Custody of Assets

Safety of assets remains a top priority for the SEC. In doing calculations of recent examination deficiencies, failure to comply with the Custody Rule (Investment Advisers Act Rule 206(4)-2) was present in over one third of the firms according to Office of Compliance, Examinations and Enforcement (“OCIE”). The SEC will be reviewing firm policies and procedures as well as books and records to determine whether firms are:

1)      Appropriately recognizing situations in which RIAs have “custody” as defined in the Custody Rule;

2)      Complying with the Custody Rule’s “surprise exam” requirement;

3)      Satisfying the Custody Rule’s “qualified custodian” provision; and

4)      Following the terms of the exception to the independent verification

requirements for pooled investment vehicles.

B)     Marketing/Performance

This is always a high risk area of concern because of the ultra competitive nature of money management. The SEC and OCIE will be reviewing instances of aberrational performance for signs of weak valuation procedures or fraudulent activity.  The SEC and OCIE’s staff will focus on the accuracy of advertised performance, including without limitation, back tested and hypothetical performance, methodologies and assumptions made and related disclosures. As always, the SEC will look at compliance with record keeping requirements by RIAs.

In conclusion, despite the odds, it makes little sense to roll the dice with an investment advisor’s fate because an adverse examination, investigation or enforcement from the SEC/OCIE could prove to be fatal to RIAs and/or their investment advisor representatives (“IARs”).

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Amended SEC rule changes to whom advisers can charge incentive fees to

New Requirement for Performance Fees.

Under the New Rule, performance based fees, i.e., a percentage of the capital gain, can be charged generally to if the client has at least $1M in assets under management with the advisor; or the client has net worth of $2M, excluding the value of the client’s primary residence.

Grandfathered Clients.

Essentially, if the contract was legal when entered then it is still legal. Under the prior version of the rule the amount under management with the advisor was $750,000 and the net worth requirement was $1,500,000. In addition, the equity in one’s home was counted as part of the client’s net worth. Such equity is no longer counted! Different rules may apply to new owners of an existing client including individual members of a private investment fund.  Please direct your specific inquiries to author listed below.

Other wrinkles.

Debt secured by the primary residence are generally not counted in the client’s net worth calculations. The exception to this rule is that any increase in the amount of debt sixty (60) days before the advisory contract is entered into is to be included as a liability. Moreover, debt on the primary residence in excess of its fair market value must be included as a liability. Given the diminished value of housing, this may be a significant exception to the rule.

The effective date for the new rule is May 22, 2012.

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