Over the past few months, several states have commenced the process of adopting revised investment adviser registration requirements and new exemptions. These changes are based on the increase in the assets under management threshold for SEC registration and the elimination of the "private adviser exemption" by the Dodd-Frank Act. Because most states currently provide exemptions from registration for investment advisers with more than $25 million in assets under management, several states are proposing revisions to correspond to changes made at the federal level and avoid a regulatory gap that would allow certain hedge fund managers to remain unregistered.

Specifically, the California Department of Corporations released an Invitation for Comments in March regarding potentially increasing the AUM threshold for the exemption to $100 million and to require all non-SEC registered hedge fund managers to register with the state as investment advisers. Additionally, the Massachusetts Securities Division recently released proposed regulations that would require all Massachusetts based hedge fund managers with less than $100 million in assets under management to register with the Massachusetts Securities Division, unless they only manage Section 3(c)(7) funds or qualify for another exemption. For the most part, the changes taking place at the state level are based on a recent NASAA model rule that suggests states adopt regulations that require registration of all non-SEC registered fund managers unless the managers advises only funds which rely on the exclusion from the definition of "investment company" under Section 3(c)(7) of the Investment Company Act of 1940, as amended. According the model rule, the rationale for this exemption is that all investors in 3(c)(7) funds must be "qualified purchasers" and therefore do not require the protection afforded by requiring registration of the fund manager.

The NASAA model rule and the recent proposals by California and Massachusetts reflect the first steps at the state level to respond to the new investment adviser regulatory regime brought on by the Dodd-Frank Act. More developments are sure to come in this area, and we will continue to monitor and provide updates on these developments and how they will impact the industry. For additional information, please contact Zac Rosenberg, Compliance Consultant by email at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or by phone at (619) 278-0020.

As part of the SEC’s attempt to increase the effectiveness of its enforcement program, the SEC has undergone a complete reorganization of the Division of Enforcement, which has resulted in more enforcement actions, including some which have been highly publicized. The SEC has indicated that it intends to continue its aggressive approach, with a particular focus on hedge funds. In a recent statement to the House Financial Services Committee, Robert Khuzami, the SEC’s Director of Enforcement, stated that the SEC will scrutinize any hedge funds that consistently generate returns that beat market indexes. Because a successful track record will draw attention from the Enforcement Division, hedge fund managers should take heed to carefully review all performance calculations prior to disseminating information to its investors and potential clients.

Several recent SEC enforcement actions have focused on private funds’ use of side pockets, inside information, and inaccurate information provided to investors, which if found liable, could have huge catastrophic consequences to any private fund. Accordingly, funds should be sure to carefully document and adhere to their stated procedures on the use of side pockets, and avoid improper for shielding of certain transactions from investors. In addition, funds should carefully review and revise their policies and procedures to protect against insider trading by ensuring that adequate precautions exist to prevent the use of material nonpublic information. Since many recent enforcement actions have turned on misrepresentations made in statements or reports provided to hedge fund investors, fund managers should carefully review all statements to ensure accuracy, and avoid promissory language or misstatements that can lead to allegations of fraud.

The SEC’s Division of Enforcement has indicated that one of its goals is to increase the total number of enforcement actions. Consequently, fund managers should be aware that the SEC will continue focusing on private fund activities for some time.  It is imperative to take steps now to address these areas.  For more information, please contact Zac Rosenberg, Compliance Consultant at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or at (619) 278-0020.

The Investment Adviser Section of the North American Securities Administrators Association (NASAA) recently released proposed changes to the NASAA model investment adviser custody rule. The most controversial aspect of the model rule, as originally proposed, was the requirement that advisers to private funds provide investors with detailed quarterly account statements including the requirement to list all transactions during the quarter with specificity as to the specific securities, trade dates, and execution prices. Widespread opposition to this requirement focused on the fact that disclosing such information would jeopardize the proprietary nature of a private fund’s trading strategy and potentially lead to the use of such strategies to the detriment of investors.

The proposed revisions to the model custody rule attempt to address some of these concerns but likely do not go far enough to protect the trading strategies of private funds. The requirement for advisers to private funds to send quarterly statements to investors remains, and these statements must include: opening and closing cash balances, the total amount of additions and withdrawals for each investor and the fund as a whole, and a listing of all portfolio holdings as of the end of the quarter. Rather than requiring a detailed list of all transactions during the quarter, advisers would be required to disclose an aggregate listing of transactions with a breakdown by type of security.

While the absence of trade dates, specific securities, and execution prices from the quarterly statements will reduce some concern over the identification of trading strategies, the information required by the revisions is still quite extensive and may nevertheless give rise to significant objection in the industry over the potential for mandating disclosure of proprietary trading strategies.

The NASAA is soliciting comments on the proposed revisions until May 19, 2011. Details on how to submit comments are available here. For additional information on the impact of the proposed revisions, please contact Zac Rosenberg, Compliance Consultant by email at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or by phone at (619) 278-0020.

On Friday, April 8, 2011, the Associate Director of the SEC's Division of Investment Management, Robert E. Plaze, issued a letter to the President of the North American Securities Administrators Association (NASAA), indicating that the SEC will likely grant additional time for investment advisers subject to Dodd-Frank’s new registration requirements to register with the states or the SEC until the first quarter of 2012. Although the letter does not constitute formal SEC action and is not binding on the Commission, it does recognize the fact that the fast approaching July 21, 2011 deadline may not provide enough time to transition to the new rules.

Section 403 of the Dodd-Frank Act repeals the “private adviser exemption” in section 203(b)(3) of the Advisers Act currently relied on by advisers to hedge funds and other private funds, and requires private fund advisers with assets under management in excess of $150 million to register with the SEC. While SEC anticipates completing its rulemaking by the July 21, 2011 deadline, the letter states that the SEC will consider providing additional time for private fund advisers to register and comply with the requirements applicable to registered advisers.

Additionally, the letter mentions that “mid-sized advisers” (advisers with assets under management between $25 million and $100 million) that are required to transition to state registration under Section 410 of the Dodd-Frank Act, will be given a grace period during which they will be permitted to come into compliance with state law before withdrawing their SEC registration. This is in part due to the fact that once final rules are adopted, the IARD system will require reprogramming in order to ease the transition from SEC to state registration, which will take until the end of the year to complete.

Although the letter indicates the likely extension of the compliance dates, firms affected by these provisions should continue to take steps necessary to register with the SEC or transition to state registration, as the case may be. For additional information, please contact Zac Rosenberg, Compliance Consultant by email at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or by phone at (619) 278-0020.

Although the SEC would maintain some functionality in the event of a government shutdown, the majority of its activities, including inspections and examinations of registered investment advisers and broker-dealers would and ongoing enforcement actions would be discontinued until after a government shutdown. According to SEC Chairman Mary Schapiro, the SEC “will do some market surveillance and a number of other activities but the vast majority of the SEC functions will not continue during a government shutdown.”

Federal agencies such as the SEC and CFTC cannot operate without spending authority provided by Congress, which is set to expire Friday unless Congress can reach agreement on a new budget. In addition, the SEC and the CFTC are the only two agencies that are subject to annual appropriations and unlike other regulators, are operating under last year’s budget level, which has already forced the SEC to defer much of its rulemaking and other activities required by the Dodd-Frank Act.

This likely means that enforcement actions, regulatory examinations and investigations, review of disclosures and applications, would come to halt. Moreover, the SEC’s rulemaking agenda, which is quite substantial given the requirements imposed by the Dodd-Frank Act, would be delayed for some time.

We will continue to monitor the developments in Congress and the effect on the industry in the event of a government shutdown. For additional information, please contact Zac Rosenberg, Compliance Consultant by email at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or by phone at (619) 278-0020.

Currently, Rules 4.13(a)(3) and 4.13(a)(4), which were adopted by the Commodity Futures Trading Commission (“CFTC”), provide exemptions from registration as a Commodity Pool Operator (“CPO”) for managers of certain private funds provided that the private funds either: (i) limit their futures contracts and commodity options trading activities; or (ii) offer interests in the private fund only to certain highly sophisticated investors. The CFTC recently proposed rescinding those exemptions, which could mean that general partners or managing members of private funds that trade futures contracts and commodity options to register as CPOs. Because private fund advisers will also be subject to registration as an investment adviser with the SEC as of July 21, 2011, if the CFTC proposal is adopted, many private fund advisers that trade in commodity options or futures will be subject to dual regulation by the SEC and the CFTC.

Absent another available exemption from registration with the CFTC, private fund managers may be subject to several requirements imposed on CPOs, including: registration with the CFTC and membership in the National Futures Association (“NFA”); registration as associated persons for individuals who solicit investors for the private fund, including the requirement to pass a Series 3 exam; delivery of a disclosure document to prospective investors meeting the requirements of CFTC Rules 4.24 and 4.25 and has been approved by the NFA; delivery of periodic and annual account statements to all investors that have been prepared in accordance with generally accepted accounting principles; and the maintenance of certain books and records about the pool and the CPO.

Unless another exemption applies or relief from certain of these requirements is provided, these requirements would be in addition to the various requirements imposed on advisers to private funds by the SEC, and would significantly increase the compliance costs to private fund advisers that invest in commodity options or futures contracts.

Comments on the proposed changes are due by April 12, 2011 and may be submitted using the CFTC’s online comment submission process. For additional information on the proposed amendments or the implications of dual SEC/CFTC regulation, please contact us at (619) 278-0020.

Two of the more significant final rules adopted by the SEC over the past year were the new "pay to play" rule adopted on July 1, 2010 and the amendments to Part 2 of Form ADV adopted on July 28,2010. The Pay to Play Rule (Rule 206(4)-5 of the Advisers Act), among other things, generally prohibits investment advisers from providing advisory services for compensation to a government client for two years after the adviser or its employees make a contribution to certain elected officials or candidates. The amendments to Form ADV Part 2 generally require investment advisers to provide new and prospective clients with a narrative brochure and brochure supplements written in plain English, replacing the check-the-box format previously required.

Last week, the staff of the SEC's Division of Investment Management issued responses to various questions with respect to these new rules and rule amendments. The staff's guidance comes just in time, since the compliance date for certain recordkeeping requirements under the Pay to Play Rule was March 14, 2011, and advisers with a fiscal year end of December 31 must file the new Form ADV Part 2A no later than March 31, 2011. The Staff Responses to Questions About the Pay to Play Rule cover such topics as: Compliance Dates; Definitions of "Covered Associate," "Government Entity," and "Official"; Use of Third-Party Solicitors, and other matters. The Staff Responses to Questions About Part 2 of Form ADV address such topics as: Compliance Dates for Part 2A and 2B; Preparing, Filing and Delivering Brochures; Covered Persons for Brochure Supplements; and Preparation and Delivery of Brochure Supplements. The staff will update the information from time to time with responses to additional questions or to make other modifications.

For additional information on the Pay to Play Rule or the amendments to Part 2 of Form ADV, please contact us at (619) 278-0020.

For firms that claim compliance with the Global Investment Performance Standards (GIPS), the 2010 edition of the GIPS standards must be adhered to when presenting performance for periods after December 31, 2010. This means that come April, when many firms will begin presenting performance for the quarter ending March 31, 2011, all presentations that include performance results must comply with the requirements of the 2010 edition of the GIPS standards.

 With respect to valuation, GIPS 2010 requires assets to be valued at fair value, which can be challenging for assets that do not have readily available prices. Additionally, firms are no longer permitted to exclude difficult-to-value assets from composites if the portfolios that hold the assets are actual discretionary accounts that are charged a management fee. Additionally, in an effort to encourage firms to be verified, the GIPS compliance statement required by the 2010 edition of the standards must affirmatively state whether the firm is verified and what verification means. Firm that claim to be GIPS verified, must secure verification by year's end and must provide the firm performing the verification with a copy of the firm’s GIPS policies and procedures. In addition to several new disclosures required to be included in performance advertisements, the new GIPS standards also require that performance advertisements containing data for 36 months or more must report a three-year standard deviation, or explain why the three-year standard deviation is not relevant or appropriate.

 The CFA Institute has published a red-lined version of GIPS 2010, which shows what has changed from the previous edition of the standards. For additional information on the revised GIPS 2010 standards, please contact us at (619) 278-0020.

Section 413(a) of the Dodd-Frank Act requires the definition of “accredited investor” under various SEC rules promulgated under the Securities Act of 1933 to exclude the value of a person’s primary residence for purposes of determining whether the person qualifies as an ‘‘accredited investor’’ on the basis of having a net worth in excess of $1 million. The change in the definition was effective upon enactment of the Dodd-Frank Act, which become law on July 21, 2010. The SEC has now proposed rule amendments to conform to the Dodd-Frank Act’s new requirements for individuals to qualify as accredited investors on the basis of net worth. The proposed amendments expand on the statutory language of Dodd-Frank to clarify that net worth is calculated by excluding only the investor’s net equity in the primary residence. As proposed, the amended definition of accredited investor with respect to the net worth test would read as follows:

 Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of purchase, exceeds $1,000,000, excluding the value of the primary residence of such natural person, calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property.

The release discussed a number of alternative approaches to calculating the value of a primary residence that the SEC chose not to adopt, including for example, excluding the fair market value of the residence without netting out secured indebtedness. The SEC is seeking comment on the proposed method of calculating the value of the residence. Additionally, the SEC considered a number of other related amendments that have not been included in the proposal, but with respect to which the SEC is seeking comments. These include, among others, whether the SEC should define the term “primary residence” for the purposes of the amended rules, and whether the calculation of net worth should be made as of a specified date before the sale of securities under Regulation D (e.g., 30, 60, or 90 days) as well as at the time of sale.

On January 25, 2011, the SEC proposed new Rule 204(b)–1 under the Advisers Act to require that SEC-registered investment advisers report systemic risk information to the SEC on Form PF if they advise one or more private funds. The information provided on Form PF would be used by the Financial Stability Oversight Council (FSOC) to monitor systemic risk. The proposed rule is adopted under Section 404 of the Dodd-Frank Act, which amends section 204(b) of the Advisers Act, and directs the SEC to require private fund advisers “to maintain records and file reports containing such information as the SEC deems necessary and appropriate in the public interest and for investor protection or for the assessment of systemic risk by FSOC.” Because Form PF would elicit non-public information about private funds and their trading strategies, which, if made public, could adversely affect the funds and their investors, the SEC and FSOC are required to ensure the information remains confidential. How exactly this will be done, and what measures the regulators will take to maintain confidentiality, remains to be seen.

Under the proposed rule, the frequency of filing and the amount of information required to be reported on Form PF would vary based on both the size of the adviser and the type of funds it advises. Large private fund advisers would include any adviser with $1 billion or more in hedge fund, "liquidity fund" (i.e. unregistered money market fund), or private equity fund assets under management. All other private fund advisers would be regarded as smaller private fund advisers. Smaller private fund advisers would file Form PF only once a year and would report only basic information regarding leverage, credit providers, investor concentration and fund performance. Smaller advisers managing hedge funds would also report information about fund strategy, counterparty credit risk and use of trading and clearing mechanisms. Large private fund advisers would file Form PF on a quarterly basis and would provide more detailed information regarding exposures by asset class, geographical concentration and turnover. In addition, for each hedge fund having a net asset value of at least $500 million, large advisers would report certain information relating to that fund's investments, leverage, risk profile and liquidity.

The SEC release explaining the proposal is available here, and includes the full text of proposed Rule 204(b)–1 and Form PF. Comments on the proposed rule may be submitted electronically using the SEC’s Internet Comment Form. For additional information on Form PF or proposed Rule 204(b)–1, please contact us at (619) 278-0020.