New SEC Rule on Political Contributions by Certain Investment Advisers

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The SEC has just published the text of the proposed rule on political contributions by investment advisers. SEC voted unanimously to propose this rule at its July 22nd Open Meeting.

http://www.sec.gov/rules/proposed/2009/ia-2910.pdf

The proposed rule is intended to curtail “pay to play” practices by investment advisers that seek to manage money for state and local governments.

The new proposed rule has four primary aspects:

1. Restricting Political Contributions

An investment adviser who makes a political contribution to an elected official in a position to influence the selection of the adviser would be barred for two years from providing advisory services for compensation, either directly or through a fund.

The contribution prohibition would also apply to certain executives and employees of the  investment adviser.

Additionally, the range of restricted officials would include political incumbents and candidates for a position that can influence the selection of an adviser.

There is a de minimis exception that permits contributions of up to $250 per election per candidate if the contributor is entitled to vote for the candidate.

2. Banning Solicitation of Contributions

The proposed rule also would prohibit an adviser from coordinating, or asking another person or political action committee to:

  1. Make a contribution to an elected official (or candidate) who can influence the selection of the adviser.
  2. Make a payment to a political party of the state or locality where the adviser is seeking to provide advisory services to the government.

3. Restricting Indirect Contributions and Solicitations

There would be prohibition on engaging in pay to play conduct indirectly, if that conduct would violate the rule if the adviser did it directly. That would include directing or funding contributions through third parties such as spouses, lawyers or companies affiliated with the adviser.

4. Banning Third-Party Solicitors

There is prohibition on paying a third party, such as a placement agent, to solicit a government client on behalf of the investment adviser.

SEC Proposes Measures to Curtail “Pay to Play” Practices

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At yesterday’s Open Meeting, the SEC voted unanimously to propose measures intended to curtail “pay to play” practices by investment advisers that seek to manage money for state and local governments. In 1999, the SEC considered a proposal to curb adviser pay to play practices modeled on MSRB Rule G37 that applies to underwriters of municipal bonds. This new proposed rule is both broader in its coverage and narrower in its applicability that the 1999 proposed rule.

The new proposed rule has four primary aspects:

1. Restricting Political Contributions

An investment adviser who makes a political contribution to an elected official in a position to influence the selection of the adviser would be barred for two years from providing advisory services for compensation, either directly or through a fund.

The contribution prohibition would also apply to certain executives and employees of the  investment adviser.

Additionally, the range of restricted officials would include political incumbents and candidates for a position that can influence the selection of an adviser.

There is a de minimis exception that permits contributions of up to $250 per election per candidate if the contributor is entitled to vote for the candidate.

2. Banning Solicitation of Contributions

The proposed rule also would prohibit an adviser from coordinating, or asking another person or political action committee to:

  1. Make a contribution to an elected official (or candidate) who can influence the selection of the adviser.
  2. Make a payment to a political party of the state or locality where the adviser is seeking to provide advisory services to the government.

3. Restricting Indirect Contributions and Solicitations

There would be prohibition on engaging in pay to play conduct indirectly, if that conduct would violate the rule if the adviser did it directly. That would include directing or funding contributions through third parties such as spouses, lawyers or companies affiliated with the adviser.

4. Banning Third-Party Solicitors

There is prohibition on paying a third party, such as a placement agent, to solicit a government client on behalf of the investment adviser.

Comments and Publication

The full text of the proposed rule is not yet available. There will be a 60 day comment period.

References:

SEC Releases Proposed Custody Rules for Investment Advisers

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On May 14, the Securities Exchange Commission said they were proposing New Custody Rules for Investment Advisers. They summarized the proposed rules but did not release the actual text of the proposed rules.

Now the proposed rules are available in Release No. IA-2876 (.pdf). Comments must be received on or before July 28, 2009.

SUMMARY: The Securities and Exchange Commission is proposing amendments to the custody rule under the Investment Advisers Act of 1940 and related forms. The amendments, among other things, would require registered investment advisers that have custody of client funds or securities to undergo an annual surprise examination by an independent public accountant to verify client funds and securities. In addition, unless client accounts are maintained by an independent qualified custodian (i.e., a custodian other than the adviser or a related person), the adviser or related person must obtain a written report from an independent public accountant that includes an opinion regarding the qualified custodian’s controls relating to custody of client assets. Finally, the amendments would provide the Commission with better information about the custodial practices of registered investment advisers. The amendments are designed to provide additional safeguards under the Advisers Act when an adviser has custody of client funds or securities.

The proposed rule is a sign of re-regulation in the industry. Some of the proposed rules were in place prior to 2003, when they removed through de-regulation. (Investment Advisers Act Release No. 2176, September 25, 2003 [68 FR 56692]).

The proposed rules are amendments to Rule 206(4)-2 [17 CFR 275.206(4)-2], Rule 204-2 [17 CFR 275.204-2] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] (the “Advisers Act” or “Act”), to Form ADV [17 CFR 279.1], and to Form ADV-E [17 CFR 279.8].

New Custody Rules for Investment Advisers

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The Securities and Exchange Commission proposed rule amendments as part of their Open Meeting on May 14, 2009. They talked about the proposed rules, but have not actually made them available. It is hard to judge the potential impact of the rules with being able to see them.

According to the press release and the speech by Mary Schapiro here is a summary of the proposed rules:

  • All registered investment advisers with custody of client assets will undergo an annual “surprise exam” by an independent public accountant to verify those assets exist.
  • If you are an investment advisers whose client assets are not held or controlled by a firm independent of the adviser, you will be required to obtain a SAS-70 report that describes the controls in place, tests the effectiveness of those controls, and provides the results of those tests.
  • You would be required to disclose in public filings with the SEC the identity of the independent public accountant that performs your “surprise exam.”
  • The proposed rules would require that all custodians holding advisory client assets directly deliver custodial statements to the clients instead of through the investment adviser, and that advisers opening custody accounts for clients instruct those clients to compare account statements they receive from the custodian with those received from the adviser.

According to Commissioner Schapiro: “We are taking this action in response to major investment scams — such as Madoff — and many other potential Ponzi schemes.”

Public comments on the proposed rule amendments must be received by the Commission within 60 days after their publication in the Federal Register.

References:

Perspectives on Hedge Fund Registration

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On Thursday, May 7, 2009, 11:00 a.m., the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises will hold a hearing on: “Perspectives on Hedge Fund Registration”

The Committee will be offering a live webcast of the hearing.

Advertising Limitations for Investment Advisers on Social Networking Sites

While FINRA has a very strict limitation on advertisements focusing on procedures, investment advisers have a principles driven approach to limitations on advertising.

To start, an advertisement is any communication addressed to more than one person that offers (1) analysis concerning a security, (2) any information to used in making a determination to buy to sell a security, or (3) any investment advisory service with regard to securities. That means bulk emails, television ads, radio ads, websites, and social networking sites are advertisements. If you label yourself as an investment adviser in your Facebook profile, Twitter profile, or blog information, those sites are advertisements. Even if you use them solely for personal purposes, they may be considered an advertisement if you mention securities or offer your services.

Given the broad definition of advertisement, you should just assume that your activity on a social networking site is an advertisement.

Let’s focus on the things you can’t do in an advertisement and then come back to how they affect an investment adviser’s use of the internet and social networking sites. These all come from the general prohibition on fraud under Section 206 of the Investment Advisers Act.

First, you can’t have “any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report or other service rendered by such investment adviser.” That means no recommendations on LinkedIn or other social networking site. That means you would need to moderate your blog comments and delete any that seem like a testimonial or recommendation.

Second, you can’t refer to past specific recommendations of securities. However, you can separately provide a separate detailed list of all past recommendations over at least the past year, with name of the security, the date recommended, and the price at which it was recommended. You also need to include a legend that past performance is not an indication of future performance. That means you can’t advertise your past success. Effectively, you can’t cherry-pick your best performing securities recommendations. You also need to disclose all material facts necessary to avoid unwarranted inference.

Third, you can’t advertise a graph, chart, formula, or other device for use in determining which securities to buy or sell or when to do so.

Fourth, you can’t offer any report, analysis, or other service for free, unless it is actually entirely free and without any condition or obligation.

Fifth, your advertisement can’t have any untrue statement or material fact or otherwise be false or misleading.

In looking at these principles, you can’t communicate something on a web 2.0 site that you could not put in a newspaper advertisement.

There has not been any additional guidance from the SEC on the use of Web 2.0 by investment advisers.  In a speech last week, Mary Schapiro said that the SEC “hasn’t come to a resolution on the new technology.” That alone may shy investment advisers away from using web 2.0 and social networking sites.

See:

Hedge Fund Adviser Registration Act of 2009

capuanoCongressmen Mike Capuano of Massachusetts and Mike Castle of Delaware introduced the Hedge Fund Adviser Registration Act of 2009 (H.R. 711). The Act, if passed, would delete Section 203(b)(3) from the Investment Advisers Act of 1940.

This section of the Investment Advisers Act exempts from registration an investment adviser who has fewer than 15 clients and does not hold themselves out to the public as an investment adviser. The general partner of a private investment fund is generally considered an investment adviser to that fund. Many private investment funds use this exemption if they have less than 15 funds.

Since the bill was just proposed on January 27, 2009 it is too early to speculate as to whether it will be passed.

This act falls into the bucket with the Hedge Fund Transparency Act of 2009 as one of several prospective changes to the private investment fund industry.

Using the Attorney-Client Privilege to Protect Drafts of SEC Filings

mintz_logoMintz Levin published a client alert about the Roth v. Aon case I mentioned a few days ago: Draft SEC Filings Can Be Protected From Discovery.

The lawyers at Mintz have these recommendations:

  • Disclosures that involve legal judgments, discussions of pending litigation, and business matters that the company must disclose for compliance purposes should be fully vetted with both in-house and outside counsel;
  • Though SEC filings eventually become part of the public domain, under the right circumstances, the attorney-client privilege may cover drafts of such filings.
  • Despite the involvement of some non-legal staff in the drafting process, the privilege may extend to teams within the company that work with counsel to make legal decisions concerning disclosures.
  • As a matter of best practices, company procedures should mandate that all drafts of SEC filings and communications concerning these filings that may implicate the attorney-client privilege be labeled “Draft” and “Attorney-Client Privileged.”
  • Internal communications seeking legal advice or opinion about disclosures should expressly state such intentions in the subject line or first sentence of an email.

Books and Records Requirement for Investment Advisers

The proposed Hedge Fund Transparency Act would require private investment funds to maintain books and records that the SEC requires. Presumably, if the Act passes the SEC would promulgate some regulations addressing what it would require.

One place to look would be Rule 204-2 under the Investment Advisers Act. The other place would be Rule 31a-1 under the Investment Company Act.