NEW REGISTRATION RULES FOR MUNICIPAL ADVISORS

As they were required to do under the Dodd-Frank Act, the SEC announced that it has now voted to adopt permanent rules requiring municipal advisors to register.  Previously, and immediately after Dodd-Frank,  municipal advisors were placed under a temporary registration requirement, and following it, more than 1,100 municipal advisors registered with the SEC.

The permanent rule, the SEC says, will address the long concern about the fallout from losses suffered, in part, by municipalities purchasing complex derivatives products and relying on the advice from unregulated advisors — advisors, who municipalities may not have been aware, may have had conflicts of interest.   In addition to defining the term “municipal advisor,” and who is exempted from that definition, the rule  identifies when a person is considered to be providing “advice.”   For example, the SEC says, other than general giving information, a  person recommending to a municipal entity advice based on a particular need related to municipal financial products or related to the muncipalities’ issuance of municipal securities would be considered providing muncipal advice. 

The SEC’s Press Release states that the new rules will be effective 60 days after publication in the Federal Register.

PRIVATE FUND OFFERINGS: With General Solicitation Relaxation Comes New Scrutiny

 

SearchingWhile under the JOBS Act the capital formation process in private offerings may have gotten easier, the regulatory scrutiny may have gotten harder.

In a speech before the PLI Hedge Fund Management Conference in New York, Norm Champ, the SEC’s Director of the Division of Investment Management, addressed the increased oversight advisers to hedge funds relying on private offering exemptions can expect.  Of concern is  the adopted amendments to rules under the Securities Act of 1933 permitting general solicitation and general advertising in private securities offerings relying on Rule 144A or Rule 506 under the Securities Act and the rule’s  disqualifying of so-called “bad actors” who rely on its safe harbor.

In short, as to advertising, Rule 506 eliminates the prohibition on general solicitation and general advertising for some private fund offerings, with exceptions noted in the rule.  Generally, to find potential accredited investors, once the removal of the ban goes effective in the next few weeks, hedge fund will be able to use certain other methods of  solicitating and advertising.  With this comes the requirement that issuers take reasonable steps, defined by an objective assessment standard, to verify “accredited investor” status, to ensure that all purchasers of the securities are accredited investors.  Champ also stressed the importance of  advisers maintaining, reviewing and updating their policies and procedures to ensure, among other things, they are reasonably designed to prevent the use of fraudulent or misleading advertisements.

Other issues hedge funds will need to concern themselves with, related to  general solicitation, and  included in SEC proposals and related request for industry comment, include the following:

  • requiring issuers to file the Form D before a general solicitation begins and when an offering is completed to evaluate how general solicitation impacts investors in the private placement market, and expanding the information that issuers must include on Form D.
  • requiring private fund issuers  to include a legend in any written general solicitation materials disclosing that the securities being offered are not subject to the protections of the Investment Company Act of 1940.
  • requiring general solicitation materials containing performance data, to have additional disclosure explaining the context and limitations on the usefulness of such data.
  • extending to private funds Rule 156 of the Securities Act of 1933 guidance on when information in sales literature could be fraudulent or misleading under federal securities laws currently applicable to registerd funds.
  •  manner and content restrictions on private fund solicitation materials that include performance advertising specific to certain types of performance advertising, such as model or hypothetical performance.
  • using  an inter-Divisional group within the SEC to assess practices and developments in the Rule 506(c) market place, by looking at accredited investor verification practices used by issuers and other participants in these offerings, and studying risk characteristics that might identify potentially fraudulent behavior.
  • reviewing the definition of accredited investor as it relates to natural persons.

The “Bad Actor” Disqualification

As for the “bad actor” rule, the second amendment to Rule 506 implementing
Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Champ warned of  serious regulatory consequences should the SEC make a  bad actor finding.  To avoid the finding, hedge  fund advisers should conduct appropriate due diligence when they hire employees, third-party solicitors, and when they screen investors.  Champ also reminded hedge funds that while disqualification applies only for triggering events that occur after the effective date of the rule, matters that existed before the effective date of the rule that would otherwise be disqualifying must be disclosed to investors.

Generally, an issuer cannot rely on the Rule 506 exemption from registration if the issuer or any other person covered by the rule is disqualified by a “triggering event,” including certain criminal convictions, certain SEC cease-and-desist orders and court injunctions and restraining orders.  Hedge funds are not the only potential “bad actors. ”  Others, Champ reminded, could  include  “the hedge fund’s general partner or managing member, its investment adviser and principals, significant shareholders holding voting interests, affiliated issuers and any placement agent or other compensated solicitor.”

Finally, from a risk perspective, how will the SEC determine which hedge funds engaged in general solicitation to examine and/or investigate?

One way, he notes, is that registration and reporting reforms related to Dodd-Frank, over the past few years, including, the adoption of amendments to Form ADV and the creation of Form PF allows the SEC to cull more  information about individual hedge fund’s practices.  Another way, is the  Division of Investment Management establishment of a Risk and Examinations Office (“REO”) staffed with analysts with strong quantitative backgrounds, along with examiners, lawyers and accountants who will  conduct quantitative and qualitative financial analysis of the investment management industry, including private funds, advisers, types of funds, strategies and make up of a fund.