DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT

July 22, 2010 -

DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT

The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed by the Senate on July 15, 2010 and enacted into law by President Obama on July 21, 2010. This comprehensive financial regulatory reform provides a substantial overhaul of the nation’s financial regulatory system.  The impact of this reform will require investment advisers to adhere to new rules and regulations. The default time of effectiveness is one year after enactment. Significant highlights of this new legislation which impact investment advisers are as follows:

Increased threshold for SEC registration to $100 million - Investment advisers who manage less than $100 million will be required to register with state regulators, unless they would be required to register with 15 or more states, in which case they may register with the SEC.

Hedge Fund Registration - Investment advisers to private funds (including private equity funds but excluding venture capital funds) who manage $150 million or more will be required to register with the SEC.  

Hedge Fund Reporting - The SEC may require any investment adviser to a private fund to
file certain reports with the SEC and/or maintain certain records that include amount of assets under management, use of leverage, (including off-balance sheet leverage), counterparty credit risk exposures, trading and investment positions, valuation policies and practices of the fund, types of assets held, side arrangements or side letters and trading practices.

Binding Arbitration Clauses - The SEC is authorized by rule to prohibit, or impose conditions or limitations on the use of agreements that require clients of investment advisers to arbitrate disputes.

Uniform Fiduciary Standard of Care - The SEC, after conducting a study, is authorized to commence rulemaking to address the legal or regulatory standards of care for broker-dealers, investment advisers, and their respective associated persons for providing personalized investment advice about securities to retail customers.  In addition, the SEC is authorized to promulgate rules to provide that the standard of conduct for all broker-dealers and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the SEC may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker-dealer or adviser providing the advice

"Qualified Clients" - The SEC shall periodically adjust for the effect of inflation on its "qualified client" standard. This refers to Rule 205-3 under the Investment Advisers Act of 1940, which allows investment advisers to receive compensation based on a share of capital gains or capital appreciation when they enter into advisory contracts with qualified clients.

"Accredited Investors" - During the four-year period that begins on the date of enactment, the net worth standard for natural person accredited investors shall be $1 million, excluding the value of the person's primary residence. The standard currently is $1 million, but the primary residence is not excluded.

AMENDMENTS TO FORM ADV

On July 21, 2010, SEC Commissioners voted unanimously to require federally registered investment advisers to create a plain-English Form ADV Part 2 brochure. The compliance date would be sometime in 2011, depending upon when your firm's fiscal year ends. Most advisers would have to file the new Form ADV Part 2 brochure by the first quarter in 2011. Many state-registered investment advisers also currently file Form ADV with their regulators. It is anticipated that the SEC staff will work with the states to accommodate technical, state-specific changes to the items and instructions of the form. This process would enable publication of Form ADV, Part 2 as a uniform SEC-state form.

Important aspects of the new Form ADV are as follows:

Format and Updating Requirements. Advisers are required to prepare a narrative, plain English, brochure, presented in a consistent, uniform manner that will make it easier for clients to compare different advisers’ disclosures. In addition, advisers must provide each client an annual summary of material changes to the brochure and either deliver a complete updated brochure or offer to provide clients with the updated brochure.

Expanded Content. The new brochure addresses the following topics the SEC believes are most relevant to clients, including:
 
Advisory business — Advisers must describe their advisory business, including the types of advisory services offered, state whether they hold themselves out as specializing in a particular type of advisory service, and disclose the amount of client assets under management.

Fees and compensation — Advisers must disclose compensation arrangements, provide a fee schedule, disclose whether fees are negotiable and describe the types of other fees or expenses, such as brokerage fees, custody fees, and fund expenses that clients may pay in connection the services provided.

Performance-based fees and side-by-side management — Advisers that accept  performance-based fees, or that supervise an individual who accepts such fees, are  required to disclose this fact. If the adviser also manages accounts that are not charged a  performance fee, the adviser must explain the conflicts of interest that arise from the  simultaneous management of these accounts and must describe how it addresses those  conflicts.

Methods of analysis, investment strategies, and risk of loss — Advisers must describe their methods of analysis and investment strategies and explain that investing in securities involves risk of loss which clients should be prepared to bear. Advisers who use a particular method of analysis or strategy or who recommend a particular type of security are required to explain the material risks involved and discuss the risks in detail if those risks are unusual.
  
Disciplinary information — Advisers are required to disclose in their brochure material facts about any legal or disciplinary event that are material to a client’s evaluation of the advisory business or to the integrity of the adviser's management personnel.
 
Code of ethics, participation or interest in client transactions, and personal trading — Advisers are required to describe briefly their code of ethics and state that a copy is available upon request and must also disclose whether it or an affiliate recommends to clients, or buys or sells for client accounts, securities in which the adviser or an affiliate has a material financial interest and, if so, the conflicts of interest associated with that practice. Advisers must disclose whether the adviser or an affiliate invests (or is allowed to invest) in the same securities recommended to clients or in related securities, such as options or other derivatives, and must explain the conflicts involved and how the adviser addresses those conflicts. In addition, advisers that trade in the recommended securities at or around the same time as the client have to explain the specific conflicts inherent in that practice and how they are addressed.
   
Brokerage practices — Advisers are required to describe the factors considered in selecting or recommending broker-dealers for client transactions and determining the reasonableness of brokers’ compensation. Advisers also must disclose soft dollar, directed brokerage and trade aggregation practices and explain how they address the various conflicts of interest associated with these practices.

Supplements. Advisers are required to deliver “brochure supplements” to new and prospective clients providing them with information about the specific individuals who will provide services to  clients. The supplement will contain brief résumé-like disclosure about the educational background, business experience, other business activities, and disciplinary history of the individual and also include contact information for the person’s supervisor.
 
Internet Availability. Advisers will be required to electronically file brochures, which will be publicly available on the SEC’s website.

POLITICAL CONTRIBUTIONS - Rule 206(4)-5

The SEC recently enacted Rule 206(4)-5 which imposes requirements on investment advisers who solicit and/or provide investment advisory services to government entities.  Important highlights of the Rule (subject to certain exceptions) are as follows:

• Investment advisers are prohibited from providing advisory services for compensation for two years, if the adviser or its executives or employees make a political contribution to an elected official at the state or local level who is in a position to influence the selection of the adviser.
• Investment advisers and their associated persons are prohibited from soliciting or coordinating campaign contributions from others for an elected official who is in a position to influence the selection of the adviser and are prohibited from soliciting or coordinating payment to political parties in the state or locality where the adviser is pursuing business from government entities.
• Investment advisers are prohibited from paying a third party, such as a solicitor or placement agent, to solicit government entity clients on behalf of the adviser, unless that third party is an SEC-registered investment adviser or broker-dealer subject to similar restrictions expected to be imposed by FINRA.