On December 20, 1996, the Securities and Exchange Commission announced that it is suspending the use of Form ADV-S indefinitely, pending the outcome of a related rulemaking.
In a separate related release, the SEC proposed new Form ADV-T, amendments to Form ADV, and related rules and rule amendments designed, among other things, to require registered investment advisers (i) to file a report on Form ADV-T with the SEC by April 9, 1997 (the effective date of the relevant provisions of the National Securities Markets Improvement Act of 1996 (the "Improvement Act")) indicating the adviser's continued status under the Investment Advisers Act of 1940 as amended (the "Adviser's Act"), and (ii) to provide similar information in a new Schedule I to Form ADV annually beginning in 1998.
The actions announced by the SEC are part of the rulemaking necessitated by the adoption of the Improvement Act last October. Among other things, the Improvement Act altered the manner in which investment advisers will be regulated. Under the Improvement Act, an investment adviser need not register with the SEC unless it (i) has more than $25 million (or such higher amount as may be established by the SEC) in client "assets under management," or (ii) advises registered investment companies, or (iii) is not regulated by the state in which it maintains its principal office, in any of which cases such advisers must register exclusively with the SEC. Supervised persons will also be regulated exclusively by the SEC, except that a state may license, register or qualify an investment adviser representative who has a place of business within the state.
Following effectiveness of the referenced provisions of the Improvements Act, states may not, except as noted below, require the registration of an investment adviser who (i) is exempt from the definition of an investment adviser under the Advisers Act; or (ii) is registered with the SEC; or (iii) does not have a place of business in the state and who has had fewer than six (6) clients who are residents of the state during the preceding twelve (12) month period. No state may impose requirements related to minimum net capital, bonding or maintenance of books or records in addition to those mandated by the state in which the adviser maintains its principal place of business. States will, however, retain the authority to investigate and bring enforcement actions for fraud and deceit against an investment adviser and associated persons. States will also retain the authority to require filings for notice purposes and to impose fees on investment advisers (and, until October 11, 1999, to require the registration of investment advisers that fail or refuse to pay fees required by the state).
Proposed Form ADV-T is designed to enable the SEC to determine whether investment advisers currently registered with the SEC will continue to be subject to SEC jurisdiction or whether an adviser's registration should be withdrawn because the investment adviser has less than $25,000,000 of "assets under management."
Assets Under Management
The instructions to proposed Form ADV-T define the term "assets under management" by reference to the "securities portfolios" for which an adviser provides "continuous and regular supervisory or management services."
A "securities portfolio" would be any account a majority of whose value (excluding cash and cash equivalents, such as demand deposits) consists of securities. The entire value of any portfolio constituting a "securities portfolio" (including the part comprised of non-securities assets) would be included as part of the adviser's "assets under management." Securities valuations would be consistent with the methods employed in client reports and in calculating advisory fees.
An adviser would be deemed to be providing "continuous and regular supervisory or management services" with respect to accounts for which the adviser has investment discretion and for which the adviser provides ongoing management services. Some nondiscretionary accounts might qualify, but only if the adviser maintains a substantial degree of day-to-day responsibility.
Because some advisers' "assets under management" might fluctuate above and below $25,000,000, causing needless SEC and state registrations and withdrawals, the SEC has exercised its discretion to raise the threshold for mandatory SEC registration to $30,000,000. Withdrawal from SEC registration would not be required unless assets under management dipped below $25,000,000. Although proposed Rule 203A-1 would permit advisers to register with the SEC with assets under management of $25 million, advisers will have a $5 million cushion available to use in determining their SEC or state registration status.
Form ADV-T
Proposed Rule 203A-5 under the Advisers Act will provide the mechanism for determining whether advisers currently registered with the SEC will continue to be SEC regulated. Every registered adviser will have to file new Form ADV-T by April 9, 1997. The Form will (i) determine whether an adviser may continue to be registered with the SEC and (ii) if the adviser no longer qualifies, serve as the document that withdraws an adviser's registration under the Adviser's Act. Calculations of "assets under management" would have to be made within ten business days before filing Form ADV-T.
New Schedule I to Form ADV will update the information called for by Form ADV-T and allow the SEC to determine on an annual basis whether an adviser remains qualified to be registered with the SEC.
Special Rules
As noted, advisers that are not "regulated or required to be regulated" by the state in which they have their principal office and place of business must register with the SEC, even if they do not have $25 million in assets under management. The term "regulated or required to be regulated" refers to the existence, or lack of existence, of a state registration requirement as to that investment adviser. The SEC also proposes to define "principal office and place of business" to be the "executive office of the investment adviser from which the officers, partners, or managers of the investment adviser, direct, control, and coordinate the activities of the investment adviser."
Special rules have also been proposed for newly-formed advisers who expect to be qualified for SEC registration within 90 days and for (i) "nationally recognized statistical rating organizations," or rating agencies; (ii) pension consultants, if they provide investment advice to employee benefit plans with respect to aggregate assets of at least $50 million and (iii) advisers that directly or indirectly control, are controlled by, or under common control with, a registered adviser and share the same principal office and place of business as the registered adviser.
State Licensing of Investment Adviser Representatives
The Improvement Act allows any state to license an "investment adviser representative" who has a "place of business" in that state, even if the adviser itself is registered with the SEC. Proposed Rule 203A-3(a) would define an "investment adviser representative" to be a partner, officer, director or employee who provides investment advice, if during the preceding twelve months more than ten percent of that person's clients were natural persons or more than ten percent of the assets under management attributable to that person were assets of natural persons. It would not include persons who provide investment advice solely to institutions, persons who provide solely "impersonal" advice, such as preparing an investment newsletter or market timing advice, nor persons who are not involved on a regular basis in meeting with, soliciting or communicating with clients.
Proposed Rule 203A-3(b) would define an adviser representative's place of business to be any "place or office from which the investment adviser representative regularly provides advisory services or otherwise solicits, meets with, or communicates to clients." If a representative had places of business in more than one state, each of those states could require that the representative register. If an adviser representative did not have a regular place or office, the rule would define his or her place of business to be each client's residence. The SEC notes, however, that not every representative that does business in a state will necessarily have a "place of business" in that state and thus be subject to that state's registration requirement. It is hoped that the SEC will clarify the provision before it adopts final rules. The state where a computer that was used to post material on a World Wide Web Site on the Internet or to send E-mail is located would generally be deemed to be a state in which an investment adviser representative maintained a place of business (rather than the state in which the computer that maintained the Web site is located or the states in which the clients are located).
Six Client de minimis Standard
States may not regulate investment advisers who have no place of business in that state and have five (5) or fewer clients who are residents of that state. Proposed Rule 222-2 would define "client" for this purpose as a natural person and any relative or spouse of that person sharing the same residence, as well as any accounts of which such persons are the principal beneficiaries (i.e., all of these related parties would count as a single client). A corporation, general partnership, trust, or other entity other than a limited partnership would be treated as a single client if it received investment advice based on its objectives, rather than the objectives of its individual shareholders, partners, members, or beneficial owners. A limited partnership would be treated as a single client if it would be treated as a single client under Rule 203(b)(3)-1, the safe harbor rule defining when a limited partnership may be treated as a single client for purposes of determining whether an adviser has fourteen (14) or fewer clients. The proposed rule provides no guidance, however, as to how to determine a client's "residence."
Applicability of the Advisers Act to State-Registered Advisers
Several provisions of the Advisers Act will continue to apply to advisers that are registered with a state and not with the SEC. These include the provisions that prohibit advisory contracts from providing for certain types of performance-based fees, require such contracts to provide that they may not be assigned without client consent, and require advisers to establish, maintain and enforce written procedures designed to prevent the misuse of material nonpublic information. The SEC asks commenters to address whether the SEC should recommend to Congress further amendments to the Advisers Act so that these provisions do not apply to state-registered investment advisers.
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According to the SEC, the proposed requirements of Rule 203A-5 and Form ADV-T would either duplicate or replace the reporting requirements of Form ADV-S. In order to avoid duplication, the SEC has elected to suspend the use of Form ADV-S. If proposed new Form ADV-T and the related proposed rules and amendments are adopted, the SEC plans to eliminate the reporting requirements of Form ADV-S.
Whether or not the SEC supplements or revises the proposed new rules before adopting them, investment advisers should begin preparing to calculate their "assets under management" in anticipation of the April 9, 1997 filing deadline for Form ADV-T.
If you would like further information relating to hedge funds and their investment managers, contact Howard Neuman at (212) 818-9200.
SATTERLEE STEPHENS BURKE & BURKE LLP
230 Park Avenue New York, N.Y. 10169 Phone: (212) 818-9200 Fax: (212) 818-960747 Maple Street Summit, N.J. 07901-2518 Phone: (908) 277-2221 Fax: (908) 277-2038
World Wide Web Site: http://www.ssbb.com
To take action on any of the information contained in this report, you should seek professional advice.