legal and regulatory developments affecting fund managers ... · legal and regulatory developments...

Legal and regulatory developments affecting fund managersWhat's new in 2012?Paul Anning, David Blair and Marie T. DeFalco28 March 2012

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Agenda

• Chairman's introduction

• US Funds Outlook and Regulatory Update – Marie T. De Falco, Lowenstein Sandler PC

• UK and European Regulatory Initiatives – David Blair, Osborne Clarke

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Themes driving regulatory agenda

G20 EU FSA UKGovernment

Financial Crisis response

Single European Market expansion/Eurozone Crisis

Increased Consumer Protection

Increased Market Integrity

Market Stimulus ()

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EU and UK regulatory initiatives compared

EU• ESMA assuming more direct role in regulation• AIFMD/Venture Capital and Social Entrepreneurship Funds Regulation/PRIPS setting minimum

harmonising standards, primarily to deliver investor protection • CRD IV/Solvency II/MiFID II/MAD II building on existing EU initiatives to increase scope of regulation

and adding to compliance regime• UCITS V building on existing EU initiative to improve operation of passporting mechanismUK• Non-bank lending to remove barriers to capital movement (but FSA applying higher capital charges

on commercial real estate lending)• Break-up of FSA to enable separate focus on market stability and consumer protection• Living wills to prevent or minimise market disruption caused by bank failure• RDR/UCIS distribution review to increase the regulatory obligations of firms dealing with retail

investors• Intensive supervision and credible deterrence to increase compliance with regulatory standards

(mostly deriving from TCF principles and prescriptive rules from EU initiatives)

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Convergence of regulatory agenda themes

• Consumer protection lobby draws authority from impact of institutional failure on consumers – this lobby is very strong in EU and FSA/FCA

• EU draws authority from market failure for increasing regulation at an EU level and thereby expand territory of Single Market

• EU favours prescriptive approach and extra-territorial approach

• Rejection of light touch regulation by FSA in light of financial crisis acts to enforce EU initiatives that have little to do with financial stability

• BUT (1) Eurozone crisis highlights flaws in Single Market and in 'Big Government' public sector budgets and (2) national reliance on 'too-big-to-fail' institutions augers against high market-entry thresholds … will this lead to greater encouragement of public participation in capital markets and re-emergence of caveat emptor?

US Funds Outlook and Regulatory Update

Presentation at the invitation of Osborne ClarkeMarch 28, 2012

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IMPORTANT DISCLAIMER

The laws and regulations discussed herein are nuanced and complex.The bullet points on the following pages are intended to be an overviewof a few of the highlights. The information is not to be construed ascomprehensive, is not intended as legal advice, and should not berelied upon as such.

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Overview: Discussion Topics

• Dodd-Frank Update

• CFTC Rulemaking

• US Legislative, Regulatory, and Political Outlook

• Other Hot Topics

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Dodd-Frank Update

• Dodd-Frank Wall Street Reform and Consumer Protection Act adopted July 2010

• Massive and comprehensive bill governing financial services industry; focusing here on several provisions most relevant to private funds segment of the industry

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Dodd-Frank Update: SEC Registration of Advisers

• SEC registration of previously unregistered advisers—elimination of ”private adviser” exemption– Particularly affecting private equity funds, since many

large hedge funds had registered previously– New exemptions: Foreign private adviser exemption Private fund ($150 million) exemption Venture capital fund exemption Registered commodity trading adviser (CTA) exemption Family office exclusion

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• Foreign Private Adviser– No place of business in US– Fewer than 15 US clients (including fund investors)– Less than $25 million under management attributable to

US clients– Does not ”hold itself out to the public” in the US as an

adviser (includes websites, social media)– Does not advise registered investment company (RIC) or

business development company (BDC)

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• Private Fund Adviser– Acts as adviser solely to private funds (no RICs, no

BDCs, no managed accounts)– Assets under management in the US of less than $150

million A private fund adviser is an ”exempt reporting adviser”

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• Venture Capital Fund Adviser– Acts as investment adviser solely to ”venture capital funds,” which

are private funds (not RICs or BDCs) that Invest at least 80% of committed capital in ”qualifying investments”* Not leveraged, except de minimis amount on short-term basis No routine redemption rights Pursue and market a ”venture capital” strategy

A private fund adviser is an ”exempt reporting adviser”

* A ”qualifying investment” is a portfolio company that (i) is an operating entity; (ii) is not a reporting company or traded on any exchange; and (iii) does not incur leverage in connection with the investment by the venture fund

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• Exempt Reporting Advisers– Required to file portions of Form ADV Part 1, which is

publicly available Basic identifying information Information about private funds advised Conflict of interest information Disciplinary history

– Not currently subject to SEC examination, but the SEC has reserved authority to examine

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– Extra-territorial effects: SEC’s general view of its jurisdiction. Recent “supervisory cooperation” arrangements between SEC

and non-US counterparts—previously FSA, several Canadian provincial securities regulators; now Cayman Islands Monetary Authority (CIMA) and European Securities and Markets Authority (ESMA). Separate from enforcement cooperation agreements, the supervisory arrangements will facilitate SEC examination of registered entities with exclusively non-US offices. These agreements may also be required for US funds to continue to use EU private placement regimes after 2013.

View of AIFMD versus Dodd-Frank.

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Dodd-Frank Update: Other Effects

• Updated requirements for ”Accredited Investor” standard– Applicable to ”private placements”

• Updated requirements to meet ”Qualified Client” standard– Applicable to ability of registered adviser to collect

performance fees

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Dodd-Frank Update: Rulemaking Status

• Rulemaking has slowed, in part due to cost-benefitchallenge that the SEC lost in court (proxy access rule).(Every rule is subject to a cost-benefit analysis).

• We have not seen significant rulemaking pertaining tofunds (as opposed to swaps/derivatives, etc.) since lastJune (private fund, family office, and venture capital fundrulemaking). The rush to register in time for March 30deadline just passed (February 14).

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Dodd-Frank Update: Volcker Rule

• Restricts proprietary trading and investments in hedge funds and private equity funds. Underlying concern is that the banks make overly risky bets because they can depend on being bailed out by government—too big to fail.

• Two-year phase-in period, but scheduled to “take effect” July 21, 2012.

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Dodd-Frank Update: Volcker Rule

• Since rules not written yet, proposal to delay effective date until after rules are written. Otherwise, financial institutions will not know which of their trading activities would be barred. Countered by Representative Barney Frank, who is calling for a simplified law to take effect on time.

• Extra-territorial implications: Affects foreign banks with US subsidiaries and branches.

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Dodd-Frank Update: Current Adviser Focus

• Form PF– Huge undertaking applicable to registered advisers– Purpose is to collect information, assess systemic risk, support SEC

examination and enforcement– Large funds will have to file quarterly, and reporting period starts June 2012

• Form SHC– By U.S.-resident custodians and end-investors holding $100 million or more

of reportable foreign securities

• Form H– Large trader reporting

• Initial examinations of previously unregistered advisers

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Dodd-Frank Update: SEC Enforcement Focus

• Insider trading (continuing focus)• Use of social media• Websites and blogs• Recordkeeping (including pre-registration)• Policies and procedures

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CFTC Rulemaking

• Elimination of a popular commodity pool operator (CPO) registration exemption: Rule 4.13(a)(4), which exempted registration of operators of pools offered solely to ”qualified eligible persons”– CFTC looking for information from previously exempt

CPOs– Rule 4.13(a)(3) (de minimis exemption) remains, but

swaps now included as “commodity interests”

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CFTC Rulemaking

• Whom does the exemption elimination affect?– Does pool trade any commodity interests?– Is sponsor registered as CPO?– Offshore effect: No exemption specific to foreign advisors. CPOs operating a pool with at least one US investor may have to

register.– Advisors to fund of funds are included.– Registration required by December 31, 2012 (and

process can take several months).

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CFTC Rulemaking

• What does the exemption loss mean?– Examination by National Futures Association (NFA) (self-

regulatory organization)– Reports to NFA– Disclosure obligations to investors– Regular offering document update and NFA review may

be required– Series 3 exams for associated persons (solicitors)

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CFTC Rulemaking

• New CPO and commodity trading adviser (CTA) reporting obligations

• Requirement of annual filing and affirmation that exemptions still applicable.

• Any manager that trades commodities (including swaps) should review registration requirements.

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US Legislative/Regulatory/Political Outlook

• Crowd funding and general solicitation legislation progress (JOBS Act)– Economy and entrepreneurs/startups; difficulty in fund-raising; lack

of availability of funding from banks– Lobbying (transparency) New ADV Part II—some of what is required to be disclosed and available

online could be construed as “general solicitation,” which is not permitted).

Fund managers don’t necessarily want to be secretive, but have always been advised that they cannot talk about funds or securities, and websites (should) say nothing about fund offerings.

Perhaps also influenced by newly registered private equity funds, whose managers are accustomed to having more fulsome websites.

Litigation (free speech)

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• Change from 500 limit to 2000 limit under ’34 Act– Will affect 3(c)(7) funds

• What would elimination of “general solicitation” (likely) mean?

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• Carried interest update– Fairly long history of calls for elimination of favorable tax

treatment– Arguments for and against elimination– Candidacy of Mitt Romney for Republican party

presidential nomination has exacerbated focus on compensation of fund professionals

– Inclusion of Warren Buffet’s secretary prominently in audience of State of the Union address.

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Other Hot Topics

• Fundraising opportunities and challenges

– Pensions– Family offices– Due diligence– Extremely long lag times– GP/LP balance—terms

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Other Hot Topics

• Pay-to-play, lobbyist registration– Pay-to-play compliance policies required– Marketing to governmental pensions

• Offshore jurisdictions:– Anti-money laundering (AML)

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Other Hot Topics

• Offshore Jurisdictions– Foreign Account Tax Compliance Act (FATCA) FATCA is part of 2010 Hiring Incentives to Restore Employment

(HIRE) Act Goal of FATCA is to combat tax evasion by US persons holding

investments in unreported offshore accounts Includes ”financial accounts” maintained by a foreign financial

institution and ”foreign financial assets” (including interests in non-US funds)

– Federal Corrupt Practices Act (FCPA) Not a new law, but increased focus and huge fines being levied

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Other Hot Topics

• Mood: Odd dichotomy between (i) anti-financialsector feeling, “occupy Wall Street,” “classwarfare” (the rich aren’t paying their “fair share”),systemic risk, revenue-raising requirements and(ii) “me too” access to bailouts and investmentopportunities, continuing unemployment and sloweconomic growth, crowdfunding legislation, whicharguably undermining historic purpose ofsecurities laws to protect retail investors.

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• Questions?

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LOWENSTEIN SANDLER: Corporate Overview

Lowenstein Sandler PC is a nationally recognized full‐service law firm withapproximately 270 attorneys and offices in New York, Palo Alto and Roseland. Ourcommitment to our clients is demonstrated through our client‐centered, service‐oriented culture. Our attorneys are regularly cited for excellence by clients and peersin national publications, including Best Lawyers in America, Chambers USA: America’sLeading Lawyers for Business and The Legal 500.

Our lawyers possess the credentials, skills and experience rivaling the largest globalfirms, yet we continue to maintain a boutique, entrepreneurial approach to thepractice of law and our relationships with clients. Regardless of the transaction ormatter, understanding our clients’ needs and helping them to achieve successfuloutcomes are at the core of what we do.

“The ‘hardworking, responsive and creative’ six‐partner team at Lowenstein Sandler PC is considered by clients to be ‘one of the best teams of hedge fund attorneys’.”

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LOWENSTEIN SANDLER: Investment Management Group

Lowenstein Sandler is home to one of the nation’s leading Investment Management practices. For morethan 30 years, our firm has represented preeminent domestic and offshore hedge funds, privateequity funds, venture capital funds and other pooled investment vehicles, as well as managedaccounts. Our global clients comprise more than 200 domestic and international investment fundsand their advisers, with assets under management ranging from $100 million to more than $25 billion.These fund clients span a broad and diverse range of organizational structures and investmentstrategies. In addition to fund managers and investment advisers, our clients include administrators,broker‐dealers and institutional investors. We provide a full range of legal services, which are outlinedon the following page, to our investment management clients. We also represent these clients on awide array of commercial transactions, including large going‐private transactions, midsizeacquisitions, and pioneering PIPE and registered direct transactions. In addition, our litigators haveachieved landmark results for fund clients in high‐profile securities law matters.

Our investment management attorneys are recognized for their innovative solutions and dedication toclient service; many have been featured in “best of” legal publications, including Best Lawyers inAmerica, Chambers USA: America’s Leading Lawyers for Business and The Legal 500. The practice hasalso been selected as one of the preeminent practices in the United States for its representation ofhedge funds and other private funds (2011 and 2010) and for its derivatives/private equity work(2011) by Best Law Firms, published by U.S. News and Best Lawyers. We take an interdisciplinaryapproach to advising our clients and collaborate with colleagues in the firm’s M&A, corporate financeand securities, litigation, venture capital, bankruptcy, intellectual property, employee benefits, realestate, specialty finance and tax practices to ensure that our clients’ varied legal and business needsare fully addressed.

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LOWENSTEIN SANDLER: Investment Management Group

As a result of the increasing regulatory oversight and enforcement in the investment fund industry, ourregulatory and compliance lawyers are called upon to provide critical advice and guidance to our clients on awide variety of matters. By establishing strong relationships with clients, and gaining a thoroughunderstanding of their business, investment strategies, and front and back office operations, we are able todevelop comprehensive and robust compliance programs, and produce novel solutions to the complexregulatory and compliance issues that our clients increasingly confront. Our practice has also played a keyrole in shaping proposed legislation and regulation at the national and state levels.

We are intimately familiar with the investment industry and, for more than three decades, have worked witha broad constituency of market participants as well as various regulatory bodies. Our attorneys includeexperienced practitioners, and former in‐house counsel and compliance personnel who provide practicaladvice and guidance on regulatory and compliance matters, from routine trading issues, regulatoryexaminations and due diligence inquiries, to enforcement proceedings and hotly contested litigation.

We counsel investment management clients on a wide variety of matters, including: Fund Formation and Advisory Services Fund Structuring Mergers and Acquisitions Financing Transactions Partnership and Limited Liability Company Law Comprehensive Regulatory and Administrative Compliance Investor Suitability Standards Marketing and Reporting Guidelines Conflicts of Interest

Public and Private Equity and Debt Instruments PIPE and RD Transactions Commodity Trading Swaps and Derivatives Transactions Insider Trading Issues Activist Investing Taxation and ERISA Employee Benefits Intellectual Property Law


Roseland65 Livingston AvenueRoseland, NJ 07068973 597 2500

© 2012 Lowenstein Sandler PC. In California, Lowenstein Sandler LLP.

www.lowenstein.com

New York1251 Avenue of the AmericasNew York, NY 10020212 262 6700

Palo Alto590 Forest AvenuePalo Alto, CA 94301650 433 5800

UK and European Regulatory InitiativesDavid Blair

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Regulatory barometer

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Regulatory barometer

Investor Protection Measures- AIFMD (EU)Requirement to appoint depositaries, lending restrictions, broad definition of 'Fund', remuneration principles, marketing restrictions, restrictions on delegation- RDR/PRIPs (FSA/EU)Adviser charging and inducements rules and exam requirements targeting retail distribution channels- Intensive Supervision and Credible Deference (FSA)Increased reporting and regulatory enforcement riskFinancial Stability- Basel/CRD IV/Solvency II (G20/EU)Increased capital requirements and haircuts on illiquid investments restricting access to institutional investorsOrderly Markets (NB. Orderly markets also save costs)- Living Wills (FSA)Increased focus on contractual effect of event of default- MiFID II/MAD II (EU)Expanded regulation of alternative trading venues

Promoting SMEs- Non-Bank Lending Review (BIS/HMT)Tax breaks and public investment;regulatory 'attitude' to crowd fundingFreedom to provide services throughout EU- AIFMD; Venture Capital and Social Entrepreneurship Funds Regulations (EU)New passporting rights (no actual improvement on ability to market funds than under MiFID; business friendly element negated by investor protection measures)

DRIVERS TO REMOVE BARRIERS TO BUSINESS• Eurozone crisis could weaken EU

influence/'Big Government' approach• 'One-in, one-out' approach to

regulation in general

DRIVERS TO INCREASE COSTS• Development of ESMA indicates

greater influence for consumer protection agenda

• Increasing trend to apply consumer protections to professional investors

BUSINESSFRIENDLY

BUSINESS COSTS

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Alternative Investment Fund Managers Directive(AIFMD)

• Scope: Pan-European regulation of managers (AIFMs) of non-retail funds (AIFs)

• Restriction in activities to be conducted by fund managers

• Requirement to appoint regulated independent depositary

• Requirement to become authorised in Europe to offer offshore funds to European investors

• Asset-stripping provisions restricting ability of managers to invest in companies in need of re-structuring

• New capital requirements

• Strict requirements to report on leverage and possibility for regulatory intervention in cases of high borrowing

• Ability to "passport" management and marketing services across EEA without seeking regulation in each jurisdiction

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HMT/BIS developments

• Non-bank lending review to decrease UK dependence on banks as source of funding

– aka "Big Society"

– mostly tax and investment-driven, rather than regulatory?

– crowd-funding developments, looking at regulatory barriers to emerging industry

• "One in, one out" initiative to staunch flow of increasing compliance (doesn't formally apply to FS, but useful governmental ethos)

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FSA break-up

• FSA, as super-regulator, did not have skills to monitor system risks posed by the financial services system to the wider economy. Bank of England is better placed to perform this oversight role.

• New structure will revert to pre-FSMA system of specialist regulators:– Financial Conduct Authority (FCA) for conduct of business and

overall regulation of smaller business– Prudential Regulatory Authority (PRA) for authorising and

monitoring capital and liquidity of banks and insurers– Financial Policy Committee of Bank of England (FPC) for

considering impact of financial services sector on UK economy• Financial Services Bill to be legislative enactment creating new

structure

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Retail Distribution Review (RDR) and PRIPS

• Improving the standards of advice provided in relation to retail financial products

• Enhanced exam requirements and further restriction on "grandfathering" experience to avoid sitting exams

• Prominent disclosure of level of independence (independent, restricted, basic, execution-only)

• "Adviser charging" required by independent advisers and restricted advisers to equate value of advice to price charged for it

• Abolition of sales-based commission for advice and, effectively, execution-only services

• Packaged Retail Investment Products (PRIPS) regime will define European standards for pre-sale disclosure and sales practices in respect of funds that are distributed to retail investors

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Other UK/EU developments

• CRD IV and Solvency II and FSA bank-lending consultation to apply high capital charges to banks and insurers investing in certain funds and providing commercial property loans (e.g. 49% of NAV capital charge on insurer investing in most unlisted equities)

• Venture Capital and Social Entrepreneurship funds to have new opt-in European passporting mechanism for non-AIFMs

• Living Wills require banks and systemically important firms to apply more attention to insolvency provisions of market contracts

• MiFID II, European Market Infrastructure Regulation and Market Abuse Directive II to expand the range of trading venues subject to regulation and regulate trading practice infrastructure

• UCITS V to simplifying passporting process for retail funds• New European super-regulators (ESMA for funds) to become more

involved in the granularity of EU regulation (more regulations and fewer directives?)

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2012/2013 Timeline (1)

2012 2013

Q2 Q3 Q4 Q1 Q2 Q3

AIFMD Implementation ofnon-third country measures by 22

July 2013

European Venture Capital Funds Regulation

Implementation by22 July 2013

European Social EntrepreneurshipFunds Regulation

Implementation by 22 July 2013

CRD IV Q2 – Q3 – Scheduled adoption of final text

UK to publish implementingmeasures 1

January 2013

Solvency II Scheduled for implementation by

October 2012

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2012/2013 Timeline (2)

2012 2013

Q2 Q3 Q4 Q1 Q2 Q3

MAD II Implementing measures and

guidelines expected

UCITS V Legislative proposalscheduled to be

adopted September 2012

Replacement of FSA

New structure expected to be

established early 2013

Living Wills Recovery and Resolution Plans are

expected to be in place by 31 December

RDR Implementation date of 31 December

PRIPs Publication of legislative proposal

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Conclusions

• Fund operations and investment powers– AIFMD will transform fund operations: depositary provisions will affect most;

new CIS and regulated activities definitions, conflicts provisions, asset-stripping registration requirements, and lending restrictions will affect many

• Investor relations– Increased costs of compliance, especially for transitioned funds, will need to be

explained (cost-benefit dividends limited and professional investor opt-outs removed)

– Explicit consents required, e.g. on borrowing• Approach of new regulators

– FCA will be consumer-focussed, but will be sensitive to BIS/HMT developments– ESMA will continue to be consumer-focussed, prescriptive (including on

structure) extra-territorial and increasingly involved in development and oversight of regulation

– Eurozone crisis could be "signal box" to divert us from current track

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