Category Archives: new hedge fund regulations

New Accredited Investor Definition

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Fund Managers Should Amend Subscription Documents

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”) immediately changed the definition of accredited investor. Prior to the enactment of the Act, an accredited investor could use the value of their primary residence to compute the $1,000,000 net worth requirement. Now, investors may not use the value of their primary residence to determine their net worth.  The mortgage or indebtedness on the primary residence, also, does not count against net worth except to the extent that the indebtedness exceeds the fair market value of the residence (see SEC discussion below).

Revising Subscription Documents

Some managers have subscription documents which describe the prior manner of calculating net worth for accredited investors. Such managers should immediately revise their subscription documents. Additionally, if a manager accepts investments from previous individual investors who have declared they are “accredited investors,” the manager should have such investors verify they meet the new net worth requirement. Generally the manager can accomplish this through a fairly simple verification or confirmation form. For those managers who have administration firms process subscription documents, the administration firm should be providing these verification forms to the subscribing investors. With respect to individual investors who are not making additional subscriptions, there is no current requirement to verify their net worth under the new rules.

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Below are the Dodd-Frank laws dealing with the new accredited investor standard.

SEC. 413. ADJUSTING THE ACCREDITED INVESTOR STANDARD.

(a) IN GENERAL.—The Commission shall adjust any net worth standard for an accredited investor, as set forth in the rules of the Commission under the Securities Act of 1933, so that the individual net worth of any natural person, or joint net worth with the spouse of that person, at the time of purchase, is more than $1,000,000 (as such amount is adjusted periodically by rule of the Commission), excluding the value of the primary residence of such natural person, except that during the 4-year period that begins on the date of enactment of this Act, any net worth standard shall be $1,000,000, excluding the value of the primary residence of such natural person.

(b) REVIEW AND ADJUSTMENT.—

(1) INITIAL REVIEW AND ADJUSTMENT.—

(A) INITIAL REVIEW.—The Commission may undertake a review of the definition of the term ‘‘accredited investor’’, as such term applies to natural persons, to determine whether the requirements of the definition, excluding the requirement relating to the net worth standard described in subsection (a), should be adjusted or modified for the protection of investors, in the public interest, and in light of the economy.

(B) ADJUSTMENT OR MODIFICATION.—Upon completion of a review under subparagraph (A), the Commission may, by notice and comment rulemaking, make such adjustments to the definition of the term ‘‘accredited investor’’, excluding adjusting or modifying the requirement relating to the net worth standard described in subsection (a), as such term applies to natural persons, as the Commission may deem appropriate for the protection of investors, in the public interest, and in light of the economy.

(2) SUBSEQUENT REVIEWS AND ADJUSTMENT.—

(A) SUBSEQUENT REVIEWS.—Not earlier than 4 years after the date of enactment of this Act, and not less frequently than once every 4 years thereafter, the Commission shall undertake a review of the definition, in its entirety, of the term ‘‘accredited investor’’, as defined in section 230.215 of title 17, Code of Federal Regulations, or any successor thereto, as such term applies to natural persons, to determine whether the requirements of the definition should be adjusted or modified for the protection of investors, in the public interest, and in light of the economy.

(B) ADJUSTMENT OR MODIFICATION.—Upon completion of a review under subparagraph (A), the Commission may, by notice and comment rulemaking, make such adjustments to the definition of the term ‘‘accredited investor’’, as defined in section 230.215 of title 17, Code of Federal Regulations, or any successor thereto, as such term applies to natural persons, as the Commission may deem appropriate for the protection of investors, in the public interest, and in light of the economy.

SEC. 415. GAO STUDY AND REPORT ON ACCREDITED INVESTORS.

The Comptroller General of the United States shall conduct a study on the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds, and shall submit a report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives on the results of such study not later than 3 years after the date of enactment of this Act.

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SEC Discussion on New Net Worth Rules

Section 179. Rule 215 – Accredited Investor

Question 179.01

Question: Under Section 413(a) of the Dodd-Frank Act, the net worth standard for an accredited investor, as set forth in Securities Act Rules 215 and 501(a)(5), is adjusted to delete from the calculation of net worth the “value of the primary residence” of the investor. How should the “value of the primary residence” be determined for purposes of calculating an investor’s net worth?

Answer: Section 413(a) of the Dodd-Frank Act does not define the term “value,” nor does it address the treatment of mortgage and other indebtedness secured by the residence for purposes of the net worth calculation. As required by Section 413(a) of the Dodd-Frank Act, the Commission will issue amendments to its rules to conform them to the adjustment to the accredited investor net worth standard made by the Act. However, Section 413(a) provides that the adjustment is effective upon enactment of the Act. When determining net worth for purposes of Securities Act Rules 215 and 501(a)(5), the value of the person’s primary residence must be excluded. Pending implementation of the changes to the Commission’s rules required by the Act, the related amount of indebtedness secured by the primary residence up to its fair market value may also be excluded. Indebtedness secured by the residence in excess of the value of the home should be considered a liability and deducted from the investor’s net worth. [July 23, 2010]

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Cole-Frieman & Mallon LLP provides legal support and hedge fund registration services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Commodity Position Limits After Dodd-Frank

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CFTC to Establish Energy Position Limits

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”) includes a number of key provisions which will affect the investment management industry in important ways. For example, the Act includes a mandate for the CFTC to impose position limits across different markets, including the energy markets, the agricultural markets and with respect to trading in certain OTC derivatives. These new position limits must be implemented by CFTC orders or through rulemakings within the next six to nine months depending on the individual markets.

New CEA Section 4a(c)

The Act establishes new SEC Section 4a(c), portions of which we have reprinted below. Generally the new sections will require the CFTC to do the following:

  • establish limits on “exempt commodities” within 180 days of the passage of the Act. [The term “exempt commodity” is defined in CEA Section 1a(14) to generally include those commodities which are not financially based commodities and not agricultural commodities. Generally the import of this provision is to have the CFTC implement position limits on energy related commodities and futures.]
  • establish limits on agricultural commodities within 270 days of the passage of the Act.
  • establish the aggregate number or amount of positions in certain contracts based upon the same underlying commodity that may be held by any person, including any group or class of traders, for each month.

The above requirements are generally subject to “bona fide hedging” exemptions and the new Section 4a(c)(2) requires the CFTC to define what constitutes a bona fide hedging transaction.

* Please note the above is a broad generalization of the applicable new sections of the CEA

CFTC’s Previous Efforts to Set Energy Position Limits

To an extent, we will look to the CFTC’s prior efforts to see where they may land with respect to setting limits. In January 2010, the CFTC proposed position limits designed to prevent any one participant from developing a concentration of futures positions (see generally Federal Register Release 75 FR 4143). The proposed limits would have restricted the position energy traders could hold and addressed concerns many lawmakers had about the connection between those traders and rising energy prices. While the proposed limits only applied to four exchange-traded energy commodities (crude oil, natural gas, and two other types of fuel), the CFTC will be revisiting those efforts to meet the new, more expansive mandate under the Wall Street Reform Act. [Note: you can view previous comments from the public on this issue on the CFTC website.]  The CFTC will be working with other agencies, including the SEC, the Federal Reserve Board, and other regulators in its efforts.

Likely Impact

These mandates will have a significant impact on the energy futures market. In 2009, more than 377 million energy futures and options contracts were traded on CFTC-regulated exchanges and this number is anticipated to increase. Energy traders will now face position limits with respect to the energy contracts that were previously largely unregulated. In addition, it is important to note that under the Act, the CFTC can set position limits not only on persons, but also on any “group or class of traders”–which means it could apply a limit, for example, to all airlines in the aggregate. While we will not know the full impact for some time, when the limits are implemented there are likely to be some groups and individuals who will need to carefully monitor their positions.

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New CEA Provisions

Section 4a(a)(2) of the Commodity Exchange Act

‘‘(2) ESTABLISHMENT OF LIMITATIONS.—

‘‘(A) IN GENERAL.—In accordance with the standards set forth in paragraph (1) of this subsection and consistent with the good faith exception cited in subsection (b)(2), with respect to physical commodities other than excluded commodities as defined by the Commission, the Commission shall by rule, regulation, or order establish limits on the amount of positions, as appropriate, other than bona fide hedge positions, that may be held by any person with respect to contracts of sale for future delivery or with respect to options on the contracts or commodities traded on or subject to the rules of a designated contract market.

‘‘(B) TIMING.—

‘‘(i) EXEMPT COMMODITIES.—For exempt commodities, the limits required under subparagraph (A) shall be established within 180 days after the date of the enactment of this paragraph.

‘‘(ii) AGRICULTURAL COMMODITIES.—For agricultural commodities, the limits required under subparagraph (A) shall be established within 270 days after the date of the enactment of this paragraph.

‘‘(C) GOAL.—In establishing the limits required under subparagraph (A), the Commission shall strive to ensure that trading on foreign boards of trade in the same commodity will be subject to comparable limits and that any limits to be imposed by the Commission will not cause price discovery in the commodity to shift to trading on the foreign boards of trade.

‘‘(3) SPECIFIC LIMITATIONS.—In establishing the limits required in paragraph (2), the Commission, as appropriate, shall set limits—

‘‘(A) on the number of positions that may be held by any person for the spot month, each other month, and the aggregate number of positions that may be held by any person for all months; and

‘‘(B) to the maximum extent practicable, in its discretion—

‘‘(i) to diminish, eliminate, or prevent excessive speculation as described under this section;

‘‘(ii) to deter and prevent market manipulation, squeezes, and corners;

‘‘(iii) to ensure sufficient market liquidity for bona fide hedgers; and

‘‘(iv) to ensure that the price discovery function of the underlying market is not disrupted.

Section 4a(a)(6) of the Commodity Exchange Act

‘‘(6) AGGREGATE POSITION LIMITS.—The Commission shall, by rule or regulation, establish limits (including related hedge exemption provisions) on the aggregate number or amount of positions in contracts based upon the same underlying commodity (as defined by the Commission) that may be held by any person, including any group or class of traders, for each month across—

‘‘(A) contracts listed by designated contract markets;

‘‘(B) with respect to an agreement contract, or transaction that settles against any price (including the daily or final settlement price) of 1 or more contracts listed for trading on a registered entity, contracts traded on a foreign board of trade that provides members or other participants located in the United States with direct access to its electronic trading and order matching system; and

‘‘(C) swap contracts that perform or affect a significant price discovery function with respect to regulated entities.

Section 4a(a)(7) of the Commodity Exchange Act

‘‘(7) EXEMPTIONS.—The Commission, by rule, regulation, or order, may exempt, conditionally or unconditionally, any person or class of persons, any swap or class of swaps, any contract of sale of a commodity for future delivery or class of such contracts, any option or class of options, or any transaction or class of transactions from any requirement it may establish under this section with respect to position limits.’’.

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Cole-Frieman & Mallon LLP provides legal support and futures and commodities compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

New Form ADV Part 2 Format Released

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SEC Announces New Format for ADV Part 2

Advisors registered with the SEC should have received a notification from the SEC about the new Part 2 format.  We have posted that release below and the communication we received from the SEC.  We have also posted the new release as well as the instructions for the new ADV Part 2.  We will be providing an overview and our thoughts on these changes in the coming days.

Complete Release – New Form ADV Part 2

New Form ADV Part 2 Instructions

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Form ADV Part 2: New Format and Brochure Supplements Required

The SEC recently adopted amendments to Part 2 of Form ADV and related rules that require investment advisers to prepare plain English narrative brochures and brochure supplements. You may view the adopting release and amended form at http://www.sec.gov/rules/final/2010/ia-3060.pdf . The revised form and rules require you to file a narrative brochure(s) electronically in a text searchable PDF format on IARD and to deliver the brochure to clients. You must also prepare, and deliver to clients, brochure supplements for certain employees and maintain them in your files. If your fiscal year ends on December 31, you are required to file a narrative brochure(s) with your annual amendment filing that is due by March 31, 2011. If your fiscal year end is other than December 31, you are required to file a narrative brochure(s) with your annual amendment filing for your 2011 year end. Please review the final release, amended rules, and amended Part 2 of Form ADV for additional information on when and how you are required to comply with these amendments. You cannot reply to this email. If you have questions, please email [email protected].

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Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

SEC Approves ADV Part II Update

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New Form to Require More Disclosure

On July 21, the SEC approved changes to the Form ADV Part II which are designed to provide more and better information to investors.  Currently Part II (and Schedule F which qualifies much of the information on Part II) contains a series of check the box options and also provides much of the same information which is also provided on Form ADV.  The changed proposed below will go into effect 60 days from the publication in the Federal Register which means that most advisers will need to have the new Part II in place by the first quarter of 2011.  In addition to traditional investment advisers, the new Part II disclosure requirements will also be applicable to hedge fund managers who are subject to registration after the passage of the Dodd-Frank reform bill.

The proposed major changes include the following:

  • Increased narrative – currently Part II and Schedule F are composed of a series of check the box answers describing an adviser’s business.  The SEC wants to move towards more of a narrative, “plain English” approach to disclosure which will be “clear and concise”.
  • Discussion of advisory business and fee structure – more disclosure will be required about the advisor’s business and the fee structure.  Increased disclosure will be required about expenses like brokerage and custody fees.
  • Performance fee discussion – the big issue is that if a manager charges performance fees to some accounts and not others, the manager will need to explain the conflicts of interest which are involved.
  • Discussion of investment methodology and risk factors – the manager will be required to explain the material risks involved in the investment program.
  • Disciplinary information – all disciplinary information material to the adviser’s business will need to be disclosed.  If there is new disciplinary disclosures which become necessary after the relationship has been established, the adviser will need to promptly update the client.
  • Supplements – the adviser will need to provide supplements to the client regarding the specific person who will be providing investment advice to the client.  This supplement will include information about the person’s education, business experience, disciplinary history, etc.

After the changes become effective, both hedge fund managers and other investment advisers will need to update their forms and also update their compliance manuals and policies and procedures.  Managers should also note that the information included in Part II will be publicly available online.

While we completely agree with appropriate and easy to understand disclosure, some of the proposed changes may have the unintended effect of creating brochures which are so long and comprehensive that investors will simply not read them.  For example, we have discussed “prospectus creep” and there is the possibility for this to happen with the Part II -especially with respect to risk disclosures.  Managers and lawyers will certainly err on the side of over-disclosure instead of under-disclosure when faced with a potential risk factor which may or may not be “material” in the eyes of the SEC (see, especially, the Goldman case).

What we see with the supplements is essentially a first step towards developing a self-regulatory organization (SRO) to oversee investment advisers.  FINRA has shown a willingness to take on this responsibility and it has become an even greater likelihood as the SEC is tasked with greater responsibilities under the Dodd-Frank bill.  While we believe that a SRO can relieve much of the regulatory burden of a government agency (see the NFA), we must note that all SROs have their own issues and this must be weighed against the increased costs (both in time and money) to investment advisers.

Text of Chairman Shapiro’s speech can be found here.
SEC News Release can be found here.

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Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Obama Signs Historic Wall Street Reform Bill

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Requires Hedge Fund and Private Equity Fund Managers to Register with SEC

As expected President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”) on Wednesday July 24, 2010.  The Act was designed to address many of the issues that led to the financial crisis of 2008 and is being hailed as the largest financial regulatory bill since the various securities acts of the 1930s.

For most hedge fund and private equity fund managers, the major concern is the requirement that managers register with the SEC by July 24, 2011.  Registration, of course, means that firms are going to be required to appoint a chief compliance office, comply with certain advertising restrictions and implement robust recordkeeping procedures.  Along with the increased compliance and reporting requirements, managers should be aware that firms will also be subject to surprise or routine SEC audits.

Fund managers who run section 3(c)(1) funds should also be aware of the fact that the definition of both qualified client and accredited investor are affected.  The definition of a qualified client will be required to be initially adjusted by the SEC and then will be adjusted every 5 years thereafter.  The definition of an accredited investor now does not include the value of an investor’s primary residence.  This definition will be subject to adjustment every 4 years.

Other interesting changes:

  • Venture Capital Funds – VC funds will not be required to register as investment advisers with the SEC, but the SEC may promulgate rules requiring such managers to keep certain records and make reports to the SEC.
  • Registered CPOs not subject to IA registration – a commodity pool operator which provides advice to a private fund which invests in securities will not also need to be registered as an investment adviser unless the CPO’s business becomes predominantly securities-related.
  • Recordkeeping – although hedge fund and private equity fund managers will be subject to reporting requirements, there is the possibility for enhanced confidentiality measures for some groups.  [This is an issue we will likely hear much more about in the future.]
  • Short sale reporting – managers generally with $100M in AUM will be required to report their short positions to the SEC.
  • SIPC protection for futures – the Act extends SIPC protection for futures and options on futures in portfolio margining accounts.
  • Futures position limits – in the next 6 months the CFTC will be required to impose aggregate position limits on energy products and metals.  In the next 9 months the CFTC will be required to impose aggregate position limits on agricultural commodities.
  • OTC Derivatives – formerly unregulated derivative transactions will now be regulated by the CFTC, SEC or both.  These transactions will generally need to be cleared through central clearinghouses.

Many pundits have noted that most of the “real” change will take place through the agency rule-making process which is expected to commence shortly and last at least 12 months.  Both the SEC and CFTC will be releasing rule proposals for comments and we will be reporting on these as they occur.

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Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Financial Reform Bill Passes Senate

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As has been widely reported, the Senate passed the Financial Reform Bill setting the stage for President Obama to sign the bill within the next week.  With respect to investment advisors, one of the central items is the private equity and hedge fund registration requirement.  We will be reporting further on the bill in the coming days and weeks.

Survey of State Securities Divisions

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Are States Equipped to Handle Increased IA Registrations?

Under the new financial reform bill, expected to be signed into law sometime in July 2010, the state securities divisions will play a larger role in the oversight of investment managers.  Under the current system, investment advisers (who generally provide financial planning services or investment advice to individuals) with $30 million of AUM are required to register with the SEC.  Under the new laws to take effect under the reform bill, investment advisers with up to $100 million of AUM will be required to register with the state of their principal place of business.  This means that thousands of managers who are currently subject to SEC jurisdiction and oversight will become subject to state jurisdiction and oversight.  We do not believe that the states have the desire, expertise or, most importantly, the budget to handle an increase in the jurisdiction and oversight.  Because we think the states securities divisions are cash strapped, we conducted our own mini-survey to find out the answer.  [Note: we also recommend the article The New Sheriffs in Town about this same issue.]

Survey of State Securities Divisions

Over the past couple of weeks, we called each state securities division and tried to speak with a person familiar with each division’s financial situation and other aspects of their operations.  While we were not always able to speak with the appropriate person, we were at times able to divine interesting information from our discussion.  For many states we have sent in record requests under the Freedom of Information Act and while our reports below are not complete, they do show us that a number of securities divisions are in fact having financial difficulties.  These questions focus on the issues we think are important.  [Please note: most of the answers below are not official but were instead taken from our informal phone conversations with people in the various divisions.]

Question: Is the securities division facing budget cuts?

  • Arizona – yes, there have been budget cuts over the last couple of years.
  • Delaware – no, but statewide salaries have been cut 2.5%
  • Kansas – there is a constrained budget
  • New Mexico – yes
  • Oregon – yes
  • Pennsylvania – budget restraints
  • Utah – yes
  • Vermont – yes, as of 2009
  • Washington – yes
  • Other: A number of divisions either stated no or that they could not provide that information.

Question: has the securities divisions faced staff reductions?

  • Utah – yes
  • Washington – operating under a hiring freeze
  • Other:  A number of states said there were vacant positions (Alaska, Arizona, Delaware, Kansas, New Mexico (3))

Question: are division staff forced to take furlough days?

  • California – yes, either 1 or 2 Fridays a month
  • Colorado – yes, 1 days per month instituted in Fall of 2009
  • Connecticut – yes, instituted in 2008
  • Delaware – yes, instituted in 2009
  • Hawaii – yes
  • Maine – yes
  • Michigan – yes
  • Minnesota – yes
  • Nevada – yes
  • New Mexico – in 2009 (5 days) but not in 2010
  • Oregon – yes
  • Vermont – yes – instituted in 2009
  • Virginia – yes
  • Washington – yes
  • Wisconsin – yes
[Note: we expect this number to rise as soon as we receive information back from our Freedom of Information Act requests.]

Question: how many staff members does the division employ?

  • Arkansas – 38
  • Delaware – 13 (2 examiners)
  • Indiana – 18-20 (1 examiner)
  • Louisiana – 11 (2 examiners)
  • Montana – 5 (2 examiners)
  • Nebraska – 10 (1 examiner)
  • New Hampshire – 10 (2 examiners)
  • New Mexico – 22 (1 examiner)
  • North Dakota – 9 (3 examiners)
  • Utah – 19 (5 examiners)
  • Washington – 38 (8 examiners)
  • West Virginia – 11 (5 examiners)
  • Wisconsin – 16 (10 examiners)
Question: how often does the division audit registrants?

  • Indiana – 3-4 year cycle
  • Louisiana – 2 year cycle
  • Montana – 3 year cycle
  • Nebraska – every 2-3 years
  • New Hampshire – risk-based cycle
  • New Mexico – 3 year cycle
  • Utah – 5 audits per month (3 routine, 2 for cause; mostly broker-dealer issues)
  • Virginia – 3.5 year cycle
  • Washington – high-risk firms audited 1-2 years; lower risk firms audited every several years
  • Wisconsin – 3 year cycle

We will periodically update this information as we receive it from the divisions.

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Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Pay to Play Rule Adopted by SEC

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Investment Advisers Act Rule 206 (4)-5

Today the SEC approved new Rule 206 (4)-5 under the Investment Advisers Act of 1940 which prohibits investment advisers from making political contributions in certain situations.  The new rule has three essential elements:

  • Investment advisory firms and employees are prohibited from managing assets for compensation if the adviser or employees make political contributions to an elected official who could influence the allocation of assets to the adviser.  The prohibition would last two years from the date of the political contribution.
  • Investment advisory firms and employees are prohibited from coordinating contributions from numerous sources to an elected official who could influence the allocation of assets to the adviser.
  • Investment advisory firms are prohibited from hiring third parties to solicit assets from government clients unless such third parties are registered with the SEC as investment advisers or broker-dealers.

While this rule may not be applicable to certain hedge fund managers and other investment advisers, it is important that all firms implement policies and procedures to make sure that the firm and employee’s activities do not inadvertently fall outside the regulations.  It is important that private equity fund managers, who will likely be subject to investment adviser registration under the Wall Street Reform and Consumer Protection Act, understand that this will be applicable to their business as well.

The text of the new rule has not yet been released.

For more information, please see the SEC press release.  SEC Chairman Mary Shapiro also provided comments on the new rule.

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Cole-Frieman & Mallon LLP provides comprehensive regulatory support and hedge fund registration.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Wall Street Reform and Consumer Protection Act

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Financial Reform Bill Overview & Hedge Fund Registration Requirement

Well over a year after Lehman and Madoff, Congress has finally drafted a single financial reform bill which will be voted on by the House and Senate before being signed by President Obama.  Below we have reprinted an overview of the major provisions of the act.  As has been regularly discussed over the last few months, hedge funds (and private equity funds) with assets of $100 million will be required to register with the SEC.  Additionally, investment advisers who were previously subject to SEC jurisdiction (i.e. mangers with AUM of $30 million to $100 million) will now become subject to state regulation (for more on this terrible idea, please see my article on overburdened state securities divisions).

In addition to hedge fund registration, other major provisions of the bill which will likely have an impact on hedge funds and the investment management industry include:

  • New Consumer Financial Protection Bureau with a Consumer Hotline
  • New Financial Stability Oversight Council (could potentially require funds to be subject to supervision by Federal Reserve)
  • Volcker Rule (limiting bank prop trading and sponsorship of hedge funds)
  • Increased Transparency into OTC Derivatives (including foreign exchange swaps)
  • Potential Fiduciary Duty for Brokers furnishing investment advice
  • Increased SEC funding

The following press release from the House Committee on Financial Services can be found here.

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Dodd-Frank Wall Street Reform and Consumer Protection Act

Create a Sound Economic Foundation to Grow Jobs, Protect Consumers,Rein in Wall Street, End Too Big to Fail, Prevent Another Financial Crisis

Washington, DC – Americans have faced the worst financial crisis since the Great Depression.  Millions have lost their jobs, businesses have failed, housing prices have dropped, and savings were wiped out.

The failures that led to this crisis require bold action.  We must restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them.  We must create a sound foundation to grow the economy and create jobs.

HIGHLIGHTS OF THE LEGISLATION

Consumer Protections with Authority and Independence: Creates a new independent watchdog, housed at the Federal Reserve, with the authority to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, and protect them from hidden fees, abusive terms, and deceptive practices.

Ends Too Big to Fail Bailouts: Ends the possibility that taxpayers will be asked to write a check to bail out financial firms that threaten the economy by: creating a safe way to liquidate failed financial firms; imposing tough new capital and leverage requirements that make it undesirable to get too big; updating the Fed’s authority to allow system-wide support but no longer prop up individual firms; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.

Advance Warning System: Creates a council to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the economy.

Transparency & Accountability for Exotic Instruments: Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated — including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders.

Executive Compensation and Corporate Governance: Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation and golden parachutes.

Protects Investors: Provides tough new rules for transparency and accountability for credit rating agencies to protect investors and businesses.

Enforces Regulations on the Books: Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefits special interests at the expense of American families and businesses.

STRONG CONSUMER FINANCIAL PROTECTION WATCHDOG

The Consumer Financial Protection Bureau

  • Independent Head: Led by an independent director appointed by the President and confirmed by the Senate.
  • Independent Budget: Dedicated budget paid by the Federal Reserve system.
  • Independent Rule Writing: Able to autonomously write rules for consumer protections governing all financial institutions – banks and non-banks – offering consumer financial services or products.
  • Examination and Enforcement: Authority to examine and enforce regulations for banks and credit unions with assets of over $10 billion and all mortgage-related businesses (lenders, servicers, mortgage brokers, and foreclosure scam operators), payday lenders, and student lenders as well as other non-bank financial companies that are large, such as debt collectors and consumer reporting agencies.  Banks and Credit Unions with assets of $10 billion or less will be examined for consumer complaints by the appropriate regulator.
  • Consumer Protections: Consolidates and strengthens consumer protection responsibilities currently handled by the Office of the Comptroller of the Currency, Office of Thrift Supervision, Federal Deposit Insurance Corporation, Federal Reserve, National Credit Union Administration, the Department of Housing and Urban Development, and Federal Trade Commission. Will also oversee the enforcement of federal laws intended to ensure the fair, equitable and nondiscriminatory access to credit for individuals and communities.
  • Able to Act Fast: With this Bureau on the lookout for bad deals and schemes, consumers won’t have to wait for Congress to pass a law to be protected from bad business practices.
  • Educates: Creates a new Office of Financial Literacy.
  • Consumer Hotline: Creates a national consumer complaint hotline so consumers will have, for the first time, a single toll-free number to report problems with financial products and services.
  • Accountability: Makes one office accountable for consumer protections.  With many agencies sharing responsibility, it’s hard to know who is responsible for what, and easy for emerging problems that haven’t historically fallen under anyone’s purview, to fall through the cracks.
  • Works with Bank Regulators: Coordinates with other regulators when examining banks to prevent undue regulatory burden.  Consults with regulators before a proposal is issued and regulators could appeal regulations they believe would put the safety and soundness of the banking system or the stability of the financial system at risk.
  • Clearly Defined Oversight: Protects small business from unintentionally being regulated by the CFPB, excluding businesses that meet certain standards.

LOOKING OUT FOR THE NEXT BIG PROBLEM: ADDRESSING SYSTEMIC RISKS

The Financial Stability Oversight Council

  • Expert Members: Made up of 10 federal financial regulators and an independent member and 5 nonvoting members, the Financial Stability Oversight Council will be charged with identifying and responding to emerging risks throughout the financial system. The Council will be chaired by the Treasury Secretary and include the Federal Reserve Board, SEC, CFTC, OCC, FDIC, FHFA, NCUA and the new Consumer Financial Protection Bureau.  The 5 nonvoting members include OFR, FIO, and state banking, insurance, and securities regulators.
  • Tough to Get Too Big: Makes recommendations to the Federal Reserve for increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, with significant requirements on companies that pose risks to the financial system.
  • Regulates Nonbank Financial Companies: Authorized to require, with a 2/3 vote, that a nonbank financial company be regulated by the Federal Reserve if the council believe there would be negative effects on the financial system if the company failed or its activities would pose a risk to the financial stability of the US.
  • Break Up Large, Complex Companies: Able to approve, with a 2/3 vote, a Federal Reserve decision to require a large, complex company, to divest some of its holdings if it poses a grave threat to the financial stability of the United States – but only as a last resort.
  • Technical Expertise: Creates a new Office of Financial Research within Treasury to be staffed with a highly sophisticated staff of economists, accountants, lawyers, former supervisors, and other specialists to support the council’s work by collecting financial data and conducting economic analysis.
  • Make Risks Transparent: Through the Office of Financial Research and member agencies the council will collect and analyze data to identify and monitor emerging risks to the economy and make this information public in periodic reports and testimony to Congress every year.
  • No Evasion: Large bank holding companies that have received TARP funds will not be able to avoid Federal Reserve supervision by simply dropping their banks. (the “Hotel California” provision)
  • Capital Standards: Establishes a floor for capital that cannot be lower than the standards in effect today.

ENDING TOO BIG TO FAIL BAILOUTS

Limiting Large, Complex Financial Companies and Preventing Future Bailouts

  • No Taxpayer Funded Bailouts: Clearly states taxpayers will not be on the hook to save a failing financial company or to cover the cost of its liquidation.
  • Discourage Excessive Growth & Complexity: The Financial Stability Oversight Council will monitor systemic risk and make recommendations to the Federal Reserve for increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, with significant requirements on companies that pose risks to the financial system.
  • Volcker Rule: Requires regulators implement regulations for banks, their affiliates and holding companies, to prohibit proprietary trading, investment in and sponsorship of hedge funds and private equity funds, and to limit relationships with hedge funds and private equity funds.  Nonbank financial institutions supervised by the Fed will also have restrictions on proprietary trading and hedge fund and private equity investments.  The Council will study and make recommendations on implementation to aid regulators.
  • Extends Regulation: The Council will have the ability to require nonbank financial companies that pose a risk to the financial stability of the United States to submit to supervision by the Federal Reserve.
  • Payment, clearing, and settlement regulation. Provides a specific framework for promoting uniform risk-management standards for systemically important financial market utilities and systemically important payment, clearing, and settlement activities conducted by financial institutions.
  • Funeral Plans: Requires large, complex financial companies to periodically submit plans for their rapid and orderly shutdown should the company go under.  Companies will be hit with higher capital requirements and restrictions on growth and activity, as well as divestment, if they fail to submit acceptable plans.  Plans will help regulators understand the structure of the companies they oversee and serve as a roadmap for shutting them down if the company fails.  Significant costs for failing to produce a credible plan create incentives for firms to rationalize structures or operations that cannot be unwound easily.
  • Liquidation: Creates an orderly liquidation mechanism for FDIC to unwind failing systemically significant financial companies.  Shareholders and unsecured creditors bear losses and management and culpable directors will be removed.
  • Liquidation Procedure: Requires that Treasury, FDIC and the Federal Reserve all agree to put a company into the orderly liquidation process because its failure or resolution in bankruptcy would have adverse effects on financial stability, with an up front judicial review.
  • Costs to Financial Firms, Not Taxpayers: Taxpayers will bear no cost for liquidating large, interconnected financial companies.  FDIC can borrow only the amount of funds to liquidate a company that it expects to be repaid from the assets of the company being liquidated.  The government will be first in line for repayment.  Funds not repaid from the sale of the company’s assets will be repaid first through the claw back of any payments to creditors that exceeded liquidation value and then assessments on large financial companies, with the riskiest paying more based on considerations included in a risk matrix
  • Federal Reserve Emergency Lending: Significantly alters the Federal Reserve’s 13(3) emergency lending authority to prohibit bailing out an individual company.  Secretary of the Treasury must approve any lending program, and such programs must be broad based and not aid a failing financial company.  Collateral must be sufficient to protect taxpayers from losses.
  • Bankruptcy: Most large financial companies that fail are expected to be resolved through the bankruptcy process.
  • Limits on Debt Guarantees: To prevent bank runs, the FDIC can guarantee debt of solvent insured banks, but only after meeting serious requirements: 2/3 majority of the Board and the FDIC board must determine there is a threat to financial stability; the Treasury Secretary approves terms and conditions and sets a cap on overall guarantee amounts; the President activates an expedited process for Congressional approval.

REFORMING THE FEDERAL RESERVE

  • Federal Reserve Emergency Lending: Limits the Federal Reserve’s 13(3) emergency lending authority by prohibiting emergency lending to an individual entity.  Secretary of the Treasury must approve any lending program, programs must be broad based, and loans cannot be made to insolvent firms.  Collateral must be sufficient to protect taxpayers from losses.
  • Audit of the Federal Reserve: GAO will conduct a one-time audit of all Federal Reserve 13(3) emergency lending that took place during the financial crisis.  Details on all lending will be published on the Federal Reserve website by December 1, 2010.  In the future GAO will have authority to audit 13(3) and discount window lending, and open market transactions.
  • Transparency – Disclosure: Requires the Federal Reserve to disclose counterparties and information about amounts, terms and conditions of 13(3) and discount window lending, and open market transactions on an on-going basis, with specified time delays.
  • Supervisory Accountability: Creates a Vice Chairman for Supervision, a member of the Board of Governors of the Federal Reserve designated by the President, who will develop policy recommendations regarding supervision and regulation for the Board, and will report to Congress semi-annually on Board supervision and regulation efforts.
  • Federal Reserve Bank Governance: GAO will conduct a study of the current system for appointing Federal Reserve Bank directors, to examine whether the current system effectively represents the public, and whether there are actual or potential conflicts of interest.  It will also examine the establishment and operation of emergency lending facilities during the crisis and the Federal Reserve banks involved therein.  The GAO will identify measures that would improve reserve bank governance.
  • Election of Federal Reserve Bank Presidents: Presidents of the Federal Reserve Banks will be elected by class B directors – elected by district member banks to represent the public – and class C directors – appointed by the Board of Governors to represent the public.  Class A directors – elected by member banks to represent member banks – will no longer vote for presidents of the Federal Reserve Banks.
  • Limits on Debt Guarantees: To prevent bank runs, the FDIC can guarantee debt of solvent insured banks, but only after meeting serious requirements: 2/3 majority of the Federal Reserve Board and the FDIC board determine there is a threat to financial stability; the Treasury Secretary approves terms and conditions and sets a cap on overall guarantee amounts; the President initiates an expedited process for Congressional approval.

CREATING TRANSPARENCY AND ACCOUNTABILITY FOR DERIVATIVES

Bringing Transparency and Accountability to the Derivatives Market

  • Closes Regulatory Gaps: Provides the SEC and CFTC with authority to regulate over-the-counter derivatives so that irresponsible practices and excessive risk-taking can no longer escape regulatory oversight.
  • Central Clearing and Exchange Trading: Requires central clearing and exchange trading for derivatives that can be cleared and provides a role for both regulators and clearing houses to determine which contracts should be cleared.  Requires the SEC and the CFTC to pre-approve contracts before clearing houses can clear them.
  • Market Transparency: Requires data collection and publication through clearing houses or swap repositories to improve market transparency and provide regulators important tools for monitoring and responding to risks.
  • Regulates Foreign Exchange Transactions: Foreign exchange swaps will be regulated like all other Wall Street contracts. At $60 trillion, this is the second largest component of the swaps market and must be regulated.
  • Increases Enforcement Authority to Punish Bad Behavior: Regulators will be given broad enforcement authority to punish bad actors that knowingly help clients defraud third parties or the public such as when Wall Street helped Greece use swaps to hide the true state of the country’s finances and doubles penalties for evading the clearing requirement.
  • Higher standard of conduct: Establishes a code of conduct for all registered swap dealers and major swap participants when advising a swap entity. When acting as counterparties to a pension fund, endowment fund, or state or local government, dealers are to have a reasonable basis to believe that the fund or governmental entity has an independent representative advising them.

NEW OFFICES OF MINORITY AND WOMEN INCLUSION

  • At federal banking and securities regulatory agencies, the bill establishes an Office of Minority and Women Inclusion that will, among other things, address employment and contracting diversity matters.  The offices will coordinate technical assistance to minority-owned and women-owned businesses and seek diversity in the workforce of the regulators.

MORTGAGE REFORM

  • Require Lenders Ensure a Borrower’s Ability to Repay: Establishes a simple federal standard for all home loans: institutions must ensure that borrowers can repay the loans they are sold.
  • Prohibit Unfair Lending Practices: Prohibits the financial incentives for subprime loans that encourage lenders to steer borrowers into more costly loans, including the bonuses known as “yield spread premiums” that lenders pay to brokers to inflate the cost of loans.  Prohibits pre-payment penalties that trapped so many borrowers into unaffordable loans.
  • Establishes Penalties for Irresponsible Lending: Lenders and mortgage brokers who don’t comply with new standards will be held accountable by consumers for as high as three-years of interest payments and damages plus attorney’s fees (if any).  Protects borrowers against foreclosure for violations of these standards.
  • Expands Consumer Protections for High-Cost Mortgages: Expands the protections available under federal rules on high-cost loans — lowering the interest rate and the points and fee triggers that define high cost loans.
  • Requires Additional Disclosures for Consumers on Mortgages: Lenders must disclose the maximum a consumer could pay on a variable rate mortgage, with a warning that payments will vary based on interest rate changes.
  • Housing Counseling: Establishes an Office of Housing Counseling within HUD to boost homeownership and rental housing counseling.

HEDGE FUNDS

Raising Standards and Regulating Hedge Funds

  • Fills Regulatory Gaps: Ends the “shadow” financial system by requiring hedge funds and private equity advisors to register with the SEC as investment advisers and provide information about their trades and portfolios necessary to assess systemic risk.  This data will be shared with the systemic risk regulator and the SEC will report to Congress annually on how it uses this data to protect investors and market integrity.
  • Greater State Supervision: Raises the assets threshold for federal regulation of investment advisers from $30 million to $100 million, a move expected to significantly increase the number of advisors under state supervision.  States have proven to be strong regulators in this area and subjecting more entities to state supervision will allow the SEC to focus its resources on newly registered hedge funds.

CREDIT RATING AGENCIES

New Requirements and Oversight of Credit Rating Agencies

  • New Office, New Focus at SEC: Creates an Office of Credit Ratings at the SEC with expertise and its own compliance staff and the authority to fine agencies.  The SEC is required to examine Nationally Recognized Statistical Ratings Organizations at least once a year and make key findings public.
  • Disclosure: Requires Nationally Recognized Statistical Ratings Organizations to disclose their methodologies, their use of third parties for due diligence efforts, and their ratings track record.
  • Independent Information: Requires agencies to consider information in their ratings that comes to their attention from a source other than the organizations being rated if they find it credible.
  • Conflicts of Interest: Prohibits compliance officers from working on ratings, methodologies, or sales; installs a new requirement for NRSROs to conduct a one-year look-back review when an NRSRO employee goes to work for an obligor or underwriter of a security or money market instrument subject to a rating by that NRSRO; and mandates that a report to the SEC when certain employees of the NRSRO go to work for an entity that the NRSRO has rated in the previous twelve months.
  • Liability: Investors can bring private rights of action against ratings agencies for a knowing or reckless failure to conduct a reasonable investigation of the facts or to obtain analysis from an independent source. NRSROs will now be subject to “expert liability” with the nullification of Rule 436(g) which provides an exemption for credit ratings provided by NRSROs from being considered a part of the registration statement.
  • Right to Deregister: Gives the SEC the authority to deregister an agency for providing bad ratings over time.
  • Education: Requires ratings analysts to pass qualifying exams and have continuing education.
  • Eliminates Many Statutory and Regulatory Requirements to Use NRSRO Ratings: Reduces over-reliance on ratings and encourages investors to conduct their own analysis.
  • Independent Boards: Requires at least half the members of NRSRO boards to be independent, with no financial stake in credit ratings.
  • Ends Shopping for Ratings: The SEC shall create a new mechanism to prevent issuers of asset backed-securities from picking the agency they think will give the highest rating, after conducting a study and after submission of the report to Congress.

EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE

Gives Shareholders a Say on Pay and Creating Greater Accountability

  • Vote on Executive Pay and Golden Parachutes: Gives shareholders a say on pay with the right to a non-binding vote on executive pay and golden parachutes.  This gives shareholders a powerful opportunity to hold accountable executives of the companies they own, and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and in turn the broader economy.
  • Nominating Directors: Gives the SEC authority to grant shareholders proxy access to nominate directors.  Also requires directors to win by a majority vote in uncontested elections.  These requirements can help shift management’s focus from short-term profits to long-term growth and stability.
  • Independent Compensation Committees: Standards for listing on an exchange will require that compensation committees include only independent directors and have authority to hire compensation consultants in order to strengthen their independence from the executives they are rewarding or punishing.
  • No Compensation for Lies: Requires that public companies set policies to take back executive compensation if it was based on inaccurate financial statements that don’t comply with accounting standards.
  • SEC Review: Directs the SEC to clarify disclosures relating to compensation, including requiring companies to provide charts that compare their executive compensation with stock performance over a five-year period.
  • Enhanced Compensation Oversight for Financial Industry: Requires Federal financial regulators to issue and enforce joint compensation rules specifically applicable to financial institutions with a Federal regulator.

IMPROVEMENTS TO BANK AND THRIFT REGULATIONS

  • Volcker Rule: Implements a strengthened version of the Volcker rule by not allowing a study of the issue to undermine the prohibition on proprietary trading and investing a banking entity’s own money in hedge funds, with a de minimis exception for funds where the investors require some “skin in the game” by the investment advisor–up to 3% of tier 1 capital in the aggregate
  • Abolishes the Office of Thrift Supervision: Shuts down this dysfunctional regulator and transfers authorities mainly to the Office of the Comptroller of the Currency, but preserves the thrift charter.
  • Stronger lending limits: Adds credit exposure from derivative transactions to banks’ lending limits.
  • Improves supervision of holding company subsidiaries: Requires the Federal Reserve to examine non-bank subsidiaries that are engaged in activities that the subsidiary bank can do (e.g. mortgage lending) on the same schedule and in the same manner as bank exams, Providesthe primary federal bank regulator backup authority if that does not occur.
  • Intermediate Holding Companies: Allows use of intermediate holding companies by commercial firms that control grandfathered unitary thrift holding companies to better regulate the financial activities, but not the commercial activities.
  • Interest on business checking: Repeals the prohibition on banks paying interest on demand deposits.
  • Charter Conversions: Removes a regulatory arbitrage opportunity by prohibiting a bank from converting its charter (unless both the old regulator and new regulator do not object) in order to get out from under an enforcement action.
  • Establishes New Offices of Minority and Women Inclusion at the federal financial agencies

INSURANCE

  • Federal Insurance Office: Creates the first ever office in the Federal government focused on insurance.  The Office, as established in the Treasury, will gather information about the insurance industry, including access to affordable insurance products by minorities, low- and moderate- income persons and underserved communities.  The Office will also monitor the insurance industry for systemic risk purposes.
  • International Presence: The Office will serve as a uniform, national voice on insurance matters for the United States on the international stage.
  • Streamlines regulation of surplus lines insurance and reinsurance through state-based reforms.

INTERCHANGE FEES

  • Protects Small Businesses from Unreasonable Fees: Requires Federal Reserve to issue rules to ensure that fees charged to merchants by credit card companies for credit or debit card transactions are reasonable and proportional to the cost of processing those transactions.

CREDIT SCORE PROTECTION

  • Monitor Personal Financial Rating: Allows consumers free access to their credit score if their score negatively affects them in a financial transaction or a hiring decision. Gives consumers access to credit score disclosures as part of an adverse action and risk-based pricing notice.

SEC AND IMPROVING INVESTOR PROTECTIONS

SEC and Improving Investor Protections

  • Fiduciary Duty: Gives SEC the authority to impose a fiduciary duty on brokers who give investment advice –the advice must be in the best interest of their customers.
  • Encouraging Whistleblowers: Creates a program within the SEC to encourage people to report securities violations, creating rewards of up to 30% of funds recovered for information provided.
  • SEC Management Reform: Mandates a comprehensive outside consultant study of the SEC, an annual assessment of the SEC’s internal supervisory controls and GAO review of SEC management.
  • New Advocates for Investors: Creates the Investment Advisory Committee, a committee of investors to advise the SEC on its regulatory priorities and practices; the Office of Investor Advocate in the SEC, to identify areas where investors have significant problems dealing with the SEC and provide them assistance; and an ombudsman to handle investor complaints.
  • SEC Funding: Provides more resources to the chronically underfunded agency to carry out its new duties.

SECURITIZATION

Reducing Risks Posed by Securities

  • Skin in the Game: Requires companies that sell products like mortgage-backed securities to retain at least 5% of the credit risk, unless the underlying loans meet standards that reduce riskiness.  That way if the investment doesn’t pan out, the company that packaged and sold the investment would lose out right along with the people they sold it to.
  • Better Disclosure: Requires issuers to disclose more information about the underlying assets and to analyze the quality of the underlying assets.

MUNICIPAL SECURITIES

Better Oversight of Municipal Securities Industry

  • Registers Municipal Advisors: Requires registration of municipal advisors and subjects them rules written by the MSRB and enforced by the SEC.
  • Puts Investors First on the MSRB Board: Ensures that at all times, the MSRB must have a majority of independent members, to ensure that the public interest is better protected in the regulation of municipal securities.
  • Fiduciary Duty: Imposes a fiduciary duty on advisors to ensure that they adhere to the highest standard of care when advising municipal issuers.

TACKLING THE EFFECTS OF THE MORTGAGE CRISIS

  • Neighborhood Stabilization Program: Provides $1 billion to States and localities to combat the ugly impact on neighborhood of the foreclosure crisis — such as falling property values and increased crime – by rehabilitating, redeveloping, and reusing abandoned and foreclosed properties.
  • Emergency Mortgage Relief: Building on a successful Pennsylvania program, provides $1 billion for bridge loans to qualified unemployed homeowners with reasonable prospects for reemployment to help cover mortgage payments until they are reemployed.
  • Foreclosure Legal Assistance. Authorizes a HUD administered program for making grants to provide foreclosure legal assistance to low- and moderate-income homeowners and tenants related to home ownership preservation, home foreclosure prevention, and tenancy associated with home foreclosure.

TRANSPARENCY FOR EXTRACTION INDUSTRY

For Investors

  • Public Disclosure: Requires public disclosure to the SEC payments made to the U.S. government relating to the commercial development of oil, natural gas, and minerals on federal land.
  • SEC Filing Disclosure: The SEC must require those engaged in the commercial development of oil, natural gas, or minerals to include information about payments they or their subsidiaries, partners or affiliates have made to a foreign government for such development in their annual reports and post this information online.

Congo Conflict Minerals:

  • Manufacturers Disclosure: Requires those who file with the SEC and use minerals originating in the Democratic Republic of Congo in manufacturing to disclose measures taken to exercise due diligence on the source and chain of custody of the materials and the products manufactured.
  • Illicit Minerals Trade Strategy: Requires the State Department to submit a strategy to address the illicit minerals trade in the region and a map to address links between conflict minerals and armed groups and establish a baseline against which to judge effectiveness.
  • Deposit Insurance Reforms: Permanent increase in deposit insurance for banks, thrifts and credit unions to $250,000, retroactive to January 1, 2008.
  • Restricts US Funds for Foreign Governments: Requires the Administration to evaluate proposed loans by institutions such as the IMF or World Bank to a middle-income country if that country’s public debt exceeds its annual Gross Domestic Product, and oppose loans unlikely to be repaid.

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Cole-Frieman & Mallon LLP provides comprehensive formation and regulatory support for hedge fund managers.  Cole-Frieman & Mallon LLP also provides private equity registration support.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

State Budget Shortfalls and Investment Adviser Registration

2 Replies

Financial Reform Bill May Devastate Overburdened State Securities Divisions

As many states are facing huge budget shortfalls, government services have been cutback and certain states have furloughed workers in certain divisions. In a number of states (including California) these budget cuts have affected the state securities divisions and accordingly the many state securities divisions are running dangerously lean. For example, I just recently talked with an examiner in the Oregon Division of Finance and Corporate Securities regarding a state blue sky filing for a hedge fund manager. The examiner told me that because of budget cuts and furlough days, the division will not even have a chance to review the blue sky filing we submit for five months! (Of course, they will cash the check immediately.)

This is obviously a huge issue and is only one instance of a state which does not currently have the resources to adequately perform oversight of the investment and securities activity which occur within its borders. In fact, many states currently don’t have the staff or expertise to adequately oversee the investment advisers and brokers registered with their securities division. While this is troubling, the problem is only going to get worse if the Financial Reform Bill proceeds as currently drafted.

While many have lauded the Senate bill, which will require hedge fund registration for managers with $100MM in AUM or more, an important issue has been overlooked. All investment advisers (in addition to hedge fund managers) with AUM of less than $100MM will be subject to state and not SEC registration. The $100MM threshold is an increase from the current threshold of $25MM. This means that a financial planner overseeing $90MM in assets (which was previously subject to SEC registration and periodic examination) will now be subject to regulation, generally, by the state in which that manager resides.

This means that if the financial reform bill goes through as currently drafted in the senate, the states are suddenly going to be responsible for overseeing a larger pool of managers. Even though the state will have increased responsibility, it is unlikely that state budgets will provide the securities divisions with more funding to properly oversee the new managers the divisions will be responsible for regulating. We find this troubling for investor protection reasons and for manager business continuity – that is, managers would be better off registered at the SEC level and subject to examination by SEC staff better trained (presumably) than state regulators.

We concede that the SEC has its own problems with funding and this provision allows them to focus on larger, more systemically important managers. However, we believe that states are going to be greatly burdened by the increase in jurisdictional oversight. Accordingly, we believe either Congress or the SEC provide a grandfathering provision which would allow current managers who exceed the $25MM threshold (but not the new $100MM threshold) to register or remain registered with the SEC.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP is one of the top hedge fund law firms and provides comprehensive formation and regulatory support for hedge fund managers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.