Wall Street Reform Bill Issues – Performance of State Securities Regulators

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As we move closer to the signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act, more groups are highlighting the fact that state securities divisions are going to be affected by the act.  After pressure from NASAA, the association of state securities regulators, Congress has provided that state regulators will be required to provide oversight of investment advisers with up to $100 million of AUM – a significant increase from the current level of $30 million of AUM.  Of course this will increase the number of advisers that the states oversee and will make the job of the securities divisions much more difficult.  We have consistently stated that we do not think the states, collectively, are going to be capable to provide proper oversight with the increase in responsibility – mostly because of budget issues.  We have been surveying the states to see which divisions have budget issues and will be reporting on that shortly.  Until then we will examine one securities division which has faced scrutiny from members of the investment community and the state legislature.

Overview of Utah Division of Securities Audit

Over the years there has been a number of complaints about the manner in which the Utah Division of Securities conducts business – a simple Google search will reveal a number of interesting stories.  After repeated complaints the state legislature decided to audit the division and released a report in July of 2008 entitled A Performance Audit of the Division of Securities.

The results are nothing less than shocking.

Faith in government agencies is based on the belief that they will act fairly and effectively.  The report shows capricious behavior and essentially a belief that members of the investment management community are ‘guilty’ until proven ‘innocent’.  Special attention should be paid to the fact that the state securities divisions do have power to make life miserable for a business owner, even if that business owner has not acted wrongly.  Redress is difficult and “the Division Always Wins” (see below).  It is in with this understanding that we question whether the states will be in the best position to oversee the investment management industry.

Below are a number of direct quotes from the audit – many should make any ready angry and sick.  [Please note that we are not saying that all securities divisions have these problems.  Additionally, we have not conducted any follow up with Utah so we do not express any opinion on the current state of the division.]

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Reason for audit:

The credibility of the Division of Securities has been challenged by those investigated by the division. Their concerns are with procedural errors, an alleged overzealous pursuit of securities violations, and the perception that those investigated do not receive fair treatment.

While the division protects securities investors, it is alleged the division has abused its power and damaged reputations. The division has significant authority but its credibility depends on using that authority judiciously.

Page i

Ad Hoc Manner of Conducting Investigations:

There does not appear to be a consistent relationship between the number of complaints, number of cases opened, and the number of actions filed. This is because cases can be opened without a resulting action, there can be multiple actions on one case, or the action may not be filed until the following year. In addition, our evaluation leads us to believe the information is not reliable.

Page 3

Reason for Division Audit

Legislators requested this audit based on concerns about how the division managed three cases. We reviewed the division’s administrative process followed in these cases and a number of others brought to our attention. We did not address the legal issues of any of the cases. Our work has been complicated by the desire of many interviewees to keep their names confidential. They fear reprisal for criticizing the division’s actions.

Page 9

Lack of Policies & Procedures Equals Inconsistent Decisions

The division has not been operating under set, written policies and procedures. As a result, division decisions for actions against the regulated industry and the treatment of its employees rest solely with department and division management. Frequent management changes have brought changes in management philosophy and an increased likelihood for inconsistent decisions.

Page 9

Years of No Policies & Procedures

During the course of this audit, we were told that the division did have policies and procedures a number of years ago. However, there have been no written policies and procedures in place, or operational procedures followed, for at least the last four years under the direction of three division directors.  Shortly before this audit’s completion, division staff found a discarded copy of a 1993 policies and procedures manual. It is disconcerting that the division has faced procedural control difficulties for a number of years, yet no one in either departmental or divisional leadership noted the lack of policies and procedures.

Page 9 and 10

HUGE ISSUE FOR STATE REGISTERED MANAGERS

Complaints surfaced that those charged with securities violations could not get a fair hearing.

Page 10

Division Bias Ignored

In several cases, it was questionable if the former director had maintained an independent and unbiased perspective. For example, the former director did not recuse himself from serving as the presiding officer after helping to draft the pleadings for the case. It was apparent he was no longer impartial. Even the perception that the presiding officer is biased is concerning as it can give the appearance of unfair treatment.

Page 10

Intimidation…and…the Division always wins…

Those accused of securities violations told us they felt intimidated into settling, given that the division’s former director would likely serve as the presiding officer. One business owner perceived the system as “a stacked deck” because the investigator, jury, and judge are all in the same office. He informed us that during an investigation, a division employee boasted that the division always wins.

Page 11

State Lawyer Effectively Pushed Out

poor communication between the former director and an attorney resulted in the exclusion of the attorney from a decision on how a case would be handled, even though the attorney had been involved in the case for a number of months. The attorney was frustrated and raised concerns when the former director drafted and sent out documents over the attorney’s name, thus implying the AG gave his approval, even though the attorney was not aware a decision had been made and had not reviewed the final document. He learned about the legal action when defendants contacted him because they assumed he represented the division. The former director contends that the attorney was familiar with the document.

Pages 12-13

Questionable Actions

During the audit, many individuals associated with various cases contacted us with complaints about the division. Our review of case files resulted in a number of questionable actions including: inappropriate publicity, emphasis on punishment rather than compliance, the use of intimidation tactics, violating terms of settlement agreements, failure to notify those being investigated, and inconsistent case management.

Page 15

Fear of Retaliation!!??

To evaluate these complaints, we reviewed case files, listened to tapes of hearings, and interviewed staff and attorneys involved with the cases. Many of those who talked with us requested confidentiality because they feared retaliatory action by the division if they were identified.

Page 15

Inconsistent Procedures…

questionable actions often can be attributed to the divisions lack of clearly defined procedures. A discarded policy manual states that “the manual will be reviewed and updated on a yearly basis to reflect current or additional practices.” Not complying with this requirement has resulted in division policies and procedures that are inconsistently applied.

Page 15

Emphasis on Punishment Rather than Compliance

The division appears to emphasize punishment of offenders rather than compliance with securities laws. A number of those involved in the division’s actions believe the division has overzealously pursued securities violations. They criticize that charges are brought one after another, cases are drawn out over long periods of time, and decisions on who to investigate can be arbitrary.

Page 17

Threats and Coercion

The division’s use of intimidation to obtain information has been cited by both those being investigated and others involved with the division. In one case, the accused stated that an investigator attempted to coerce cooperation by intimidating and threatening that the person would be arrested. In another case, investigators seized personal information by copying all information from the business owner’s computer without distinguishing business and personal information. The owner said that he complied with the investigator’s demands only because they threatened to immediately close him down if he refused.

Page 18-19

Does not Honor Settlement Agreements

The division has, at times, violated the terms of its settlement agreements. In one case, the division agreed to not publicize the action or commence further administrative actions and then violated both terms of the agreement. The person accused told us he felt compelled to plead guilty to a lesser criminal charge rather than place his business in jeopardy defending a greater charge. The division agreed to not seek additional charges but nevertheless pursued an administrative action. The respondent then signed the settlement agreement after the division agreed to not publicize it. However, the day the settlement was signed, the division publicized the information on its web page and also published the information in its newsletter the following month.

Page 19-20

Surprised Charges Filed…Harming Innocent Business

According to the business owner, he learned about the investigation only after it was completed and charges were filed. Before he had an opportunity to respond, the media called to ask about the division revoking his license and issuing fraud charges. The media release was damaging to the business and the resulting retraction and apology was damaging to the division.

Page 21

Fines Arbitrary!!??

The division has been criticized for not identifying how fines are set. Board minutes disclosed the former director explained that fines are set to “make it hurt,” which is troublesome to those in the securities industry. The former director explained to us that fines are set based on an evaluation of the seriousness, nature, circumstances, and persistence of the conduct which is consistent with the Financial Industry Regulatory Authority (FINRA) guidelines. However, because the division does not have written guidelines or procedures identifying the process used to set fines, they appear to be set arbitrarily, based solely at the discretion of the division.

Page 22

Staff Demoralized, Scared of Reprisal

Personnel conflicts within the Division of Securities (division) have resulted in management turnover and a demoralized staff. Both the department executive director and the division’s former director have been open about their beliefs that specific employees have seemed reluctant to accept change and may be subverting management authority. A number of division staff feel their jobs are threatened or other forms of management reprisal may occur should they offend management in some way. The escalating conflicts have resulted in reprimands, restructuring, and ultimately, the resignation of the director, and the threat of legal action by several employees.

Page 25

Division Blatantly Breaks Laws at Director’s Direction

After being hired in October 2005, a number of the former director’s actions have been questionable. He was reprimanded and received a one-day suspension without pay for instructing staff to hold fine payment checks without processing them within the three-day time period required by statute (Utah Code 51-4-1). Delaying the deposit would allow the division to retain funds in the division rather than transfer them to the state general fund. By statute, if a balance in the division’s education fund exceeds $100,000 at the close of a fiscal year, the excess must be transferred to the General Fund (Utah Code 61-1-18.7(6)).

Staff related other instances in which they feel the former director gave them inappropriate directions. For example, staff provided information showing the director:

  • directed staff to sign pleadings that the former director had either drafted or modified, possibly to prevent his name, as the presiding officer, from appearing on documents. Administrative rules state “the signature shall be deemed to be a certification that the signer has read the pleading and that, to the best of his knowledge and belief, there is good ground to support it.”
  • directed staff to provide protected information to an influential person which violates Utah securities law prohibiting employees from disclosing non-public information filed with or obtained by the division (Utah Code 61-1-18.3).
  • used coercive settlement tactics by instructing staff to keep unwarranted allegations in the pleadings to serve as a bargaining chip for the negotiations. The respondent agreed to the settlement after the allegations were removed.
Page 30-31

We hope that this provides another look at the issue of having the states responsible for investment advisers with a wide ranging practice which may involve investors from many states.

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Other related hedge fund law articles:

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

Hedge Fund Court Case | SCERS v. Epsilon Global

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Recently, the U.S. District Court for the Western District of Washington came down with a ruling primarily addressing two issues for hedge fund managers: (1) providing investors with timely annual reports and financial statements and (2) delayed redemptions that could bar the management company from charging management fees (see Seattle City Employees’ Retirement System v. Epsilon Global Active Value Fund II, L.P. ).  Although the decision is not binding authority in any jurisdiction, it sheds light on how the redemption provisions in a fund’s offering documents fund’s offering documents can affect the management company’s right to continue charging those fees when a redemption is suspended or delayed.

Case Background & Remedy Sought

On March 15, 2010, Seattle City Employees’ Retirement System (“SCERS”), an investor of Epsilon Global Active Value Fund II, L.P. (“Epsilon”), filed suit against the Epsilon, the general partner, the investment manager, and officers of the fund for failing to provide a 2008 annual report and audited financial statement to its investors.  When SCERS inquired about the required disclosures and did not receive a satisfactory response from the fund, it decided to request a redemption of its investment on January 28, 2010.  About a week later, on February 4, 2010, an Epsilon officer temporarily suspended the redemption of shares in a letter issued to the investors.  The letter stated that the funds had not received their audited financial statement for 2008 because an SEC investigation of one of the funds was pending.

Ultimately, SCERS sought a preliminary injunction to:

  • to disclose the name/address of undisclosed investors, to disclose the name/address of Epsilon’s directors and officers, and
  • to present documents showing investments into the master fund and the specific fund pending SEC investigation,and
  • bar Epsilon from collecting management fees,

Court Findings

Disclosures

The court found that although SCERS would likely succeed on the merits of its claim–that Epsilon breached its agreement to produce an annual report and audited financial statement–the court had no power to cure that breach because Epsilon’s auditors had not completed the report and the court could not compel the production of a non-existent report.  In addition, SCERS was not entitled to the disclosures that it requested.  Neither the offering documents nor the governing substantive law gives SCERS the right to those documents.

Management Fees

With respect to the management fees, the court found that SCERS was unlikely to succeed on the merits.  The court reviewed the redemption provisions in the fund’s offering documents.  The offering documents grant Epsilon two separate authorities–the power to suspend redemptions and the power to delay redemptions (two very common provisions).  The documents provided that the fund shall not charge management fees when the fund delays redemptions, but the documents did not provide that the fund would not charge fees if there was a suspension of redemptions.  The court found that the language Epsilon used in its February 4, 2010 letter to the investors indicated a suspension of redemptions, not a delay.  Therefore, the court could not bar Epsilon from charging management fees.

Other

The court concluded by indicating that SCERS failed to meet the remaining elements required for a preliminary injunction.  In terms of the requested disclosures, SCERS failed to describe what harm would result if it did not receive them.  The court denied SCERS’ motion for a preliminary injunction and with no remaining causes of action, the suit was resolved.

Manager Take-Aways

First, manager should always be aware of the possibility of litigation when redemptions are delayed or suspended and should plan accordingly.  Although the facts we have about this case are limited to what was included in the opinion, it seems like there may have also been ways that the fund managers could have communicated with the investors to avoid litigation.  Another important aspect to this case is drafting of the offering documents – managers should address the issue of management fees on delayed or suspended redemptions.  In this case, the documents were drafted (perhaps unintentionally) in a way that favored the manager.

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

Investment Adviser Representative Information Now Publicly Available on IAPD

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IAPD Update Provides Information on IA Reps

The Investment Adviser Public Disclosure (IAPD) was updated this week so that information on investment adviser representatives will now be available online.  Previously the search function allowed members of the public to access information on IA firms only.  The previous information available through the adviser search function consisted of an advisory firm’s Form ADV, Form ADV Part II and Schedule F.  Now, the IAPD provides the following information on each representative of a registered investment advisory firm:

  • Current employer (including employer’s IARD number and adress)
  • Number of jurisdictions representative is registered in
  • Whether the representative is suspended in any jurisdictions
  • Registration and Employment History (including dates registered at previous firms)
  • Disclosure information (including any U-4 disclosures and current and past complaints)
  • Whether there is information on representative in BrokerCheck (run by FINRA)

Certain representatives will not show up in the system if the person is not currently registered with a state, has not been registered with a state in the last two years, or has not been the subject of a final regulatory event that has been reported to IARD.

It is important for representatives of investment advisory firms to understand that the above information will now be publicly available and may be accessed by investors during the due diligence process.   Accordingly, we recommend reps occasionally check their profile on the IAPD to make sure there is no incorrect information listed.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive regulatory support and hedge fund registration 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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Other related hedge fund law articles:

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

Massachusetts Hedge Fund Exemption

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Exclusion From Definition of Investment Adviser

Generally Massachusetts will require hedge fund managers with a place of business in Massachusetts to register as an investment adviser with the Massachusetts Securities Division.  However, there is an exemption from registration for some hedge fund managers located in Massachusetts.  [Note: to be more accurate, the “exemption” really is an exclusion from the definition of investment adviser under the Massachusetts Securities Act.]

Definition of Investment Adviser

Under Section 401(m) of the Massachusetts Securities Act, the term investment adviser means:

any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as a part of a regular business, issues or promulgates analyses or reports concerning securities. …“Investment adviser” shall not include: … a person whose only clients in this state are federal covered advisers, other investment advisers, broker-dealers, banks, savings institutions, trust companies, insurance companies, investment companies as defined in the Investment Company Act of 1940, employee benefit plans with assets of not less than $5,000,000, governmental agencies or instrumentalities, or other financial institutions or institutional buyers, whether acting for themselves or as trustees with investment control; (emphasis added)

This definition is similar for most states and is based on the Uniform Securities Act which was designed to help standardize state securities laws.  Normally the definition of “other financial institutions or institutional buyers” is not defined under state law or division regulations and will normally be understood to mean large institutions.

Massachusetts has specifically defined “Institutional Buyer”.

Definition of “Institutional Buyer” for Section 401(m)

Under Massachusetts regulations,

Institutional Buyer shall include any of the following:

a. An organization described in Section 501(c)(3) of the Internal Revenue Code with a securities portfolio of more than $ 25 million.

b. An investing entity whose only investors are accredited investors as defined in Rule 501(a) under the Securities Act of 1933 (17 CFR 230.501(a)) each of whom has invested a minimum of $ 50,000.

c. An entity whose only investors are financial institutions and institutional buyers as set forth in M.G.L. c. 110A, § 401(m) and 950 CMR 12.205(1)(a)6.a. and b.

See 950 CMR Section 12.205(1)(a)(6)

For hedge fund managers, section (b) above is important.  A hedge fund would be considered to be an “institutional buyer” if (i) the fund only accepts accredited investors and if (ii) each investor has contributed at least $50,000 to the fund.  If the fund does not meet both parts of the test, the fund will not be an “institutional buyer” and the fund manager would not be excluded from the definition of investment adviser and would need to register as such with the Massachussetts Securities Division.

Consequences for Not Registering

If a fund manager does not meet the two tests above, the manager will need to be registered or face certain consequences.  These consequences may include:

  • An order to cease and desist conducting business
  • A requirement to register with the division
  • Administrative fines
  • Offer of rescission of fund interests to investors
  • Further division scrutiny

Some managers may be tempted to not register but as we can see from a previous Massachussetts Securities Division Complaint against an unregistered hedge fund manager, the consequences and the time/money/effort spent with a formal division complaint will be far more cumbersome than simply registering with the division in the first place.

Conclusion

Many states have intricate laws with respect to hedge fund manager registration.  These laws will become even more important to understand if/when the Wall Street Reform bill passes in which case many SEC registered advisers will need to switch to state registration.

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Other related hedge fund law articles:

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

Hedge Fund Events July 2010

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The following are various hedge fund events happening this month.  Please email us if you would like us to add your event to this list.

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July 1

July 6-7

July 6-7

July 8

July 9

July 12-14

July 12-15

July 13

July 13-14

July 13-15

July 14-15

July 14-16

July 15

July 15

July 15

  • Sponsor: Seattle Alternative Investment Association
  • Event: The China Century
  • Location: Seattle, WA

July 19

July 19-20

July 19-21

July 19-21

July 20

  • Sponsor: Southeastern Hedge Fund Association
  • Event: SEHFA Barbeque
  • Location: Atlanta, GA

July 21

July 21

July 21-22

July 21-23

July 21-23

July 22

July 22

July 22-23

July 22-23

July 27

July 27

July 27

July 27

July 27-28

July 28

  • Sponsor: Bay Area Hedge Funds
  • Event: Bay Area Hedge Fund Roundtable
  • Location: San Francisco, CA

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Bart Mallon, Esq. runs the hedge fund law blog and provides hedge fund registration services through Cole-Frieman & Mallon LLP  He 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.

CFTC Issues Report on NFA Registration Process

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Report Indicates Many Areas Needing Improvement

The CFTC registration process is handled almost exclusively by the NFA and last year the CFTC audited the NFA to see how successful the organization was at conducting the registration process.  The audit report, issued this week, indicates that the NFA needs to improve on many different areas.  One of the most important items which was mentioned a number of times in the report is that the NFA has not standardized the registration process in some areas.

While the CFTC report focuses only on the registration process, there are a number of other issues with the NFA which should have been highlighted.  The first and most important for many managed futures professionals, is the lack of standardization with respect to the disclosure document review process.  CTAs and CPOs both need to have their disclosure documents reviewed by the NFA and during this review process, depending on which examiner is assigned to the review, the process can be relatively straight-forward or quite difficult.  This obviously increases the time before the disclosure document is approved and most likely increases the legal costs involved.  Because our firm completes a number of CTA and CPO registrations each month we see this first hand.

As an anecdote, I have one CPO group who has two separate programs represented by two separate disclosure documents.  The documents are exactly the same except for slightly different investment programs.  These documents went to the NFA for review at the same time and were assigned to two different examiners.  Each deficiency letter came back with about 16 items that needed to be changed for the next draft – however, only 5 were the same!  The fact that two almost exactly same documents receive such disparate treatment is amazing and shows no standardization.  It also perfectly illustrates the oft said statement that “it depends on who you get” when discussing how long it will take for the disclosure documents to be approved.

Below I have included some of the statements I found in the report as well as the CFTC notice.

CFTC Notice: Press Release

The full report: CFTC Report on NFA Registration Process

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Quotes from the Report

The Registration Department does not have a procedures manual that documents all of the procedures followed in processing registrations and withdrawals.

The Registration Department’s procedures manual for the Information Center is, in various areas, incomplete, inconsistent and/or outdated.

[T]he Registration Department tends to concentrate responsibility in a small number of staff members and to depend heavily on these staff members’ institutional knowledge in executing certain registration processing procedures. … This reliance on key persons’ institutional knowledge, coupled with the sparseness of the Registration Department’s documented procedures … interjects an unnecessary level of key person risk to the Registration Department.

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June 24, 2010

CFTC Releases Report on the Registration Program of the NFA

Washington, DC – The Commodity Futures Trading Commission (CFTC) Division of Clearing and Intermediary Oversight (Division) today notified the National Futures Association (NFA) of the results of the Division’s “Report on the Registration Program of the NFA”. In the Report, the Division assessed whether the NFA has sufficient procedures to execute the Commission’s delegated registration and fitness functions.

The Division found that NFA has sufficient procedures to execute the Commission’s delegated functions with respect to the vast majority of registrants. However, the Division also identified nine areas in which the Commission’s and/or NFA’s procedures must be improved.

Copies of the Report are available the Commission’s website at www.cftc.gov.
Last Updated: June 24, 2010

Media Contacts

Scott Schneider
202-418-5174

R. David Gary
202-418-5085

Office of Public Affairs

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Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for commodity pool operators.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Massachusetts RIA Net Worth Reminder

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Today we received an email reminder from the Massachusetts Securities Division with respect to investment adviser minimum financial requirements.  Essentially hedge fund managers registered as investment advisers with Massachusetts will either need to (i) post a $10,000 surety bond or (ii) establish a separate account with $10,000 and maintain a positve net worth.  Managers who choose to establish the separate account need to provide the Securities Division with a balance sheet on an annual basis.

The email stated:

Please see the attached reminder of the Division’s policy regarding minimum financial requirements for certain Massachusetts-based registered investment advisers.  Please call the Division if you have any questions.

The attachment stated:

POLICY STATEMENT

DEMONSTRATION OF POSITIVE NET WORTH FOR CERTAIN MASSACHUSETTS-BASED, STATE-REGISTERED INVESTMENT ADVISERS

The Massachusetts Securities Division (the “Division”) hereby provides this reminder to certain investment advisers described as follows:  those (1) who are required to be registered with the Division; and (2) whose principal place of business is in Massachusetts; and (3) who (i) exercise investment or brokerage discretion, (ii) have custody of clients’ funds or securities, or (iii) require the payment of more than $500 in advisory fees more than 6 months in advance.  The regulation found at 950 CMR 12.205(5) requires such investment advisers to either (a) post a $10,000 surety bond, or (b) establish a separate, segregated account of $5,000 [for (i) above] or $10,000 [for (ii) and/or (iii) above] and maintain at all times a positive net worth.  The Division requires that those investment advisers who choose option (b) demonstrate, on an annual basis, their positive net worth with a certified balance sheet prepared in accordance with generally accepted accounting principles applied on a consistent basis.  See 950 CMR 14.412(C).

If you are registered as an investment adviser in Massachusetts and have any questions, please feel free to contact us at Mallon P.C.

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Cole-Frieman & Mallon LLP provides comprehensive hedge fund start up and regulatory support for managers and registered investment advisers.  Bart Mallon, Esq. can be reached directly at 415-868-5345.

Hedge Fund Registration

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Hedge Fund Registration Overview

After the Wall Street Reform and Consumer Protection Act, hedge funds will be required to register.  When the bill is signed into law, we will update this page with all of the information on the new registration requirement (which will apply to private equity funds as well).

More forthcoming…