This memorandum contains information regarding eligible and ineligible uses of soft dollars within the safe harbor found under Section 28(e) of the Securities Exchange Act of 1934. This memo is structured in three parts: (i) discusses, generally, the eligibility of research services; (ii) discusses, generally, the eligibility of brokerage activities; and (iii) discusses, generally, mixed-use items. Continue reading
The Securities Exchange Act of 1934 (the “Exchange Act”) is a very important act for hedge fund managers. This act affects many aspects of the hedge fund industry and Section 10 (and accompanying Rule 10b-5) is a central source of power for the SEC. I have included an overview of the important sections of the Exchange Act and have also included the SEC’s summary discussion of the Act as well. This is not meant to be exhaustive and you should discuss any questions you have with your hedge fund attorney.
Section 3 – Definitions
One of the more important questions in the hedge fund industry is whether or not the managers of hedge funds need to be registered as brokers under the Exchange Act. The SEC has provided guidance on broker registration which indicates that hedge fund managers may be required to register as brokers. While only a few of the very large hedge funds actually follow the prudent practice of registering a manager as broker, it is an issue which hedge fund managers should be aware of.
Below is the definition of a broker which is extremely broad.
The term “broker” means any person engaged in the business of effecting transactions in securities for the account of others.
Section 10 – Manipulative and Deceptive Devices
It is very important that hedge fund managers do not engage in manipulative or deceptive practices. Because of the importance of this section, I have published it in its entirety:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange-
(1) To effect a short sale, or to use or employ any stop-loss order in connection with the purchase or sale, of any security registered on a national securities exchange, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
(2)Paragraph (1) of this subsection shall not apply to security futures products.
(b)To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
Rules promulgated under subsection (b) that prohibit fraud, manipulation, or insider trading (but not rules imposing or specifying reporting or recordkeeping requirements, procedures, or standards as prophylactic measures against fraud, manipulation, or insider trading), and judicial precedents decided under subsection (b) and rules promulgated thereunder that prohibit fraud, manipulation, or insider trading, shall apply to security-based swap agreements (as defined in section 206B of the Gramm-Leach-Bliley Act) to the same extent as they apply to securities. Judicial precedents decided under section 17(a) of the Securities Act of 1933 and sections 9, 15, 16, 20, and 21A of this title, and judicial precedents decided under applicable rules promulgated under such sections, shall apply to security-based swap agreements (as defined in section 206B of the Gramm-Leach-Bliley Act) to the same extent as they apply to securities.
Section 12(g)(1) is important for hedge fund managers of Section 3(c)(7) hedge funds. This provision provides that a Section 3(c)(7) hedge fund would need to register under the Exchange Act as a reporting company if the hedge fund had more than $10,000,000 in assets and 500 or more investors.
Section 13 Reporting Requirements
There are three main reporting items which hedge funds need to be aware of under Section 13.
Section 13(d) – hedge fund managers which “beneficially own” more than 5% of a class of publicly traded equity securities must file disclosure reports within 10 days of the acquisition of the 5% share. Managers will file a Schedule 13D with the SEC.
Section 13(f) – requires hedge fund managers which have investment discretion over $100 million or more of publicly traded equity securities to file quarterly reports. These quarterly reports disclose the amount and type of the hedge fund’s holdings. Managers will file a Schedule 13F with the SEC.
Please also see a discussion of Section 13F filings for hedge funds.
Section 13(g) – certain hedge fund managers which “beneficially own” more than 5% of a class of publicly traded equity securities can make an alternative filing under this section in lieu of the Schedule 13D filing. Managers will file a Schedule 13G with the SEC.
Provides certain rules applicable to hedge funds which are involved in activist investing or getting involved in portfolio companies. Section 16 applies if the fund owns more than 10% of a class of the public’s company’s outstanding equity securities. Section 16 may also apply if directors or employees of a hedge fund serve as an officer or director of a publicly traded company.
Section 28(e) provides the statutory safe harbor for certain “soft dollar” practices.
In addition to the above sections, below is the SEC’s description of the Securities Exchange Act of 1934 and its important provisions. This description can also be found here.
Securities Exchange Act of 1934
With this Act, Congress created the Securities and Exchange Commission. The Act empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation’s securities self regulatory organizations (SROs). The various stock exchanges, such as the New York Stock Exchange, and American Stock Exchange are SROs. The National Association of Securities Dealers, which operates the NASDAQ system, is also an SRO.
The Act also identifies and prohibits certain types of conduct in the markets and provides the Commission with disciplinary powers over regulated entities and persons associated with them.
The Act also empowers the SEC to require periodic reporting of information by companies with publicly traded securities.
Companies with more than $10 million in assets whose securities are held by more than 500 owners must file annual and other periodic reports. These reports are available to the public through the SEC’s EDGAR database.
The Securities Exchange Act also governs the disclosure in materials used to solicit shareholders’ votes in annual or special meetings held for the election of directors and the approval of other corporate action. This information, contained in proxy materials, must be filed with the Commission in advance of any solicitation to ensure compliance with the disclosure rules. Solicitations, whether by management or shareholder groups, must disclose all important facts concerning the issues on which holders are asked to vote.
The Securities Exchange Act requires disclosure of important information by anyone seeking to acquire more than 5 percent of a company’s securities by direct purchase or tender offer. Such an offer often is extended in an effort to gain control of the company. As with the proxy rules, this allows shareholders to make informed decisions on these critical corporate events.
The securities laws broadly prohibit fraudulent activities of any kind in connection with the offer, purchase, or sale of securities. These provisions are the basis for many types of disciplinary actions, including actions against fraudulent insider trading. Insider trading is illegal when a person trades a security while in possession of material nonpublic information in violation of a duty to withhold the information or refrain from trading.
Registration of Exchanges, Associations, and Others
The Act requires a variety of market participants to register with the Commission, including exchanges, brokers and dealers, transfer agents, and clearing agencies. Registration for these organizations involves filing disclosure documents that are updated on a regular basis.
The exchanges and the National Association of Securities Dealers (NASD) are identified as self-regulatory organizations (SRO). SROs must create rules that allow for disciplining members for improper conduct and for establishing measures to ensure market integrity and investor protection. SRO proposed rules are published for comment before final SEC review and approval.
The full text of this Act can be read at: http://uscode.house.gov/download/pls/15C2B.txt. (Please check the Classification Tables maintained by the US House of Representatives Office of the Law Revision Counsel for updates to any of the laws.)