As we move into a new year, we have taken the opportunity to prepare an Annual Update for our investment adviser and private fund clients. This Annual Update reflects on major statutory and regulatory changes from 2016, considers recently adopted and potential changes in 2017, and summarizes key upcoming filing deadlines and related compliance best practices. We encourage you to contact us to discuss any of the topics and deadlines.

2016 Retrospective

Adjustment of Qualified Client Definition. On June 14, 2016 (and effective August 15, 2016), the U.S. Securities and Exchange Commission (“SEC”) issued an order increasing the net worth threshold for "qualified clients" under the Investment Advisers Act of 1940 (“Advisers Act”) from $2,000,000 to $2,100,000. This change, reflecting the SEC's obligation to revise the qualified client thresholds to account for inflation, affects investment advisers who contract with clients (including fund investors) for performance-based compensation. The assets-under-management threshold of $1,000,000 is unchanged. Additional information can be found here.

Supreme Court Rejects Effort to Cut Back Insider Trading Liability. On December 6, 2016, the U.S. Supreme Court rejected an attempt to cut back on liability for insider trading where insiders give tips to family members and friends. In Salman v. United States, the Court unanimously held the breach of duty needed to establish insider trading liability is created when an insider tips a family member, even if the tipper does not receive a pecuniary benefit. Additional information about this ruling can be found here.

Defend Trade Secrets Act of 2016. On May 11, 2016, President Obama signed into law the Defend Trade Secrets Act of 2016 (the “DTSA”). The DTSA provides companies with a new federal cause of action for the misappropriation of trade secrets. To take advantage of this new cause of action, however, specific language must be included in a company’s employment and contractor agreements. As many investment advisers rely on trade secrets to protect their “competitive edge”, investment managers should review and amend their existing agreements in light of the DTSA. Additional information about the DTSA and specific requirements can be found here.

Revisions to Form ADV. On August 25, 2016, the SEC adopted revisions to Part 1A of the Form ADV. These revisions become effective on October 1, 2017, meaning that most investment advisers will first encounter the SEC’s revised Form ADV and new informational requests when they file their annual Form ADV amendment in the first quarter of 2018. Additional information about the specific revisions can be found here.

SEC Publishes Guidance on Qualified Institutional Buyer Status. In December 2016, the SEC updated its FAQ regarding an entity’s status as a Qualified Institutional Buyer (“QIB”) under Rule 144A offerings. Under Rule 144A, an entity must have assets of at least $100 million to be considered a QIB. In its updated FAQ, the SEC clarified that securities held in margin accounts count towards the $100 million threshold, but short positions and borrowed securities do not. Relatedly, a limited partnership (such as a private investment fund) can be considered a QIB under Rule 144A if all of its limited partners are QIBs; the general partner of the limited partnership need not be a QIB if the general partner is not also a limited partner. See Section 138 of the FAQ, which can be found here.

Cayman Islands Enacts Limited Liability Company Law. On July 18, 2016, the Cayman Islands enacted the Limited Liability Companies Law, 2016 (the “LLC Law”). The LLC Law created a new entity form in the Cayman Islands (a limited liability company) with features similar to a Delaware limited liability company. This new entity form is available to investment advisers with offshore fund operations. Investment advisers should contact their offshore counsel to determine whether a Cayman limited liability company is appropriate for their current and future fund structuring needs.

Amendment of U.S. Partnership Audit Rules. The rules and procedures used by the IRS when auditing partnerships, including limited partnerships, were recently amended to facilitate the collection of tax payment deficiencies. Under rules enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”), the IRS was required to audit at the partnership level, and assess and collect any tax underpayment at the partner level. In practice, the foregoing approach has been difficult to administer and enforce as the number and complexity of tax partnerships (including limited liability companies taxed as partnerships) has grown. In 2015, Congress repealed the TEFRA partnership audit rules for taxable years beginning after December 31, 2017. In place of TEFRA are new rules that are intended to ease the administrative burden on the IRS in connection with the assessment and collection of underpayments of income tax. Under the new rules and procedures, any adjustment to items of income, gain, loss or deduction is determined at the partnership level, and any underpayment attributable thereto may be assessed and collected at the partnership level, rather than at the partner level. The new approach may cause a portion of the economic burden of any assessed tax to be borne by partners who had no interest in the partnership during the taxable year under audit. Certain partnerships may be able to avoid the foregoing result pursuant to detailed provisions which may allow certain partnerships with 100 or fewer partners, all of which are either individuals or corporations, to elect out of the new rules, and which may allow partnerships to elect to “push out” the tax liability to the persons who were partners during the audited year. The new rules also include complex provisions governing how partnership adjustments and imputed underpayments will be determined, and how interest and penalties will be computed. Given the complexity of the new rules and their potential impact on partners, it is a good time for partnerships to review their agreements to determine if any amendments are necessary or advisable.

2017 Considerations

SEC Examination Priorities. On January 12, 2017, the SEC released its Examination Priorities for 2017 (the “Priorities”). As further described in the Priorities, the SEC will continue its focus on protecting retail investors and minimizing system-wide risks. Specific areas of interest include cybersecurity, anti-money laundering compliance, “roboadvisers”, and investment managers who have yet to be examined. Notably, private fund advisers remain on the list of the SEC’s examination priorities.

Increased Interlocking Directorate Thresholds under Clayton Act. On January 26, 2017, the Federal Trade Commission published its annual revision to the interlocking directorates thresholds under Section 8 of the Clayton Act. These rules prohibit a “person” from serving as officer or director of corporations that compete with each other, unless that competition is very limited. Private equity and venture capital fund sponsors who serve on the Board of Directors for their portfolio companies should review the thresholds to ensure that their directorate activities comply with the rules. Additional information about the increased thresholds can be found here.

President Trump Orders Further Review of “Fiduciary Rule”. In April 2016, the U.S. Department of Labor (“DOL”) released a new rule (the “Fiduciary Rule”) that expanded who is considered a “fiduciary” under the Employee Retirement Income Security Act of 1972. Under the Fiduciary Rule, which was set to become effective in April 2017, certain investment advisers would be subject to a higher “best interest” standard of care with respect to their retirement plan clients. President Trump’s executive order on February 3, 2017 instructed the DOL to prepare additional analyses of the Fiduciary Rule’s impact on the availability retirement savings and financial advice, the pricing of retirement savings services, and related issues. Based on such analyses, the DOL may be required to revise the Fiduciary Rule or eliminate it entirely. It is unclear at this time whether the Fiduciary Rule will ever become effective.

SEC Settles Pay-to-Play Enforcement Actions. In January 2017, the SEC settled enforcement actions against ten separate advisory firms who allegedly received compensation in violation of the pay-to-pay rule from public pension funds to which the firms’ associates had made political contributions within the prior two years. The pay-to-play rule imposes a two year moratorium on providing advisory services for compensation to a government investor if a “covered associate” of an advisory firm has made political contributions to any candidate who can influence the decision of such government investor to engage such advisory firm. Many of the prohibited contributions in the ten enforcement actions were small (such as $400), indicating that the SEC requires strict compliance with the pay-to-play rule. Advisory firms are encouraged to regularly review their pre-clearance procedures and ensure that all employees are aware of the applicable regulations. Additional information about the enforcement actions can be found here.

Supreme Court to Hear Whether 5-Year Statute of Limitations Applies to SEC Disgorgement Actions. In a case with important consequences for SEC enforcement, the U.S. Supreme Court has agreed to address whether a five-year statute of limitations applies to SEC actions seeking disgorgement of ill-gotten gains. If the Supreme Court rules that the statute of limitations does not apply, there is scant limitation on the SEC's power to reach back in time to recover gains from securities law violations. Additional information about the case can be found here.

Anti-Money Laundering. The U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) is expected to publish the final version of a rule that subjects SEC-registered investment advisers (“RIAs”) to the same anti-money laundering (“AML”) rules and regulations applicable to banks, broker-dealers, and other financial institutions. The rule is expected to, amongst other things, require RIAs to develop and implement a written AML program that is designed to identify and prevent the use of the RIA by its investors for money laundering purposes, as well as require the RIA to submit Suspicious Activity Reports for investor activities involving more than $5,000 in funds. As AML regulations continue to expand, we encourage all investment advisers to continually monitor existing regulations and proactively build out their AML compliance programs in anticipation of forthcoming requirements.

AIFMD Passport for US-Based Investment Advisers. While EU-based investment advisers may market their investment funds across the European Economic Area (“EEA”) under a “marketing passport” without the registering under the private placement regimes in each EEA country, US-based investment advisers may not. The European Securities and Markets Authority (“ESMA”), who regulates the marketing passport program, is actively considering expanding the program to include investment advisers based in Canada, Japan, the United States and other countries. However, it is anticipated that any such expansion to US-based investment advisers will include restrictions on the types of funds that can be marketed under the program, such as funds that only admit institutional investors. For the time being, US-based investment advisers will remain subject to the myriad private placement regimes when marketing their investment funds in the EU.

Taxation of Carried Interest. President Trump has indicated that he would support taxing carried interest at ordinary tax rates, but so far there has not been any indication from the President as to whether this is a priority. We will continue to monitor this closely.

On-Going and Annual Compliance Requirements and Best Practices

Investment advisers should incorporate the following annual obligations into their compliance calendars:

• Advisers are required to provide a copy of their privacy policies to clients and fund investors who are natural persons at the beginning of the relationship and then annually. Many advisers satisfy this obligation by providing their privacy policies with their annual ADV delivery.
• Rule 206(4)-7 of the Advisers Act requires advisers to conduct an annual compliance review by reviewing their policies and procedures to ensure their adequacy and effective implementation. In connection with this review, advisers should consider the SEC’s 2017 Examination Priorities (outlined above) and recent risk alerts on topics such as cybersecurity and the use of outsourced chief compliance officers.
• Advisers must collect a personal securities holdings report from each “access person” containing certain required information regarding securities holdings and securities accounts at the time the person becomes an access person, and then annually.
• Advisers should strongly consider adopting cybersecurity policies and procedures to protect the personally identifiable information (“PII”) of its clients. Failure to implement and follow appropriate guidelines for protecting client PII (and other information susceptible to cyber attack) could lead to an enforcement action under Rule 30(a) of Regulation S-P, referred to as the Safeguards Rule. The 2017 Examination Priorities, as have the examination priorities in prior years, indicate the SEC’s continued commitment to examination of investment advisers’ cybersecurity compliance.
• Advisers to private investment funds who are engaged in open or continuous offerings should consider their on-going obligations including:
  • Annual amendments to SEC Form D on or before anniversary of initial Form D filing or most recent amendment. In addition, Form D must be amended as soon as practicable if there are any material mistakes of fact or error or to reflect a change in the information provided in the previously filed notice.
  • Many states require annual renewal of state blue sky notice filings (typically Form D). In addition, updates to a blue sky filing may be required if there are material changes to information in the filing (e.g., name or address).
  • Private funds, their general partners, investment advisers and placement agents should obtain updated certifications and review their obligations under the Bad Actor Rule (Rule 506(d) of Regulation D) at least on an annual basis, if not more frequently.

Best Practices

The following is a brief list of best practices that we recommend private fund advisers consider at least annually:

• Review disclosures in marketing materials, partnership agreements, offering memoranda and side letters for any certifications, notices and reporting obligations. Ensure that your disclosures in Form ADV, Form PF and your offering documents are consistent and representative of your business. Confirm fee and expense allocations conform with your offering documents, internal policies and procedures and investor communications.
• Confirm ongoing monitoring of the ERISA plan asset Also, have you committed to deliver VCOC or REOC certifications?
• Consider seeking an annual representation from all fund investors as to any changes in their eligibility to participate in profits and losses from new issues.
• Review state and local lobbyist filings and monitor required obligations.
• Perform diligence on Key Service Providers. Are there any material service level issues that need to be addressed? Distribute questionnaires, conduct on-site visits and background checks as necessary.
• Review recent guidance issued by the SEC concerning activities that do and do not qualify as “general solicitation” for purposes of offerings under Regulation D. Review fundraising and marketing activities to ensure they are in line with the recent guidance and take appropriate steps to comply moving forward.

Selected 2017 Compliance Calendar

The following compliance calendar includes selected deadlines for SEC-registered investment advisers and is not indented to be complete. State-registered investment advisers may be subject to additional or different deadlines. Please contact us to discuss which deadlines are applicable to you.

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