SEC Releases

No Comment
SEC Proposes Rule Amendments to Allow General Solicitation and General Advertising in Rule 506 Offerings

The Securities and Exchange Commission proposed yesterday, August 29, 2012, amendments to Rule 506 of Regulation D and Rule 144A under the Securities Act of 1933 as directed by the Jumpstart Our Business Startups Act. The SEC proposed new Rule 506(c) which allows general solicitation and general advertising, provided that all purchasers are accredited investors, the issuer takes reasonable steps to verify that the purchasers are accredited investors, and the satisfaction of certain other terms and conditions of Regulation D. The SEC also proposed amendments to Rule 144A allowing offers to persons other than qualified institutional buyers, including through general solicitation, provided that the securities are sold only to persons that the seller or its representative reasonably believe are qualified institutional buyers.

I. Background

A. Current Framework

Section 5 of the Securities Act of 1933 (“Securities Act”) requires that every time a security is sold, it either must be registered with the Securities and Exchange Commission (“SEC”) or exempt from registration. Section 4(a)(2) of the Securities Act exempts transactions by an issuer “not involving any public offering.”

Rule 506 of Regulation D, one of the safe harbors available under Section 4(a)(2), exempts private offerings from registration requirements of the Securities Act of 1933. Currently, Rule 506 allows offers and sales by issuers without any limitation on the offering amount, to an unlimited number of “accredited investors”[1] and up to 35 non-accredited sophisticated investors,[2] subject to certain requirements and conditions, including Rule 502(c)’s requirement that any offer or sale may not be through any form of “general solicitation or general advertising.” By rule and interpretation, examples of “general advertising” include newspaper and magazine, communications broadcast over television and radio, seminars whose attendees were invited by general solicitation, and other uses of publicly available media, such as unrestricted websites. To demonstrate that a general solicitation has not occurred, the issuer or its agent must have a pre-existing, substantive relationship with the potential investor. A substantive relationship exists when the issuer has information regarding a potential offeree such that the issuer can evaluate the prospective offeree’s sophistication and financial circumstances. A relationship is pre-existing if it existed for some duration prior to the current private offering.[3]

Rule 144A is a safe harbor exemption from the registration requirements of the Securities Act for resales of certain “restricted securities”[4] to qualified institutional buyers (“QIBs”). Currently, Rule 144A provides offers of securities only to QIBs, which has the practical effect of a prohibition against general solicitation.

The estimated capital raised in 2011, based off of debt and equity Form D filings, through Rule 506 and Rule 144A offerings was $895 billion and $168 billion, respectively (or approximately $1,063 billion combined), compared to $984 billion raised in registered offerings.

B. Section 201(a) of the JOBS Act

The Jumpstart Our Business Startups Act (the “JOBS Act”) was enacted on April 5, 2012. Section 201(a) thereof directed the SEC to modify certain rules within 90 days of its enactment.

Section 201(a)(1) of the Jumpstart Our Business Startups Act (the “JOBS Act”) directed the SEC to amend Rule 506 of Regulation D to permit general solicitation or general advertising in offerings made under Rule 506, provided that all purchasers of the securities are accredited investors, and that the issuer shall be required “to take reasonable steps to verify that purchasers of the securities are accredited investors[.]”

Section 201(a)(2) of the JOBS Act directed the SEC to revise Rule 144A(d)(1)11 under the Securities Act to permit offers of securities pursuant to Rule 144A to persons other than QIBs, including by means of general solicitation or general advertising, provided that the securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are QIBs.

II. Proposed Amendments to Rule 506 and Related Issues

A. Proposed New Rule 506(c)

Proposed Rule 506(c) would permit the use of general solicitation, and not be subject to compliance with Rule 502(c), to offer and sell securities under Rule 506,[5] provided the following conditions are satisfied:

  • the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors;
  • all purchasers of securities must be accredited investors, either by way of one of the enumerated categories in Rule 501(a) or the issuer reasonably believes that they do, at the time of the sale of the securities;
  • and all terms and conditions of Rule 501 and Rules 502(a) and 502(d) must be satisfied.

NOTE: Broker-dealers participating in offerings relying on proposed Rule 506(c) would continue to be subject to the rules of FINRA regarding communications with the public. See FINRA Rule 2210.

B. Reasonable Steps to Verify Accredited Investor Status

The SEC proposes an objective standard, based on the particular facts and circumstances, that issuers are required to “take reasonable steps to verify” that the purchasers are accredited investors. Examples of the non-exclusive and interconnected factors include:[6]

  • the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
    • Verification varies depending on type of accredited investor – e.g. a broker-dealer’s status could be checked on FINRA’s BrokerCheck website
  • the amount and type of information that the issuer has about the purchaser; and
    • The more information an issuer has indicating that a prospective purchaser is an accredited investor, the fewer steps it would have to take, and vice versa
    • Examples of information include: publicly available information in filings with a federal, state or local regulatory body; W-2, personal bank and brokerage account statements; average annual compensation as provided in industry/trade publications; and reasonable reliance on verification by broker-dealer, attorney or accountant.
  • the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.
    • The more public the offering (e.g. website or media versus pre-screened database by reasonably reliable third-party), the more information to verify
    • Ability to meet high minimum investment, not through financing

In addition, the SEC provides the following additional guidance for compliance: (i) issuers should retain adequate records that document the steps taken to verify that a purchaser was an accredited investor[7] and (ii) many practices currently used by issuers in connection with existing Rule 506 offerings are anticipated to satisfy the proposed verification requirements.

C. Reasonable Belief that All Purchasers Are Accredited Investors

The proposal clarifies the intent that the reasonable belief standard will continue to apply to Rule 506(c). If a person purchases securities who does not meet the criteria for any category of an accredited investor in a Rule 506(c) offering, the SEC believes that the issuer would not lose the ability to rely on the proposed Rule 506(c) exemption, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor.

D. Form D Check Box for Rule 506(c) Offerings

SEC proposal only adds or amends check boxes on Form D relating to the type of federal exemptions and exclusions claimed, including Rule 506(c) under Item 6 of Form D.

E. Specific Issues for Privately Offered Funds

The SEC interprets the directive contained in the JOBS Act to apply to the two common exemptions claimed by hedge funds from the provisions of the Investment Company Act of 1940.[8] Section 3(c)(1) excepts from the definition of investment company a fund that meets two requirements: (i) it must be beneficially owned by less than 100 persons and (ii) “which is not making and does not presently propose to make a public offering of its securities.” Section 3(c)(7) applies to any issuer, the outstanding securities of which are owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers,” and which is not making and does not at the time propose to make a public offering of such securities. As the SEC has historically regarded Rule 506 transactions as non-public offerings for the purposes of Sections 3(c)(1) and 3(c)(7), they believe the effect of the JOBS act is to permit such privately offered funds to make a general solicitation under the proposed Rule 506(c) without losing the exclusions under the Investment Company Act.

IV. Proposed Amendment to Rule 144A – Offers to Persons Other Than Qualified Institutional Buyers

SEC proposes to amend Rule 144A(d)(1) to eliminate the references to “offer” and “offeree,” which would allow for general solicitation, but the limitation as to the purchasers remain – securities must be sold to a QIB or a purchaser that the seller and any person acting on behalf of the seller reasonably believe is a QIB.

IV. Integration with Offshore Offerings

The SEC clarifies that, consistent with historical treatment, concurrent offshore offerings that are conducted in compliance with Regulation S would not be integrated with domestic unregistered offerings that are conducted in compliance with Rule 506 or Rule 144A, as proposed to be amended. Therefore, in a global offering where the United States portion is conducted in accordance with proposed rule 506(c) or proposed amended Rule 144A, it would not run afoul of the second of the two general conditions for safe harbor under Regulation S – no directed selling effort in the United States.[9]

V. Comments

The SEC requests comments within 30 days of publication on the proposal, including its operation, procedure and alternatives.

Full Text of Proposal: Release No. 33-9354

 

[1] Rule 501(a) of Regulation D

[2] Rule 506(b)(2)(ii) requires non-accredited investors, up to 35, to have “such knowledge and experience in financial and business matters that he [or she] is capable of evaluating the merits and risks of the prospective investment.”

[3] E.F. Hutton & Company Incorporated, SEC No Action Letter, December 3, 1985.

[4] “Restricted securities” include, in part, “[s]ecurities acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a chain of transactions not involving a public offering.” Rule 144(a)(3) of the Securities Act.

[5] Existing Rule 506(b) would be preserved for issuers not interested in general solicitation or that wish to sell privately up to 35 non-accredited investors meeting its sophistication requirements.

[6] The SEC specifically avoided any exclusive or non-exclusive list and further provides that the factors are interconnected – the information gained by looking at factors would help assess likelihood of being an accredited investor and thus, affect the types of steps required to verify.

[7] An issuer claiming an exemption from the registration requirements of Section 5 of the Securities Act has the burden of showing that it is entitled to that exemption.

[8] Section 3(a)(1) of the Investment Company Act of 1940 defines an investment company as any issuer of securities which “is or holds itself out as being engaged primarily or proposes to engage primarily, in the business of investing, reinvesting or trading in securities.”

[9] Rule 902(c)(1) “directed selling effort” is broadly defined as “conditioning the market” in the U.S. for any of the securities offered in reliance on Regulation S, which includes placing an advertisement in a publication “with a general circulation in the United States” referring to the Regulation S offering.

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No Comment
Net Worth Standard for Accredited Investors – Securities Act Release No. 9287

On December 21, 2011, the Securities and Exchange Commission, in Securities Act Release No. 9287, amended net worth standard in the definition of “accredited investor” excluding the value of a person’s home from net worth calculations in order to participate in unregistered securities offerings as required by the Dodd-Frank Wall Street Reform Act and Consumer Protection Act (the “Dodd-Frank Act”). The amendments clarify the treatment of borrowing secured by a primary residence for purposes of the net worth calculation and under limited circumstances, permit persons who previously qualified as accredited investors pre-Dodd-Frank Act to use the prior net worth standard definition for certain follow-on investments.

Summary

The most significant revisions from the proposed rule include the addition of (i) a grandfathering provision that permits the application of the former accredited investor net worth test in certain limited circumstances and (ii) a provision addressing the treatment of incremental debt secured by the primary residence that is incurred in the 60 days before the purchase of securities.

Grandfather Provision

The grandfather provision allows an investor to re-invest in a particular security under the pre-Dodd-Frank Act definition of net worth if the following requirements are satisfied: (i) the right to purchase was held by the person on July 20, 2010 (day before the effectiveness of the Dodd-Frank Act); (ii) person qualified as an accredited investor on the basis of net worth at the time of acquiring such right; and (iii) person actually held securities of the same issuer, other than such right, on July 20, 2010.

Mortgage Debt
 

Under the amended net worth calculation, indebtedness secured by the person’s primary residence, up to the estimated fair market value of the primary residence, is not treated as a liability. Exceptions include indebtedness secured by a person’s primary residence in excess of the property’s estimated fair market value or borrowing that occurs in the 60 days preceding the purchase of securities in the exempt offering and is not in connection with the acquisition of the primary residence. In both cases, the excess debt or the recent debt acquired must be treated as a liability in the net worth calculation.

Of importance, the 60 day look-back provision was intended to prevent manipulation of the net worth standard by eliminating the ability of individuals to artificially inflate net worth by borrowing against home equity shortly before participating in an exempt securities offering. Further, the rules do not require a third party opinion on valuation of the primary residence or for any other assets or liabilities – only an estimate of fair market value.

Amended Net Worth Standard 

The individual net worth standard in the accredited investor definition in Rule 501 and 215 of the Securities Act of 1933 is:

Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000.

(1) Except as provided in paragraph (2) of this section, for purposes of calculating net worth under this paragraph:

(i) The person’s primary residence shall not be included as an asset;

(ii) Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (except that if the amount of such indebtedness outstanding at the time of the sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess shall be included as a liability); and

(iii) Indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities shall be included as a liability.

(2) Paragraph (1) of this section will not apply to any calculation of a person’s net worth made in connection with a purchase of securities in accordance with a right to purchase such securities, provided that:

(i) such right was held by the person on July 20, 2010;

(ii) the person qualified as an accredited investor on the basis of net worth at the time the person acquired such right; and

(iii) the person held securities of the same issuer, other than such right, on July 20, 2010.

Other Issues Considered

The SEC determined to not change the proposed rules to:

  • Define “primary residence”
  • Generally, exclude debt secured by a primary residence whether or not the proceeds were used to invest in securities (except for the 60 day look-back provision)

Effective Date: 60 days after publication in the Federal Register

If you have any questions on Securities Act Release No. 9287 or any other legal matter, please contact any of the partners at Evans & Kob, PC at info@eklawpc.com.

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No Comment
SEC’s Whistleblower Program is Officially Launched

On Friday, August 12, 2011, the Securities and Exchange Commission’s much discussed whistleblower program became effective with the launch of a new webpage for people to report a violation of the federal securities laws and apply for a financial award and the introduction of the new Office of the Whistleblower.

To be considered for an award, the final rules require that a whistleblower must:

  • Voluntarily provide the SEC …
    • In general, a whistleblower is deemed to have provided information voluntarily if the whistleblower has provided information before the government, a self-regulatory organization or the Public Company Accounting Oversight Board asks for it directly from the whistleblower or the whistleblower’s representative.
  • … with original information …
    • Original information must be based upon the whistleblower’s independent knowledge or independent analysis, not already known to the SEC and not derived exclusively from certain public sources.
  • … that leads to the successful enforcement by the SEC of a federal court or administrative action …
    • A whistleblower’s information can be deemed to have led to a successful enforcement action if:
    1. The information is sufficiently specific, credible and timely to cause the Commission to open a new examination or investigation, reopen a closed investigation, or open a new line inquiry in an existing examination or investigation.
    2. The conduct was already under investigation when the information was submitted, and the information significantly contributed to the success of the action.
    3. The whistleblower reports original information through his or her employer’s internal whistleblower, legal, or compliance procedures before or at the same time it is passed along to the SEC; the employer provides the whistleblower’s information (and any subsequently-discovered information) to the SEC; and the employer’s report satisfies prongs (1) or (2) above.
  • … in which the SEC obtains monetary sanctions totaling more than $1 million.
    • The rules permit aggregation of multiple SEC cases that arise out of a common nucleus of operative facts as a single action. These may include proceedings involving the same or similar parties, factual allegations, alleged violations of the federal securities laws, or transactions or occurrences.

A successful blower may be entitled to 10-30% of the SEC sanctions over $1 million.

Contact Evans & Kob for experienced regulatory and legal counsel regarding whistleblower claims or any broker-dealer and investment adviser, arbitration, regulatory or securities matter at info@eklawpc.com.

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No Comment
SEC Proposes Rules on Disclosure of Incentive-Based Compensation Arrangements at Financial Institutions

On March 2, 2011, the Securities and Exchange Commission proposed rules to require certain financial institutions, broker-dealers and investment advisers with $1 billion or more in assets, to disclose their incentive-based compensation practices and prohibit such institutions from having compensation arrangements that encourage inappropriate risks.

Proposed Rules

1) Disclosures about Incentive-Based Compensation Arrangements

Annual Filing with appropriate federal regulator information including:
Narrative description of the components of the firm’s incentive-based compensation
Description of the firm’s policies and procedures governing such arrangements
A statement of why the firm believes the structure will help prevent it from suffering a material financial loss and/or why it does not provide covered persons with excessive compensation

2) Prohibition on Encouraging Inappropriate Risk

General prohibition against establishing or maintaining an incentive-based compensation arrangement that encourages inappropriate risks by providing excessive compensation, or that could lead to material financial loss – deemed assumption unless arrangements meet certain standards

“Covered persons” include executive officers, employees, directors, or principal shareholders

Prohibitions for larger financial institutions – specific requirements for executive officers and certain other designated individuals at financial institutions with $50 billion or more in total consolidated assets – 3 year deferral at least 50% of incentive-based compensation and must be adjusted for losses incurred

3) Establishing Policies and Procedures

A covered financial institution would be barred from establishing such arrangement unless the arrangement has been adopted under policies and procedures developed and maintained by the institution and approved by its board of directors.

Comments: should be received within 45 days after it is published in the Federal Register.

Assuming the rules are approved, financial institutions will need to significantly alter policies and procedures regarding incentive-compensation arrangements to ensure and monitor compliance with the requirements. Please contact our firm if you need experienced legal representation and advice if you need assistance updating your written supervisory procedures, providing comments to the SEC, or any other regulatory or arbitration related legal assistance at info@eklawpc.com.

Link: Broker-Dealer Advisory Services and Investment Adviser Services

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No Comment
SEC Approves FINRA New Member Restrictions Regarding Disqualified Persons

On February 18, 2011, the Securities and Exchange Commission issued Release No. 34-63933, approving FINRA Rule 1113 (Restrictions Pertaining to New Member Applications) and amendments to the FINRA Rule 9520 Series (Eligibility Proceedings) to restrict new applicants’ and certain members’ association with disqualified persons based on the belief that “new member applicant[s] should enter FINRA membership free of the supervisory and operating concerns raised by association with a statutorily disqualified person or being itself subject to a statutory disqualification.”

FINRA Rule 1113 (Restrictions Pertaining to New Member Applications)

FINRA shall reject any application for membership in which either the applicant or an associated person is subject to a statutory disqualification. Further, any approval in error shall be subject to cancellation.

FINRA Rule 9520 Series (Eligibility Proceedings)

The amendments to Rule 9520, which sets forth the eligibility proceedings for membership, would:

  1. remove the ability of new members to sponsor the association of a disqualified person;
  2. clarify that a new member applicant is not eligible to submit an application for relief  if the new member itself is subject to disqualification; and
  3. preclude any member from sponsoring the association the association or continued association of a disqualified person, who is directly or indirectly a beneficial owner or more than 5% of the sponsoring member, to be admitted, readmitted or permitted to continue in association.

Statutory Disqualification – Securities Exchange Act Section 3(a)(39)

A person is subject to a “statutory disqualification” with respect to a membership or participation in, or association with a member of, a self-regulatory organization if such person, among others: (1) has been convicted of certain misdemeanors or any felony criminal convictions within the ten years preceding the date of the filing of an application for membership or participation in, or to become associated with a member of, such SRO; (2) is subject to a temporary or permanent injunction (regardless of its age) issued by a court of competent jurisdiction involving at least one of a broad range of unlawful investment activities; (3) has been expelled or suspended from membership or participation in an SRO; or, (4) is subject to an SEC order denying, suspending, or revoking broker-dealer registration.

Experienced counsel is important in the new membership application phase with FINRA. Our attorneys have not only advised broker-dealers, but also formed and operated national and wholesale broker-dealers. If you have a question regarding about a potential or ongoing membership application, contact Evans & Kob PC for expert legal representation and counsel at info@eklawpc.com.

Link: Broker-Dealer Advisory Services

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No Comment
Proposed Rule: Net Worth Standard for Accredited Investors – Release 9177

On January 25, 2011, the Securities and Exchange Commission proposed a revised net worth standard as required under the Dodd-Frank Street Reform and Consumer Protection Act in Securities Act Release Number 9177. The SEC has requested comments by March 11, 2011. The link above is a summary of the important proposals of the SEC’s Release 9177, in particular the proposed amendment to the definition of accredited investor. For a summary of the release, please go to our resources section of the website. For the full text, please visit the Securities and Exchange Commission’s site.

Link: Securities Offerings practice area

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No Comment
SEC Extends with Additional Conditions the No Action Letter for Broker-Dealers Relying on Registered Investment Advisers for Customer Identification Program

The SEC Division of Trading and Markets extended, but amended by increasing the conditions, for broker-dealers relying on registered investment advisers to perform customer identification program (“CIP”) requirements. On January 11, 2011, the SEC agreed to extend for two years the position taken in a 2004 No-Action Letter (and subsequent extensions in 2005, 2006, 2008 and 2010), which permitted broker-dealers to rely upon registered investment advisers to perform CIP as a result of the Securities Industry and Financial Market Association’s request for No-Action relief on behalf of its member broker-dealers. Section 326 of the USA PATRIOT Act of 2001 requires financial institutions (including broker-dealers) to obtain, verify and record information that identifies each person opening an account (see FINRA, Customer Identification Notice).

Background

The PATRIOT Act requires financial institutions to establish to establish Anti-Money Laundering Programs (“AML Program Rule”) and to have a Customer Identification Program (“CIP”), implemented by 31 C.F.R. § 103.121. The CIP regulation provides that a financial institution may rely on another financial institution subject to the Act, see 31 C.F.R. § 103.121(b)(6), but registered investment advisers are not a financial institution subject to the AML Program Rule requirements of the PATRIOT Act (rules were proposed, but withdrawn by FinCEN). The No-Action Letter issued in 2004 first provided no-action relief allowing a broker-dealer to rely upon a registered investment adviser (“RIA”) to perform some or all of its CIP obligations by treating the RIA as if were subject to the AML Program Rule, which was subsequently and modified in 2005, 2006, 2008 and 2010.

The No-Action Letter issued on January 11, 2011 (“2011 No-Action Letter”) further modifies the requirements for no-action relief by requiring that broker-dealers to undertake appropriate due diligence of the registered investment adviser (RIA) and enter into an agreement with specific performance and production obligations.

Conditions Required in Order to Rely on the 2011 No-Action Letter

In the 2011 No-Action Letter, the Division of Trading and Markets will not recommend enforcement under Rule 17a-8 under the Securities Exchange Act of 1934 if a broker-dealer treats an investment adviser as if were subject to an AML Program Rule for purposes of 31 C.F.R. § 103.121(b)(6) provided that other provisions of the CIP Rule are met, and:

  1. the broker-dealer’s reliance on the investment adviser is reasonable under the circumstances (discussed below)
  2. the investment adviser is a U.S. investment adviser registered with the SEC under the Investment Advisers Act of 1940; and
  3. the investment adviser enters into a contract with the broker-dealer in with specific performance and production obligations (discussed below)

Agreement with the Registered Investment Adviser

The broker-dealer must enter into a contract with the registered investment in which the investment adviser agrees that:

  1. it has implemented its own AML Program consistent with the requirements of 31 U.S.C. 5318(h) and will update such AML Program as necessary to implement changes in applicable laws and guidance;
  2. it (or its agent) will perform the specified requirements of the broker-dealers CIP in a manner consistent with Section 326 of the PATRIOT Act;
  3. it will promptly disclose to the broker-dealer potentially suspicious or unusual activity detected as part of the CIP being performed on the broker-dealer’s behalf in order to enable the broker-dealer to file a Suspicious Activity Report, as appropriate based on the broker-dealer’s judgment;
  4. it will certify annually to the broker-dealer that the representations in the reliance agreement remain accurate and that it is in compliance with such representations; and
  5. it will promptly provide its books and records relating to its performance of CIP to the SEC, to an SRO that has jurisdiction over the broker-dealer, or to authorized law enforcement agencies, either directly or through the broker-dealer, at the request of (i) the broker-dealer, (ii) the SEC, (iii) an SRO that has jurisdiction over the broker-dealer or (iv) an authorized law enforcement agency.

The 2011 No-Action Letter specifically lists whom the RIA must provide its books and records on direct request (as opposed to a request of the broker-dealer), which includes the self-regulatory agency with jurisdiction over the broker-dealers, such as FINRA.

Due Diligence Requirements

Of importance, the 2011 No-Action Letter requires that the reliance of the broker-dealer on the registered investment adviser (RIA) must be reasonable. To establish reasonableness of the reliance, a broker-dealers must undertake “appropriate due diligence on the investment adviser…commensurate with the broker-dealer’s assessment of the anti-money laundering risk presented by the investment adviser and the investment adviser’s customer base.” The due diligence must be undertaken at both “the outset” of the relationship with the RIA and “updated during the course of the relationship, as appropriate.”

In particular, prior to any reliance on the RIA, broker-dealers must assess the AML risks of the investment adviser and its customer base and must update the due diligence during relationship, depending on such risks and circumstances arising subsequent to establishment of the relationship. Therefore, broker-dealers will need to establish procedures to address how they will conduct the requisite due diligence, and in particular the AML risks associated with both the investment adviser and its customer base, and the extent and timing of ongoing due diligence depending on such risks.

In addition, a broker-dealer may choose to not rely on the no-action relief of the 2011 No-Action Letter while still contractually delegating the implementation and operation of its CIP to a registered investment adviser, but the broker-dealer will remain solely responsible for assuring compliance with the CIP Rule; thus, a broker-dealer must actively monitor the operation of its CIP and assess its effectiveness.

Conclusion

Broker-dealers relying on the 2011 No-Action Letter should adopt reasonable procedures to address their due diligence requirements and review any existing agreements to verify such agreements contain appropriate performance and production obligations on the registered investment adviser. For additional assistance regarding due diligence procedures or drafting effective agreements with registered investment advisers, please contact Evans & Kob PC at info@eklawpc.com.

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No Comment
SEC Issues Compliance Extension to Part 2B of Form ADV and the Brochure Supplement

On December 28, 2010, the Securities and Exchange Commission issued Release No. IA-3129, which among other things extended the compliance date for Part 2B of the Form ADV, the brochure supplement and rules related to delivery of the supplement for registered investment advisers under the Investment Advisers Act of 1940.

Background

Previously, the SEC adopted amendments to the Investment Advisers Act of 1940 to require registered investment advisers to provide clients with a brochure and brochure supplements written in plain English. The brochure contains information about the advisory firm, while the supplement contains information about the advisory personnel. Without the extension discussed below, most existing advisers would be required to deliver brochure supplements to new and prospective clients no later than March 31, 2011 and to existing clients no later than May 31, 2011. The extension only applies to the following:

Existing Registered Investment Advisers

Investment Advisers registered with the SEC as of December 31, 2010, and having a fiscal year ending on December 31, 2010 through April 30, 2011, now have until July 31, 2011 to begin delivering brochure supplements to new and prospective clients and until September 30, 2011 to deliver supplements to existing clients. The dates remain unchanged for those with fiscal years ending after April 30, 2011.

Newly-registered Investment Advisers

Advisers filing applications for registration from January 1, 2011 through April 30, 2011, have until May 1, 2011 to begin delivering brochure supplements to new and prospective clients and until July 1, 2011 to deliver supplements to existing clients. The dates remain unchanged for those filing applications for registration after April 30, 2011.

California Department of Corporations – Securities Regulation Division

The Securities Regulation Division of the California Department of Corporations also is extending the deadline to be consistent with the SEC.

Please contact our firm if you need assistance completing your brochure supplement, Form ADV, responding any regulatory issue, modifying your policies and procedures, assessing your compliance risks, ror any other regulatory or arbitration related legal advice at info@eklawpc.com.

Link: Investment Adviser Services

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