Editor column

Citation

Davis, H.A. (2012), "Editor column", Journal of Investment Compliance, Vol. 13 No. 2. https://doi.org/10.1108/joic.2012.31313baa.001

Editor column

Article Type: Editor column From: Journal of Investment Compliance, Volume 13, Issue 2

Henry A. Davis

We begin this issue with a 2012 regulatory watch list for hedge funds and other private funds by James Cain, Daphne Frydman, David Roby, Michael Koffler, and Raymond Ramirez. The authors comment that they wrote the alert because many funds are not yet focused, or just starting to focus, on the potential impact of recent changes in Commodity Futures Trading Commission (CFTC) oversight of commodity interests and the implications of these changes for their business, including registration and compliance obligations. Post-Dodd-Frank, such interests, and the entities that invest/trade in such interests, will be subject to increased oversight. In particular:

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  The Dodd-Frank Act expanded the CFTC’s reach by being more inclusive in the types of activities that are subject to oversight and, by extension, the entities engaging in those activities, i.e. including swaps as commodity interests and those investing in them as commodity pools.

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  The CFTC, in furtherance of the Dodd-Frank’s goals, has limited possible exemptions and exclusions from registration as a commodity pool operator (CPO) and commodity trading advisor (CTA).

The next two articles further pursue the changes to CFTC regulations governing CPOs and CTAs. Concerning the first article, Kenneth Rosenzweig, Wendy Cohen, Marilyn Okoshi and Fred Santo note that the repeal of CFTC Rule 4.13(a)(4) will have significant and far-reaching implications for hedge fund managers, and particularly managers of funds-of-funds, that currently utilize futures and/or swaps in the direct or indirect investment activities of their funds. Unless a manager can qualify for the exemption provided in CFTC Rule 4.13(a)(3), which has limitations on the amount of a fund’s assets that can be used for trading futures and other CFTC-regulated instruments (including most swaps), it generally will be required to register with the National Futures Association as a CPO before December 31, 2012. The next article by Peter Shea, Kathleen Moriarty, Kenneth Rosenzweig, Marybeth Sorady and Gregory Xethalis further explains how the amended Rule 4.5 will be applied to advisors and sub-advisors of registered investment companies and the managers of foreign corporations controlled by registered investment companies as well as the impact of the CPO compliance regime under a proposed harmonization of CFTC CPO regulation with Securities and Exchange Commission (SEC) regulation of registered fund advisors. The authors explain that since 2003 advisors to registered investment companies have enjoyed a blanket exemption from regulation by the CFTC. The February 2012 amendment to CFTC Rule 4.5, which now requires an analysis of each investment company’s use of futures and swaps and marketing efforts, seeks to bring registered fund advisors under CFTC regulation as CPOs if they cannot meet the revised exemption by the later of December 31, 2012 or 60 days after the CFTC defines the terms “swap.” Consequently, registered fund advisors now need to begin evaluating their status as CPOs and their ability to meet the CFTC’s regulatory burdens.

Roger Wise and Mary Burke Baker explain long-awaited proposed regulations on the Foreign Account Tax Compliance Act (FATCA) released by the US Treasury Department on February 8 providing further guidance on many topics including steps that foreign financial institutions (FFIs) will need to take to ensure that they identify their US accounts and report information about these accounts to the US Internal Revenue Service (IRS) each year. The authors comment that foreign financial institutions are struggling to understand FATCA and what they must do to comply with new IRS requirements in order to avoid a substantial withholding tax on their US-source income – especially when local privacy laws and impending new EU regulatory requirements clash with the FATCA rules. Mr Wise and Ms Baker hope this article will eliminate some of the confusion, as well as encourage FFIs to take advantage of the opportunity to submit comments to the US Treasury to suggest changes before final regulations are issued.

Roger Blanc, Howard Kramer, Martin Miller, and Matthew Comstock analyze a recent SEC order dismissing an administrative proceeding against the former general counsel of a broker-dealer relating to his failure to supervise a registered representative in a case where the general counsel recommended that the registered representative be fired for misconduct but was overruled by the vice chairman of the firm who supervised that registered representative. The authors explain that the SEC’s dismissal of the proceeding leaves unresolved questions of when and if a broker-dealer’s in-house legal counsel and compliance personnel have supervisory responsibilities with respect to registered representatives and other personnel, and what constitutes reasonable supervision of such persons by in-house counsel and compliance personnel. As the SEC effectively acknowledged in its order denying summary affirmance of the administrative law judge’s decision, it is unclear what constitutes reasonable supervision on the part of legal personnel who are determined to have such responsibility. The dismissal of the proceeding in its entirety leaves this issue unsettled.

Keith Robinson, Joseph Kelly and Andrea Baron discuss the implications of an SEC risk alert and two FINRA regulatory notices concerning the use of social media by registered investment advisers. The SEC comments in its risk alert that the use of social media by the financial services industry is rapidly accelerating and that many firms currently have multiple overlapping procedures in areas such as advertising, client communications, and electronic communications that may generally apply to the use of the social media rather than single, unified social media policies; as a result there has been confusion as to which social networking activities are permitted or prohibited for investment advisers. The authors comment that the risk alert represents the SEC staff’s first effort to apply the investment adviser advertising, client communication and recordkeeping rules to a new, evolving form of communication that does not fit easily into the existing regulatory framework. US-registered advisers need to keep abreast of these developments, and particularly the SEC staff’s potentially expansive views regarding what may constitute a client testimonial in the context of social media.

Rory Cohen explains the SEC’s new dollar threshold test revisions to the qualified client standard under the Investment Advisers Act, which provide for inflation adjustments to the assets under management and net worth tests every five years, the exclusion of net equity in a primary residence from the net worth calculation, and certain transactional provisions designed to allow investment advisers and their clients to maintain performance fee arrangements that existed when they entered into advisory contracts. Mr Cohen comments that the SEC’s revisions to the qualified client standard at first raised more questions than answers. Recent amendments clarify how one should treat mortgage debt when calculating net worth but, importantly, provided relief to permit the maintenance of existing arrangements (and to allow clients to make new investments). Such relief is significant to 3(c)(1) fund managers and other investment advisers.

Frederic Sosnick, Ned Schodek, and Alexa Loo explore the arguments made in favor of and against treating “TBA contract” claims as “customer claims” under the Securities Investor Protection Act of 1970 (SIPA) in the Lehman Brothers Inc. SIPA proceeding and the resulting decision of the United States Bankruptcy Court for the Southern District of New York on the issue. “TBA contracts” are forward contracts for the future purchase of “to be announced” debt obligations of the three US government-sponsored agencies that issue or guarantee mortgage-backed securities. The authors’ purpose is to help parties to TBA contracts better understand how their claims would be treated in the event that a SIPA proceeding was commenced with respect to their counterparty. The Bankruptcy Court found that TBA contract claims are not “customer claims” under SIPA and properly are classified as general unsecured claims. The authors note that this was an issue of first impression for the Bankruptcy Court and may have a binding effect on other TBA contracts (although other TBA contracts may have distinguishable facts). Future investors may alter the way they purchase and sell these securities in order to manage counterparty risk. Deeming TBA contract claims as general unsecured claims will also result in a larger pool of assets for creditors actually deemed customers of Lehman Brothers Inc. under SIPA.

Peter McGowan and Kimberly Everitt trace current developments in the treatment of the venture capital industry in the EU, including recently proposed legislation. They explain that Europe is entering an era where alternative products will be more tightly regulated, or regulated for the first time. However, there have been some recent indications that special consideration needs to be given to venture capital investment, which has been identified as having a key role to play in driving economic growth. New regulation appears to be part of a trend that may create a more liberal framework in which venture capital investment may be created and marketed.

Robert Sobol provides an introduction to the distribution of mutual funds around the world and explains some of the legal, compliance and tax impediments to greater sales of US funds offshore. Mr Sobol observes, “In a multi-jurisdictional world, high net worth investors are wherever you find them.” As collective investment vehicle asset managers’ attention turns to distribution and sales efforts in more and more jurisdictions, compliance risks increase rapidly. An increasingly complex set of laws, regulations and historic practices continues to accrete, challenging the acuity of the compliance and legal professional. Mr. Sobol’s article first sets forth some of the reasons why the seminal and regulatorily-sophisticated US 1940 Act mutual fund has experienced, to date, some disfavor in the international financial services markets. The article then explains the potential distribution advantages of certain jurisdictional alternatives, such as UCITS, and finally charts a course through a number of specific jurisdictions’ requirements and prohibitions, setting forth some key strategic and other considerations.

The issue concludes with selected Financial Industry Regulatory Authority (FINRA) regulatory notices and disciplinary actions, including regulatory notices on supervision of sales of complex financial products, verification of e-mailed instructions to protect customer accounts, and best execution, and disciplinary actions concerning sales of unsuitable investment products, inadequate supervision, failure to conduct reasonable due diligence, unwarranted claims in advertising, and inadequate procedures to review electronic correspondence.