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SEC’s New Transparency Rules Target Private Fund Advisors

On Feb. 9, 2022 the U.S. Securities and Exchange Commission (SEC) proposed new rules and amendments to the Investment Advisors Act of 1940 directed at private fund advisors. The proposals would provide a statutory mandate for audits of private funds, enhance transparency to investors about the costs of investing in a private fund and the performance of such fund, limit and/or ban certain transactions or activities that represent a conflict of interest for the private fund adviser, as well as prohibit certain sales practices that are contrary to the public interest and protection of investors.

The proposal anchors around five central areas, two of which would comprise all private fund advisors (i.e., registered and unregistered private fund advisors).

Proposal Affecting Registered Advisors

 

PRIVATE FUND AUDIT RULE

The Private Fund Audit Rule would require:

  • Registered Advisors to have all of their managed private funds’ financial statements undergo an audit at least annually and upon liquidation
  • Such audits to be conducted in accordance with U.S. generally accepted audit standards (GAAS)
  • Such audits to be performed by an accounting firm that:
    • is registered with, and subject to inspection by, the Public Company Accounting Oversight Board (PCAOB)
    • maintains auditor independence in accordance with SEC independence rules
  • Notification by the accounting firm to the SEC:
    • any changes in the audit firm (e.g., through resignation or dismissal)
    • any modified opinion that the accounting firm issues at the completion of the audit

TAKEAWAY

For the most part, registered private fund advisors currently have the funds they manage undergo an annual audit as an option to satisfy the Custody Rule under the Act. However, not all registered private fund advisers are subject to the Custody Rule, and even those that are subject to the Custody Rule are not required to obtain an audit in order to comply with the Custody Rule. Therefore, in addition to providing protection for the fund and its investors against the misappropriation of fund assets under the Custody Rule, the Private Fund Audit Rule will not replace, modify, or substitute the Custody Rule. The SEC notes that the audit mandate would provide an important check on all registered advisors’ valuations of private fund assets, which often serve as the basis for the calculation of the advisers’ fees.

 

QUARTERLY STATEMENT RULE

(Fees and Expenses, and Fund Performance)

Through the quarterly statement rule, the Act proposes to increase transparency of information to investors about the cost of investing in a private fund and the private fund’s performance.

Fees and Expenses: This rule would require registered private fund advisors to distribute to private fund investors a quarterly statement that details, in table format, the following:

  • All compensation, fees, and other expenses allocated or paid by the fund to the advisor or to any of its affiliates during the reporting period
  • Other expenses paid by the fund
  • Any offsets, rebates, or waivers carried forward during the current reporting period to subsequent quarterly periods to reduce future payments or allocations to the advisor or its affiliates.

The proposed quarterly statement rule would also require advisors to disclose the following information with respect to any covered portfolio investment in a single table, as applicable to all such covered portfolio investments:

  • A detailed account of all portfolio investment compensation allocated or paid by each covered portfolio investment during the reporting period
  • The private fund’s ownership percentage of each such covered portfolio investment as of the end of the reporting period. If the fund does not have an ownership interest in the covered portfolio investment, the adviser would be required to list 0 percent as the fund’s ownership percentage, along with a brief description of the history of the fund’s investment in such covered portfolio investment.

Fund Performance: This disclosure is divided between private funds that are “illiquid” or “liquid” funds.

For illiquid funds, the quarterly statement would be required to have performance information covering the period from inception through the end of the current calendar quarter covered by the statement, including:

  • Gross and net internal rate of return for the fund
  • Gross and net multiple of invested capital for the funds
  • Gross internal rate of return and gross multiple of invested capital for the realized and unrealized portions of the fund’s portfolio, with the realized and unrealized performance shown separately

The proposed rule also would require advisors to provide investors with a statement of contributions and distributions for the illiquid fund, detailing the capital inflows and outflows since inception by date for each cash in(out)flow and the amount of each in(out)cash flow, as well as the net asset value as of the end of the current quarter covered by the statement.

For liquid funds, the quarterly statement would disclose fund performance information that includes:

  • Annual net total returns for each calendar year since inception
  • Average annual net total returns over the one, five, and ten calendar year periods
  • Cumulative net total returns for the current calendar year as of the end of the most recent calendar quarter covered by the quarterly statement

TAKEAWAY

While private fund advisors may currently provide statements periodically to investors, there is no requirement for advisors to do so under the Act. The Quarterly Statement Rule proposal is designed to improve the quality of information provided to fund investors and allow them to better assess, monitor, and analyze the value of their private fund investments, and to better compare their private fund investments. Additionally, it is worth noting that the proposed performance information for liquid funds is similar to those required for mutual funds.

 

ADVISOR-LED SECONDARIES RULE

The proposal would require a registered private fund advisor to obtain a fairness opinion in connection with an advisor-led secondary transaction where the advisor offers fund investors the option to sell their interests in the private fund, or to exchange them for new interests in another of the advisor’s vehicles. An independent opinion provider would opine on the fairness of the price being offered to the private fund for any assets being sold as part of the transaction. The proposal also would require the advisor to prepare and distribute to the private fund investors a summary of any material business relationships the independent opinion provider has or has had within the past two years with the advisor or any of its related persons.

TAKEAWAY

Advisor-led transactions provide liquidity for investors and secure additional time and capital to maximize the value of fund assets. However, these transactions also raise certain conflicts of interest. Ensuring that the private fund and the investors that participate in the secondary transaction are offered a fair price is a critical component of preventing the type of harm that might result from the advisor’s conflict of interest in leading the transaction. This rule requirement would provide a check against an advisor’s conflicts of interest in structuring and leading a transaction from which it may stand to profit at the expense of private fund investors.

 

Proposals Affecting All Advisors

 

PREFERENTIAL TREATMENT RULE
The preferential treatment rule eliminates the sales practice by all private fund advisors of providing preferential treatment regarding redemptions from the fund or information about portfolio holdings or exposures to investors. This proposal also prohibits these advisors from providing any other preferential treatment to any investor in the private fund, unless such treatment is disclosed to all current and prospective investors in writing.

TAKEAWAY

Private fund advisors often provide preferential treatment to large investors for strategic reasons that benefit the advisor and also benefit the fund — for example, through increased fund assets that may enable the fund to make certain investments, to attract additional investors, and to spread expenses over a broader investor and asset base.

However, there are scenarios where the preferential liquidity terms harm the fund and other investors. For example, if an advisor allows a preferred investor to exit the fund early and sells liquid assets to accommodate the preferred investor’s redemption, the remaining investors may be left with a less liquid pool of assets, which can inhibit the fund’s ability to carry out its investment strategy or promptly satisfy other investors’ redemption requests.

 

PROHIBITED ACTIVITIES RULE

The prohibited activities rule is designed to reduce the likelihood of fraud by removing adviser incentives. The proposal would ban private fund advisors from:

  • Charging certain fees and expenses to a private fund or its portfolio investments, such as fees for unperformed services (e.g., accelerated monitoring fees, servicing fees, consulting, or other fees)
  • Charging fees associated with an examination or investigation of the advisor
  • Seeking reimbursement, indemnification, exculpation, or limitation of its liability for breach of fiduciary duty, willful misfeasance, bad faith, negligence, or recklessness in providing services to the private fund
  • Reducing the amount of an advisor clawback by the amount of certain taxes
  • Charging fees or expenses related to a portfolio investment on a non-pro rata basis
  • Borrowing or receiving an extension of credit from a private fund client

TAKEAWAY

The SEC has observed certain conflicts of interest and compensation practices over the past decade that have persisted, despite the regulatory body’s enforcement actions, and for which they believe disclosure alone will not adequately address. Accordingly, the SEC proposal is to outright ban these practices in order to prevent certain activities that could result in fraud and harm to investors.

 

Summary and Takeaway

This SEC proposal comes at a busy time of the year for private fund advisors — and it also comes on the heels of two other rule proposals: the Cybersecurity Risk Management Rule for Advisors and the proposal to amend, and expand the disclosures in, Form PF. While the additional SEC proposed requirements may not represent a seismic shift for large private equity and hedge fund advisors, they may be more consequential for mid-size and smaller private fund advisors. Across the board, the proposed changes to the Act mean that private fund advisors will face more compliance requirements. As a result, compliance and technology departments may need to either bolster their headcount to support and keep up with the additional documentation requirements and monitoring surveillance for compliance or engage external firms to supplement their own resources.

These proposed changes to the Act also reflect a move to boost transparency of costs and performance that are similar to those provided by mutual funds. The proposed standardized information will allow investors to understand the costs of a dollar invested and to evaluate the value derived from such costs through fund performance.

Advisors should closely monitor evolving developments to ensure operational and compliance readiness. Comments and feedback on the proposal are due the later of 30 days after publication in the Federal Register or April 11 (which is 60 days after issuance).

We would be pleased to provide more information about the SEC’s new rule proposals. Please contact your Kreischer Miller relationship professional or any member of our Investment Industry Group.

 

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What You Need to Know About the New Schedules K-2 and K-3

With the 2021 tax filing season well underway, there has been uncertainty and controversy surrounding the IRS’s new schedules K-2 and K-3.

The IRS created Schedules K-2 and K-3 to provide greater certainty and consistency in reporting international information to partners and shareholders. The schedules are intended to make international tax items less obscure for partners and shareholders needing the information to file their own returns.

These schedules are new for tax year 2021 and are intended to be used by S corporations, partnerships, and filers of Form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships) to report items of “international tax relevance.” The schedules replace, supplement, and clarify the reporting of certain amounts formerly reported on the Schedule K-1 as foreign transactions.

There has been a great deal of controversy surrounding what technically constitutes “international tax relevance” as well as the filing process for these new schedules. In response, on February 16 the IRS announced transition relief for certain domestic partnerships and S corporations intended to ease the change to the new schedules. This relief, while appreciated, has given rise to more questions than answers. The IRS also posted a series of FAQs to its website in an attempt to provide further clarification on the items that must be reported.

Tax practitioners have been strongly advocating for a delay to the schedules’ 2021 tax year implementation requirement. On February 24, the AICPA authored a letter to the IRS and the Treasury requesting that the implementation be delayed to 2023 (the 2022 tax year filing season), citing implementation difficulties due to software development and the ongoing challenges of the COVID-19 pandemic, as well as the lack of clarity regarding the filing instructions.

There has been no word from the IRS regarding a delay as of the time of this writing. Given that fact, Kreischer Miller’s Tax Strategies team is moving forward with filing Schedules K-2 and K-3, as applicable for our clients.

We recognize that this is a complex topic exacerbated by a lack of clarity and an environment in which IRS resources are significantly limited. If you have any questions or concerns regarding Schedules K-2 and K-3, including whether you have a filing requirement or whether certain international transactions would be applicable, please contact your Kreischer Miller relationship professional or any member of our Investment Industry Group at your earliest convenience.

 

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Kreischer Miller Exhibiting at 20th Annual PMAR North America Conference

The Journal of Performance Measurement’s 20th Annual Performance Measurement, Attribution & Risk (PMAR) North America Conference

May 10-11, 2022
Westin Philadelphia
Philadelphia, PA

Each year, the PMAR conference provides an opportunity for performance measurement professionals to learn about recent developments in performance, attribution, risk, and GIPS, as well as network with peers and gain new insights and solutions.

Kreischer Miller will once again be exhibiting at this year’s PMAR Conference. Stop by and see us!

More details about PMAR North America.

 

Beware of the SEC When It Comes to GIPS Claims of Compliance

The CFA Institute created and administers the GIPS Standards. However, a ruling in this SEC case demonstrates that while the SEC did not develop the GIPS Standards, it will take action against investment advisors that falsely claim compliance or omit key disclosures.

The case involves an advisor that advertised its performance in several magazines and investment newsletters. The advertisements cited the firm’s GIPS claim of compliance, but did not include all of the disclosures required by the GIPS Advertising Guidelines (including since inception returns, currency used, and how an interested party can obtain a GIPS Report).

The judge in the case ruled that, among other things, the advisor violated Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 by misrepresenting its compliance with GIPS standards in the advertisements and newsletters. The judge also ruled that the advisor’s owner aided and abetted the firm’s violations. The firm was censured and ordered to pay civil penalties. The firm’s owner received a permanent bar from association with any advisor or broker-dealer, a cease-and-desist order, and an order to pay civil penalties.

The case serves as a reminder that a firm’s claim of compliance is often an advertising claim. Claiming GIPS compliance involves more than having formal policies and procedures for calculating and presenting composite performance presentations. The GIPS standards also include the GIPS Advertising Guidelines. If a firm mentions GIPS in an advertisement, the GIPS Advertising Guidelines require certain presentation and disclosure items to be included.

As a reminder, here is the way the GIPS Advertising Guidelines define “advertisement”:

An advertisement includes any materials that are distributed to or designed for use in newspapers, magazines, firm brochures, pooled fund fact sheets, pooled fund offering documents, letters, media, websites, or any other written or electronic material distributed to more than one  party, and there is no contact between the firm and the reader of the advertisement. One-on-one presentations and individual client reporting are not considered advertisements.

Presentation and disclosure items required by the GIPS Advertising Guidelines vary depending on whether a firm includes performance in its advertisement, versus just basic language that it is GIPS compliant. While the 2020 edition of the GIPS Standards, effective January 1, 2020, did not see large scale changes to the GIPS Advertising Guidelines (now included in Section 8 of the GIPS Standards for Firms), there were updates made to certain criteria for advertisements including performance. As an alternative to meeting the requirements of the GIPS Advertising Guidelines, firms may provide a GIPS Report with the advertisement to satisfy the GIPS Advertising Guidelines.

As firms begin to evaluate their advertising policies in response to the release of the SEC’s Marketing Rule, which is required to be adopted by all firms no later than November 2022, it may be prudent for firms to take a fresh look at their policies and procedures related to their advertisements and compliance with the GIPS Advertising Guidelines. Policies and procedures often incorporated into a firm’s regulatory review of advertisements should include:

  • The process for determining whether the document is considered an advertisement under the GIPS Standards.
  • Utilization of a checklist designed to ensure the completeness of the presentation and disclosure requirements in the advertisement. This checklist may also include any regulatory requirements and should be completed by the preparer of the advertisement.
  • The policy for reviewing the advertisements, with documentation that the review occurred. Ideally, these advertisements should be reviewed by someone other than the preparer (often a representative from legal and compliance) and should include a review of the completed disclosure checklist related to the advertisement.

And as a reminder, while it is important to have documented policies and procedures, it is equally important to have a documented process that demonstrates how the firm has followed them. If any errors or deficiencies are noted, the firm should proactively correct them and then  adopt policies and procedures to reduce reoccurrence. Independent oversight by internal or external compliance counsel is highly recommended.

If you are currently claiming compliance with the GIPS standards or would like to claim compliance in the future, and would like to know more information about this subject, please contact us.

Todd E. Crouthamel, Director, Audit & Accounting can be reached at tcrouthamel@kmco.com.


Ashley Jiang, Senior Accountant, Audit & Accounting can be reached at ajiang@kmco.com

 

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Recent SEC Rule Proposal Changes and Additions

On February 9, 2022, the SEC proposed new rules and amendments that will have an impact on investment advisors, funds, and what is received by certain investors.

SEC Proposes New Rules on Private Funds to Protect Investors

There are 5,037 registered private fund advisors in a $18-trillion marketplace. The private fund industry continues to evolve and grow in quantity and complexity, and plays an increasingly important part in the financial system.

The SEC revealed plans to:

  • Require SEC-registered private fund advisors to provide quarterly statements disclosing information on funds fees, expenses, and performance
  • Create new requirements for private fund advisors related to fund audits, books and records, and advisor-led secondary transactions
  • Prohibit private fund advisors (including those not registered with the SEC) from sales practices, conflicts of interest, and compensation schemes that are against public interest and the protection of investors, and prohibit them from providing preferential treatment to investors in their funds
  • Propose amendments to the Advisors Act compliance rule.

The following rules would apply to private fund advisors registered with the SEC:

  • Provide and distribute within 45 days to investors a quarterly statement detailing
    • Fees and expenses, including those paid by underlying portfolio investments to the advisor or its related persons
    • Standardized fund performance:
      • For liquid funds: Annual total returns for each calendar year since inception and the fund’s cumulative total return for the current calendar year
      • For illiquid funds: IRR and MOIC (multiple of invested capital), the gross IRR, and the gross MOIC for the unrealized and realized portions of the portfolio, and a statement of contributions and distributions
  • Undergo a financial statement audit of each private fund at least annually and upon liquidation, conducted by a PCAOB-inspected independent public accountant
  • Obtain an independent fairness opinion when leading an advisor-led secondary transaction and provide a summary of any material business relationships the advisor has had within the past two years
  • Must retain books and records related to the proposed quarterly statement rule and the mandatory advisor audit rule, and support their compliance with the proposed advisor-led secondaries rule and the proposed preferential treatment disclosure rule.

The following rules would apply to private fund advisors both registered and unregistered with the SEC:

  • Certain sales practices, conflicts of interest, and compensation schemes against public interest and the protection of investors are prohibited, including
    • Charging certain regulatory and compliance fees and expenses or fees or expenses associated with certain examinations or investigations
    • Charging fees for certain unperformed services
    • Charging fees or expenses related to a portfolio investment on a non-pro rata basis
    • Borrowing or receiving an extension of credit from a private fund client
    • Reducing the amount of any advisor clawback by the amount of certain taxes
    • Limiting or eliminating liability for certain advisor misconduct
  • Granting preferential terms to certain investors regarding liquidity or transparency such as holdings and exposure is prohibited. Other preferential treatment may be permitted if disclosed to current and prospective investors.

In addition, amendments are proposed that all registered advisors (not just those to private funds) must document the annual review of their compliance policies and procedures in writing.

Cybersecurity Risk Management

With many professionals in the investment industry still working remotely and continuing to deal with the fallout from COVID-19, the tendency to depend on technology for business operations is at an all-time high. As a result, cybersecurity and cyber-attacks need to be examined more closely by all professionals.

The SEC has proposed new rules related to cybersecurity risk management to help with preparedness against cybersecurity threats and attacks. These proposed rules would require advisors and funds to create and implement written policies and procedures to address cybersecurity risks that could harm advisory clients and fund investors or lead to unauthorized access to client or fund information.

The new proposals would also ask advisors and funds to enhance disclosures to their prospective and current clients related to cybersecurity risks and incidents. The proposal would amend Form ADV Part 2A and require disclosure of any cybersecurity risks and incidents. It would also require advisors to maintain records related to cybersecurity risk management rules and any occurrences of cybersecurity incidents.

Finally, advisors would have to report significant cybersecurity incidents to the SEC on a new proposed form, ADV-C. The hope is that this new form will assist the SEC with monitoring the effects of any cybersecurity incidents at advisors while protecting investors.

Reducing Risk in Clearance and Settlement of Securities

In order to increase market efficiencies and reduce the credit, market, and liquidity risks in the clearing and settling process of security transactions, the SEC proposed to require compliance with a T+1 settlement cycle by March 31, 2024 (if adopted).

  • Old Rule 15c6-1 amendments:
    • Shorten the standard settlement cycle from T+2 to T+1 for broker-dealer security transactions
    • Repeal T+4 for certain firm commitment offerings
  • New Rule 15c6-2 requirements:
    • Broker-dealers: Must complete allocations, confirmations, and affirmations as soon as technologically practicable by end of trade date (T+0)
    • Investment advisors: Must properly document allocations and affirmations, and retain confirmations received from broker-dealers
    • CMSPs: Must have written policies and procedures to facilitate straight-through processing and submit an annual report to the SEC on progress with the process
  • The SEC also solicits comments on how best to further achieving a same-day settlement cycle

The public comment period for these proposals will remain open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.

We would be pleased to provide further information related to this subject. For more information, contact Ashley Jiang, Senior Accountant, Audit & Accounting at ajiang@kmco.com or Frank Varanavage Manager, Audit & Accounting at Fvaranavage@kmco.com.

 

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Risk Alert from Examinations of Private Fund Advisors

On June 23, 2020, the SEC’s Division of Examinations (“EXAMS”), which mainly focuses on private funds, published a Risk Alert entitled the “2020 Private Fund Advisor Risk Alert.” The alert details observations made by EXAMS staff of registered investment advisors that manage private funds.

The goal of the SEC’s exam was to protect investors, identify and monitor risks, and improve industry practices. The EXAMS staff observed the following three risks from investment advisors.

Conduct Inconsistent with Disclosures

EXAMS staff observed the failure of private fund advisors to act in accordance with material disclosures to investors. For example, certain private fund advisors failed to follow the practices of the written agreements, such as limited partnership agreements, between fund managers. EXAMS staff observed that there were fund disclosures and transactions that were not reviewed, consented, or approved between the limited partners or general partners when the agreements called for such approvals. In addition, certain private fund advisors did not follow the terms of the agreements in relation to the calculations of management fees which resulted in inaccurate management fees being charged.

Use of Misleading Disclosures Regarding Performance and Marketing

Staff observed that certain private fund advisors provided inaccurate or misleading disclosures about their track record. EXAMS staff observed that certain private fund advisors did not market all track records, but only presented a cherry-picked track record. In certain instances, EXAMS noted that private fund advisors failed to disclose material leverage on a fund’s performance. Likewise, certain private fund advisors failed to follow portability requirements, resulting in incomplete prior track records.

Due Diligence Failures

EXAMS staff observed potential due diligence failures relating to the selection of underlying investments or funds. An investment advisor must have reasonable belief that it is providing advice which is in the best interests of its clients. For example, the staff observed that certain advisors failed to address compliance and internal controls of private funds in which they invested. This includes failing to perform due diligence on important service providers.

Conclusion

It’s important to follow client agreements and provide useful, consistent disclosures. It is common for agreements to specify events that require investor consent, and it is critical for private fund advisors to seek such consent when those circumstances arise.

Performance and marketing are commonly cited areas of concern in SEC examinations. Problems can arise when aggressive marketing or unknowledgeable personnel put together performance presentations and advertisements. Although not an SEC requirement, we note that many firms follow the investment reporting requirements of the Global Investment Performance Standards (GIPS) as a best practice.

Private fund advisors that invest in underlying funds have unique concerns. There is no substitute for performing proper operational due diligence in these underlying structures.  Addressing the underlying fund’s internal controls and compliance are key components of the process.

Great investment selection is important, but it’s not enough. Investment advisors have a fiduciary duty under the Investment Advisors Act of 1940. Failure to heed fiduciary duties is a disservice to a firm’s clients and presents heightened regulatory risk.

We would be pleased to provide further information related to this subject. For more information, contact Vanessa Ciolkosz, Staff Accountant, at vciolkosz@kmco.com

 

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SEC Proposes Private Fund Reporting Changes

In what appears to be a response to continued evolvement and growth of the private fund industry, on January 26, 2022 the SEC proposed amendments to Form PF which would require reporting of certain events as well as lower the threshold for large private equity advisers.

Form PF was originally adopted in 2011. Private fund advisers (i.e., SEC-registered managers of hedge, private equity, and other alternative funds) are generally required to file Form PF if they manage at least $150 million in private fund assets. It further requires “large” advisers to provide additional disclosures. Currently, those thresholds are as follows:

  • Large Hedge Fund Advisers – At least $1.5 billion in hedge fund assets under management
  • Large Liquidity Fund Advisers – At least $1 billion in combined money market and liquidity fund assets under management
  • Large Private Equity Advisers – At least $2 billion in private equity fund assets under management

Further background on Form PF as it currently stands, including the form and the instructions, can be found at Form PF (sec.gov). Additionally, the SEC has posted staff responses to frequently asked questions here.

The SEC’s new proposal would require certain hedge funds and private equity funds to file reports within one business day of stress events, which the SEC believes would be relevant to financial stability and improve investor protection. The proposal would also lower the threshold for large private equity advisers from $2 billion in private equity assets under management to $1.5 billion.

The proposal is expected to be published to the Federal Register and will include a 30-day comment period. Kreischer Miller’s Investment Industry Group will continue to monitor the status of the proposal and provide updates as they become available.

We would be pleased to provide further information related to this subject. For more information, contact Craig B. Evans, Director, Audit & Accounting at cevans@kmco.com

 

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H.R.4620: What Family Offices Should Know about The Family Office Regulation Act of 2021

Background – The Family Office Rule

Family offices are generally excluded from the definition of an investment adviser under the Investment Advisers Act of 1940.  This was a result of the Dodd-Frank Act which gave the SEC the authority to exempt family offices.  Since June 2011, a family office is excluded from the definition of an investment adviser if it:

  • has no clients other than family clients;
  • is wholly owned by family clients and is exclusively controlled (directly or indirectly) by one or more family members and/or family entities; and
  • does not hold itself out to the public as an investment adviser

The size of the family office (i.e., assets under management/AUM or number of family member participants) nor the types of assets managed (e.g., equities, fixed income, derivatives) are qualifying factors.

For further background on SEC Rule 202(a)(11)(G)-1 (the “Family Office Rule”) the original text can be found at Final Rule: Family Offices (sec.gov). The SEC has also posted several staff responses to questions at SEC.gov | Staff Responses to Questions About the Family Office Rule.

H.R. 4620 – The Family Office Regulation Act of 2021

In what appears to be a response to testimony by Archegos Capital Management before the House Financial Services Committee, New York Congresswoman Alexandria Ocasio-Cortez has introduced H.R. 4620.

Under H.R. 4620, the exclusion described above would now be limited to “covered family offices” with a threshold of $750 million or less in AUM. Those family offices with more than $750 million in AUM would still be exempt from registering with the SEC but would have to file reports with the SEC as an “exempt reporting adviser.” Additionally, all family offices that are subject to an SEC order, as described in Section 15(b)(4)(H) of the Securities Exchange Act of 1934, for conduct constituting fraud, manipulation, or deceit, would not be considered a covered family office. Furthermore, certain family offices that utilized a grandfathering clause within the Dodd-Frank Act to qualify for the family office exclusion despite having clients who are not members of the family would also not be considered a covered family office since such grandfathering clause would be repealed.

H.R. 4620 also directs the SEC to exclude family offices that are below $750 million in AUM from being a covered family office if they are highly leveraged or engage in high-risk activities. H.R. 4620 does not define “highly leveraged” or “high-risk activities.” The full text of H.R. 4620 can be found at Text – H.R.4620.

With the House returning from recess this week, family offices should keep an eye on the progress of H.R. 4620. If The Family Office Regulation Act of 2021 were to pass through Congress as currently written, it would significantly alter the availability of existing exemptions for many family offices and the SEC would have the ability obtain data it currently does not have access to.

We would be pleased to provide further information related to this subject. For more information, contact Craig B. Evans, Director, Audit & Accounting at cevans@kmco.com

 

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Beware Phony FINRA Phishing Schemes

There has been a recent wave of cybercriminals impersonating the Financial Industry Regulatory Authority (FINRA). Because organizations strive to be compliant with regulations, receiving an email from FINRA can be quite startling and cause recipients to inadvertently fall for the scam.

In this FINRA-themed phishing email, the sender’s email address uses the domain gateway-finra.org. The email claims that your organization has received a compliance request and it directs you to click on a link for more information. To add a sense of urgency, the message also states “Late submission may attract penalties.” The email even includes a case number, request ID, and a footer with legal jargon to make it feel legitimate. However, clicking the link will redirect you to a malicious website.

Use these 3 tips to stay safe from these types of attacks:

  1. Look for threats of urgency, such as the need to pay a penalty if you don’t act quickly enough. These scams rely on impulsive actions, so always think before you click.
  2. Check who sent the email. In this case, while the email address includes the name FINRA, it did not use the official FINRA.org domain.
  3. If you are worried that the email could be legitimate, reach out to FINRA another way. Do not click any links or use the contact information provided in the email.​

 

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Certain Smaller Broker-Dealers Have Opportunity to Extend Filing Deadline of Annual Reports

On February 12, 2021, the Securities and Exchange Commission (SEC) issued an order that extends the filing deadline for annual audit and related reports an additional 30 days for smaller broker-dealers that meet certain conditions. These filings are normally required to be completed within 60 calendar days after the fiscal year-end. With this new order, qualifying broker-dealers now have 90 calendar days to complete the filings.

The order was issued to provide firms and auditors additional time to prepare and audit the annual reports required within a compressed time period, when professional service providers are at their greatest demand. It was also noted that the 30 day extension could result in better quality of annual reports.

A broker-dealer must meet all of the following conditions in order to be granted the 30 calendar day extension:

  • As of its most recent fiscal year-end, be in compliance with rule 15c3-1 and have total capital and allowable subordinated liabilities of less than $50 million, as reported in box 3530 of Part II or Part IIA of its FOCUS Report
  • Be permitted to file an exemption report as part of its most recent fiscal year-end annual reports
  • Submit a written notification to its designated examining authority of its intent to rely on this order on an ongoing basis for as long as it meets the conditions of the order
  • Files the annual report electronically with the Commission using an appropriate process

This comes as welcome news for some smaller broker-dealers who are challenged to meet a higher standard with limited resources at their disposal. Based on the order’s interpretation, as long as the conditions noted in the order are met and the submitted written notification is accepted, the deadline will be extended on an ongoing basis, allowing for 90 days to file the required audit and related reports with the SEC. To reiterate, broker-dealers that meet the criteria summarized above, must submit a written notification to FINRA of its intent to rely on this order on an ongoing basis for as long as it meets the conditions of the order.

The text of the SEC’s order is available here.

We would be pleased to provide further information related to this subject. For more information, contact Frank L. Varanavage, Manager, Audit & Accounting at fvaranavage@kmco.com

 

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