RECENT AMENDMENTS
TO THE INVESTMENT ADVISERS ACT OF 1940
By:
Mary Moran Zeven
New York
On October 11, 1996, President Clinton signed into law the National Securities Markets Improvement Act of 1996 (the "1996 Act"), which revised several aspects of how investment advisers are regulated under the Investment Advisers Act of 1940 ("Advisers Act") and how investment companies are regulated under the Company Act of 1940 ("Company Act"). The 1996 Act became effective on April 9, 1997, with respect to the regulation of investment companies under the Investment Company Act of 1940 and on July 8, 1997, with respect to amendments to the Advisers Act regarding investment advisers, with the exception of the provision relating to performance fees charged by investment advisers, which had become immediately effective last October.
Performance Fee Arrangements with Non-U.S. Clients. Registered investment advisers may now enter into performance fee arrangements with (i) a person who is not a resident of the United States or (ii) Qualified Purchaser Pools, which are comprised of highly sophisticated investors meeting certain minimum investment requirements pursuant to the recently created Section 3(c)(7) of the Company Act that generally permits unregistered funds (Qualified Purchaser Pools) to privately offer interests to highly sophisticated investors without regard to registration.
The amendment permitting the use of performance fee arrangements presents a significant opportunity for U.S.-registered investment advisers to enter into performance fee arrangements with offshore funds and other clients that are not residents of the United States, effectively leveling the playing field for U.S. and non-U.S. investment advisers with respect to non-U.S. clients. Prior to the 1996 Act, U.S.-registered investment advisers were generally required to comply with the prohibitions against performance fees contained in the Advisers Act for all clients, including those clients residing offshore, with certain exceptions. Those exceptions, which were for clients that were either registered investment companies or had a portfolio in excess of US$1 million, required the investment adviser to comply with stringent requirements under Rule 205-3 under the Advisers Act. Such exceptions under Rule 205-3 are still available if an adviser cannot take advantage of the new performance fee exceptions. In addition, investment advisers registered with the Securities and Exchange Commission ("SEC") will be able to use performance fee arrangements with Qualified Purchaser Pools, which, by definition, will generally consist of individual investors that have $5 million or more in investments, or entities that have $25 million or more in investments. Importantly, the 1996 Act does not provide for an adviser to charge performance fees in connection with a separate account of a qualified purchaser. Therefore, any performance fees charged to such an account would have to continue to meet the technical requirements set forth in Rule 205-3 under the Advisers Act.
Pre-Emption of State Regulation of Large Investment Advisers. The Advisers Act has been amended to divide the regulation of investment advisers between the states and the SEC, so that the states will have primary responsibility for small, local advisers, with less than $30 million in assets under management. In addition, due to the SEC's recognition that assets under management will fluctuate, and in order to eliminate the possibility that advisers with assets under management near the SEC registration threshold will have to register and de-register with the SEC on a frequent basis, the SEC has adopted a rule under the Advisers Act that permits advisors with between $25 and $30 million in assets to register with the SEC. Advisers with $30 million or more in assets under management, and advisers to registered investment companies, will be required to register exclusively with the SEC.
The 1996 Act, in addition, provides for a national de minimis standard under the Advisers Act which eliminates state registration requirements for an investment adviser that does not have a place of business in a state and has fewer than six clients who are residents of that state. A state may have a higher, but not a lower, de minimis threshold. The SEC has clarified the definition of a single "client" to be a (i) a natural person and a spouse or relative who has the same principal residence; (ii) a natural person and all accounts of which such natural person and related persons are the sole primary beneficiaries; or (iii) a corporation, general partnership, trust or other legal organization that receives investment advice based on its investment objectives, as opposed to the individual investment objectives of its shareholders, partners or beneficial owners. The Advisers Act has also been amended to provide that state regulators may enforce books and records and financial responsibility laws only for investment advisers who maintain their principal place of business in that state. Although state registration and other regulatory requirements such as record keeping and capital requirements have been federally pre-empted for SEC-registered advisers as of July 8, 1997, both the SEC and the states have retained antifraud authority over all investment advisers, regardless of whether the investment adviser is registered with the state or the SEC. Four Classes of Advisers Permitted to Register with SEC. In addition to investment advisers with $30 million or more in assets under management, the Advisers Act will also require SEC registration of (i) Nationally Recognized Statistical Rating Organizations, (ii) pension consultants who provide advisory services or recommend investment advisors to fiduciaries of pension plans with more than $50 million in assets, and (iii) investment advisory affiliates of an SEC-registered adviser if the affiliate controls, is controlled by or is under common control and located at the same principal office and place of business as the SEC-registered adviser. In addition, investment advisors that reasonably expect that they will be eligible to be SEC-registered within a 120-day period also may register with the SEC. If the adviser is not eligible 120 days after its registration is effective, it will be required to withdraw its SEC registration.
