Investment Management Update
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Covering legal developments and regulatory news for registered funds, their advisers and industry participants through December 31, 2019.
RULEMAKING AND GUIDANCE
SEC Proposes to Update Accredited Investor Definition to Increase Access to Investments
On December 18, 2019, the Securities and Exchange Commission (SEC) proposed amendments to the definition of “accredited investor” in Rule 501(a) of Regulation D under the Securities Act of 1933 and to the definition of “qualified institutional buyer” under Rule 144A under the Securities Act of 1933. The proposed amendments would add additional means for individuals to qualify to participate in private securities offerings, including offerings such as hedge funds, venture capital funds and private equity funds.
Currently, accredited investor status is determined if a person meets an income or net worth threshold.
The proposed amendments would expand the pool of investors who can participate in private offerings by conferring accredited investor status on natural persons based on their professional knowledge, experience or certifications — even if they do not meet the current income or net worth threshold. The proposed amendments would also add new categories for entities, including a “catch-all” category for any entity owning in excess of $5 million in investments. In particular, the proposed amendments to the accredited investor definition would:
- add new categories to the definition that would permit natural persons to qualify as accredited investors based on certain professional certifications and designations, such as holding a Series 7, 65 or 82 license, or other credentials issued by an accredited educational institution
- with respect to investments in a private fund, add a new category based on the person’s status as a “knowledgeable employee” of the fund
- add limited liability companies that meet certain conditions, registered investment advisers and rural business investment companies (RBICs) to the current list of entities that may qualify as accredited investors
- add a new category for any entity, including Indian tribes, owning “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act of 1940, as amended (1940 Act), in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered
- add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act of 1940, as amended (Investment Advisers Act)
- add the term “spousal equivalent” to the accredited investor definition so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.
The proposed amendments to the qualified institutional buyer definition in Rule 144A under the Securities Act of 1933 would add limited liability companies and RBICs to the types of entities that are eligible for qualified institutional buyer status if they meet the $100 million in securities owned and investment threshold in the definition. The proposed amendments would also add a “catch-all” category that would permit institutional accredited investors under Rule 501(a), of an entity type not already included in the qualified institutional buyer definition, to qualify as qualified institutional buyers when they satisfy the $100 million threshold.
No amendments were proposed to the current rule’s definition of how much net worth, income and total assets are required to meet the accredited investor definition. The current thresholds have remained unchanged since the 1980s.
The public comment period for the proposed amendments will remain open for 60 days following publication in the Federal Register.
The SEC’s proposed rule is available at https://www.sec.gov/rules/proposed/2019/33-10734.pdf.
SEC Proposes Rule to Modernize Use of Derivatives by Registered Investment Companies
On November 25, 2019, the SEC voted to propose new and amended rules and form amendments, designed to provide an updated, comprehensive approach to regulating the use of derivatives and certain other transactions by registered investment companies, including mutual funds, exchange-traded funds (ETFs) and closed-end funds, as well as business development companies. In particular, the proposal includes:
- new Rule 18f-4, which would impose a uniform set of conditions and provide certain exemptions from the 1940 Act
- new Rule 15l-2 under the Securities Exchange Act of 1934 (Exchange Act) and new rule 211(h)-1 under the 1940 Act, which are designed to address specific considerations raised by leveraged and inverse funds and exchange-listed commodity or currency pools (leveraged investment vehicles)
- amendments to proposed Rule 6c-11 under the 1940 Act to allow certain leveraged or inverse ETFs to operate without obtaining an exemptive order.
Proposed Rule 18f-4
Derivatives Risk Management Program. Proposed Rule 18f-4 would impose a uniform set of conditions and provide certain exemptions from the 1940 Act. Rule 18f-4 would generally require that any fund that engages in derivatives transactions, including securities borrowing for short sales, adopt a written derivatives risk management program. The program would have to include risk guidelines, weekly stress testing, daily back testing, protocols for internal reporting and escalation, and a periodic review of the program no less frequently than annually.
In addition, a derivatives risk management program would be required to be administered by a derivatives risk manager who is an officer of the fund’s adviser or sub-adviser and is approved by the fund’s board of directors. The fund’s derivatives risk manager would have to report to the fund’s board on the derivatives risk management program’s implementation and effectiveness to facilitate the board’s