[House Report 114-698]
[From the U.S. Government Publishing Office]
114th Congress } { Report
HOUSE OF REPRESENTATIVES
2d Session } { 114-698
======================================================================
INVESTMENT ADVISERS MODERNIZATION ACT OF 2016
_______
July 21, 2016.--Committed to the Committee of the Whole House on the
State of the Union and ordered to be printed
_______
Mr. Hensarling, from the Committee on Financial Services, submitted the
following
R E P O R T
together with
MINORITY VIEWS
[To accompany H.R. 5424]
[Including cost estimate of the Congressional Budget Office]
The Committee on Financial Services, to whom was referred
the bill (H.R. 5424) to amend the Investment Advisers Act of
1940 and to direct the Securities and Exchange Commission to
amend its rules to modernize certain requirements relating to
investment advisers, and for other purposes, having considered
the same, report favorably thereon with an amendment and
recommend that the bill as amended do pass.
The amendment is as follows:
Strike all after the enacting clause and insert the
following:
SECTION 1. SHORT TITLE.
This Act may be cited as the ``Investment Advisers Modernization Act
of 2016''.
SEC. 2. MODERNIZING CERTAIN REQUIREMENTS RELATING TO INVESTMENT
ADVISERS.
(a) Investment Advisory Contracts.--
(1) Assignment.--
(A) Assignment defined.--Section 202(a)(1) of the
Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a)(1))
is amended by striking ``; but'' and all that follows
and inserting ``; but no assignment of an investment
advisory contract shall be deemed to result from the
death or withdrawal, or the sale or transfer of the
interests, of a minority of the members, partners,
shareholders, or other equity owners of the investment
adviser having only a minority interest in the business
of the investment adviser, or from the admission to the
investment adviser of one or more members, partners,
shareholders, or other equity owners who, after such
admission, shall be only a minority of the members,
partners, shareholders, or other equity owners and
shall have only a minority interest in the business.''.
(B) Consent to assignment by qualified clients.--
Section 205(a)(2) of the Investment Advisers Act of
1940 (15 U.S.C. 80b-5(a)(2)) is amended by inserting
before the semicolon the following: ``, except that if
such other party is a qualified client (as defined in
section 275.205-3 of title 17, Code of Federal
Regulations, or any successor thereto), such other
party may provide such consent at the time the parties
enter into, extend, or renew such contract''.
(2) Not required to provide for notification of change in
membership of partnership.--Section 205 of the Investment
Advisers Act of 1940 (15 U.S.C. 80b-5) is amended--
(A) in subsection (a)--
(i) in paragraph (1), by striking the
semicolon and inserting ``; or'';
(ii) in paragraph (2), by striking ``; or''
and inserting a period; and
(iii) by striking paragraph (3); and
(B) in subsection (d), by striking ``paragraphs (2)
and (3) of subsection (a)'' and inserting ``subsection
(a)(2)''.
(b) Advertising Rule.--
(1) In general.--Not later than 90 days after the date of the
enactment of this Act, the Commission shall amend section
275.206(4)-1 of title 17, Code of Federal Regulations, to
provide that paragraphs (a)(1) and (a)(2) of such section do
not apply to an advertisement that an investment adviser
publishes, circulates, or distributes solely to persons
described in paragraph (2) of this subsection.
(2) Persons described.--A person is described in this
paragraph if such person is, or the investment adviser
reasonably believes such person is--
(A) a qualified client (as defined in section
275.205-3 of title 17, Code of Federal Regulations),
determined as of the time of the publication,
circulation, or distribution of the advertisement
rather than immediately prior to or after entering into
the investment advisory contract referred to in such
section;
(B) a knowledgeable employee (as defined in section
270.3c-5 of title 17, Code of Federal Regulations) of
any private fund to which the investment adviser acts
as an investment adviser;
(C) a qualified purchaser (as defined in section 2(a)
of the Investment Company Act of 1940 (15 U.S.C. 80a-
2(a))); or
(D) an accredited investor (as defined in section
230.501 of title 17, Code of Federal Regulations),
determined as if the investment adviser were the issuer
of securities referred to in such section and the time
of the publication, circulation, or distribution of the
advertisement were the sale of such securities.
SEC. 3. REMOVING DUPLICATIVE BURDENS AND APPROPRIATELY TAILORING
CERTAIN REQUIREMENTS.
(a) Brochure Delivery.--Not later than 90 days after the date of the
enactment of this Act, the Commission shall amend section 275.204-3(c)
of title 17, Code of Federal Regulations, to provide that an investment
adviser is not required to deliver a brochure or brochure supplement to
a client that is a limited partnership, limited liability company, or
other pooled investment vehicle for which each limited partner, member,
or other equity owner has received, before purchasing a security issued
by the pooled investment vehicle, a prospectus, private placement
memorandum, or other offering document containing (to the extent
material to an understanding of the pooled investment vehicle, the
business of the pooled investment vehicle, and the securities being
offered by the pooled investment vehicle) substantially the same
information as would be required by Part 2A or 2B of Form ADV at the
time of delivery of the brochure or brochure supplement, as the case
may be.
(b) Form PF.--Not later than 90 days after the date of the enactment
of this Act, the Commission shall amend section 275.204(b)-1 of title
17, Code of Federal Regulations, to provide that an investment adviser
to a private fund is not required to report any information beyond that
which is required by sections 1a and 1b of Form PF, unless such
investment adviser is a large hedge fund adviser or a large liquidity
fund adviser (as such terms are defined in such Form).
(c) Custody Rule.--Not later than 90 days after the date of the
enactment of this Act, the Commission shall amend section 275.206(4)-2
of title 17, Code of Federal Regulations, as follows:
(1) The Commission shall provide additional exceptions to the
independent verification requirement of paragraph (a)(4) of
such section for an investment adviser with respect to funds
and securities of a limited partnership (or a limited liability
company or other type of pooled investment vehicle), as
follows:
(A) An exception that applies if the outstanding
securities (other than short-term paper, as defined in
section 2(a) of the Investment Company Act of 1940 (15
U.S.C. 80a-2(a))) of the pooled investment vehicle are
beneficially owned exclusively by--
(i) the investment adviser;
(ii) affiliated persons of the investment
adviser;
(iii) supervised persons of the investment
adviser;
(iv) officers, directors, and employees of
the affiliated persons of the investment
adviser;
(v) family members and former family members
(as such terms are defined in section
275.202(a)(11)(G)-1 of title 17, Code of
Federal Regulations) of persons described in
clause (iii) or (iv); or
(vi) officers, directors, employees, or
affiliated persons of, or persons who provide,
have provided, or have entered into a contract
to provide services to--
(I) the investment adviser of the
pooled investment vehicle;
(II) one or more clients of the
investment adviser of the pooled
investment vehicle; or
(III) issuers from which the pooled
investment vehicle or any other client
of the investment adviser of the pooled
investment vehicle has acquired
securities, such as the portfolio
company of a private fund.
(B) An exception that applies if the pooled
investment vehicle has been established to hold only
the securities of a single issuer in which one or more
pooled investment vehicles managed by the investment
adviser have acquired a controlling interest.
(2) Consistent with, and expanding on, IM Guidance Update No.
2013-04, titled ``Privately Offered Securities under the
Investment Advisers Act Custody Rule'', published by the
Division of Investment Management of the Commission, the
Commission shall, with respect to the exception for certain
privately offered securities in paragraph (b)(2) of such
section--
(A) remove the requirement of clause (i)(B) of such
paragraph (relating to the uncertificated nature and
recordation of ownership of the securities); and
(B) remove the requirement of clause (ii) of such
paragraph (relating to audit and financial statement
distribution requirements with respect to securities of
pooled investment vehicles).
(d) Proxy Voting Rule.--Not later than 90 days after the date of the
enactment of this Act, the Commission shall amend section 275.206(4)-6
of title 17, Code of Federal Regulations, to provide that such section
does not apply to any voting authority with respect to client
securities that are not public securities.
SEC. 4. FACILITATING ROBUST CAPITAL FORMATION BY PREVENTING REGULATORY
MISMATCH.
The Commission may not--
(1) amend section 230.156 of title 17, Code of Federal
Regulations, to extend the provisions of such section to
offerings of securities issued by private funds; or
(2) adopt rules applicable to offerings of securities issued
by private funds that are substantially the same as the
provisions of such section.
SEC. 5. EXCLUSION OF ADVISORY SERVICES TO REGISTERED INVESTMENT
COMPANIES.
This Act shall not apply with respect to advisory services provided,
or proposed to be provided, to an investment company registered under
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).
SEC. 6. REFERENCES TO REGULATIONS.
In this Act, any reference to a regulation shall be construed to
refer to such regulation or any successor thereto.
SEC. 7. DEFINITIONS.
In this Act:
(1) Public security.--The term ``public security'' means a
security issued by an issuer that--
(A) is required to submit reports under section 13(a)
or 15(d) of the Securities Exchange Act of 1934 (15
U.S.C. 78m(a); 78o(d)); or
(B) has a security that is listed or traded on any
exchange or organized market operating in a foreign
jurisdiction.
(2) Terms defined in investment advisers act of 1940.--The
terms defined in section 202(a) of the Investment Advisers Act
of 1940 (15 U.S.C. 80b-2(a)) have the meanings given such terms
in such section.
Purpose and Summary
Introduced by Representatives Robert Hurt, Bill Foster,
Randy Hultgren, Kyrsten Sinema, Steve Stivers and Juan Vargas,
on June 9, 2016, H.R. 5424, the Investment Advisers
Modernization Act of 2016, updates the application of the
Investment Advisers Act of 1940 (``Advisers Act'') to better
reflect today's capital markets. The Investment Advisers
Modernization Act of 2016, as amended, would make modest,
common sense modifications to the IAA while maintaining strong
regulatory oversight of investment advisers.
Background and Need for Legislation
The rationale for most federal securities regulation is to
protect ordinary investors. Under this rationale, federal
securities regulation is supposed to protect those investors
who may lack the sophistication to knowledgably invest in
complex or esoteric securities, or who may not be wealthy
enough to withstand significant losses on their investments. By
contrast, investors who have significant personal wealth or
expertise are considered to be sufficiently sophisticated that
they do not require the same level of protection that the
securities laws afford to other investors. These investors
often pool their funds in private investment vehicles to expand
the reach of their investment portfolios beyond equity
securities or mutual funds to include real estate, oil and gas
partnerships, or private equity or debt offerings. Private
equity funds are an important source of capital in the economy
and were not a cause of the 2008 financial crisis. They should
not be subject to stifling regulations that only have the
effect of limiting private equity's ability to invest in
American businesses.
Mr. Joshua Cherry-Seto, Chief Financial Officer of Blue
Wolf Capital Partners, LLC, testified before the Subcommittee
on Capital Markets and Government Sponsored Enterprises on May
17, 2016, in support of H.R. 5424 and he observed that as a
result of the Advisers Act's ``ambiguity, firms like ours spend
many hours and significant dollars trying to comply with ill-
fitting rules for our industry that don't further the intent to
protect our investors, including spending investor resources on
advisors and lawyers to try to interpret regulations not
specifically written with our industry in mind.''
Private equity
Private equity firms are also structured as limited
partnerships, but unlike hedge funds they usually employ just
one main investment strategy: buying and selling other
businesses. Most private equity firms provide financing and
management to financially troubled existing businesses or to
start-up businesses, or they create buyout funds by acquiring
ownership positions in businesses of all sizes, usually through
a leveraged buyout. Both types of private equity investments
seek to make profits for their investors by improving the
business operations of the companies they acquire, rearranging
their capital structure, or selling the business through an
initial public offering or to a larger company.
Private investment funds and the Dodd-Frank Act
Title IV of the Dodd-Frank Act imposes new registration and
reporting requirements on advisers to hedge funds and private
equity funds. Title IV also eliminated an exemption for
advisers that serve less than fifteen clients, an exemption
that was commonly exercised by private fund advisers. Title IV
requires investment advisers to private investment funds to
register with the Securities and Exchange Commission (SEC)
under the Advisers Act. Private funds are defined as those
funds that meet the definition of investment companies under
the Advisers Act.
Title IV of the Dodd-Frank Act exempts from registration
advisers to VC funds (as defined by the SEC's definition) as
well as advisers to Small Business Investment Companies
(SBICs). Private fund advisers with assets under management of
less than $150 million qualify for a limited exemption from
registration if they comply with recordkeeping and reporting
requirements established by the SEC. The Dodd-Frank Act also
exempts ``family offices'' from registration, as those are
defined by SEC rule. Lastly, advisers registered with the
Commodity Futures Trading Commission as commodity trading
advisers are exempt from registration, unless the business of
the adviser becomes predominantly securities-related.
Title IV's registration requirements impose a duty on the
advisers to private funds to maintain records and file reports
with the SEC, which are made available to other regulators,
including the Financial Stability Oversight Council. These
records must include the amount of assets under management and
use of leverage, counterparty credit exposure, trading and
investment positions, valuation policies and practices, types
of assets held, side arrangements, trading practices, and other
information the SEC, in consultation with the Financial
Stability Oversight Council, deems necessary to promote the
public interest or facilitate the assessment of systemic risk.
Title IV directs the SEC to periodically examine the
records of private fund advisers, and it authorizes the SEC to
conduct additional examinations as the SEC deems necessary.
Private fund investment advisers are required to safeguard
client assets over which they have custody, and assets must be
verified by independent accountants.
Advisers also must report on Form ADV general information
about private funds that they manage, such as basic
organizational and operational information, fund size and
ownership. Form PF is filed by SEC-registered investment
advisers with at least $150 million in private funds assets
under management to report information about the private funds
that they manage. Most advisers file Form PF annually to report
general information such as the types of private funds advised
(e.g., hedge funds or private equity), each fund's size,
leverage, liquidity and types of investors. Certain larger
advisers provide more information on a more frequent basis
(including more detailed information on certain larger funds).
SEC Regulation of private funds
The SEC has reported that since the enactment of the Dodd-
Frank Act, approximately 1,800 advisers to hedge funds and
private equity funds have registered with the SEC. Beginning in
2013, the SEC began to conduct ``presence'' examinations, which
``are more streamlined than typical examinations, and are
designed both to engage with the new registrants to inform them
of their obligations as registered entities and to permit the
Commission to examine a higher percentage of new registrants.''
While the SEC's stated examination goal is to identify systemic
risks at private funds, the examinations have mainly served to
identify deficiencies related to investor protection.
Unfortunately, once the adviser to a private equity fund became
subject to the SEC's jurisdiction, the SEC has
disproportionately focused on these firms, rather than asset
managers. Former SEC Commissioner Dan Gallagher testified
before the Subcommittee on Capital Markets and Government
Sponsored Enterprises on May 17, 2016 that, ``such advisers
must bear the burden of the ongoing compliance costs that come
with SEC registration and reporting on Form PF. This will
continue to impose significant costs and burdens not only on
the private advisers, but also on the Commission. And yet, this
expansion of our regulatory reach will not serve to protect
ordinary retail investors, but rather investors who could, as
the Supreme Court so notably said, ``fend for themselves.''
It is also important to note that the Advisers Act was
enacted in 1940 to address the roles and responsibilities of
investment advisers, which at the time included investment
trusts and investment companies. Many of the Act's provisions
are structured around investment advisers' involvement with
publicly traded securities and retail-facing investors, and
this does not fit the business model of the private equity
industry.
Given the antiquated application of the statute and the
growth of private equity, private fund advisers now registered
with the SEC are required to comply with numerous requirements
that do not fit their business model. Private fund advisers
spend hundreds of thousands, if not millions of dollars on
complying with these rules and have dedicated countless hours
to compiling information and reports, which provides little to
no benefit to regulators or the investment community.
Commissioner Gallagher notes that the Act is not the best legal
framework for the regulation of private fund advisers and that,
``higher costs will threaten the ability of certain funds--such
as certain private equity funds--to promote capital formation
through investments in operating companies. And let me be
clear: capital formation leads to job creation, which is
something we could certainly use right now. Indeed, around
4,100 private equity firms headquartered in the U.S. currently
back about 14,300 American businesses. These private equity-
backed companies have hired around 7.5 million employees as of
March 2016.''
Private equity fund advisers have engaged regularly with
the SEC in hopes of modifying the reporting requirements so
that they are appropriate for such funds and are more helpful
to regulators. H.R. 5424, the Investment Advisers Modernization
Act of 2016, would make several modifications to the IAA as it
relates to private fund registration while largely maintaining
the existing regulatory structure for investment advisers.
Specifically, the bill would remove or modernize some of the
more unnecessary and overly burdensome requirements in the IAA
that serve only to drive up the costs for funds and investors,
and that hinder the efficient allocation of capital that helps
grow businesses and jobs. For example, the bill would permit
advisers to advertise previous recommendations to certain
clients, modify rules related to the assignment of advisory
contracts, and revise the custody rule for advisers to funds
and securities of a limited partnership. Additionally, the bill
would reduce Form PF reporting obligations for certain adviser.
Conclusion
Mr. Cherry-Seto noted that H.R. 5424, ``provides a
modernized, clear and rational regulatory framework for
advisers to comply with, given current realities. This will
allow for regulatory oversight that is efficient and
meaningful, while allowing private equity advisers to continue
to focus on growing companies, providing important returns to
our investors, and most importantly, creating new jobs, now and
into the future.''
Hearing
The Committee on Financial Services' Subcommittee on
Capital Markets and Government Enterprises held a hearing
examining matters relating to H.R. 5424 on May 17, 2016.
Committee Consideration
The Committee on Financial Services met in open session on
June 16, 2016, and ordered H.R. 5424 to be reported favorably
to the House as amended by a recorded vote of 47 yeas to 12
nays (recorded vote no. FC-109), a quorum being present.
Committee Votes
Clause 3(b) of rule XIII of the Rules of the House of
Representatives requires the Committee to list the record votes
on the motion to report legislation and amendments thereto. The
sole record vote in committee was a motion by Chairman
Hensarling to report the bill favorably to the House as
amended. That motion was agreed to by a recorded vote of 47
yeas to 12 nays (Record vote no. FC-109), a quorum being
present.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Committee Oversight Findings
Pursuant to clause 3(c)(1) of rule XIII of the Rules of the
House of Representatives, the findings and recommendations of
the committee based on oversight activities under clause
2(b)(1) of rule X of the Rules of the House of Representatives,
are incorporated in the descriptive portions of this report.
Performance Goals and Objectives
Pursuant to clause 3(c)(4) of rule XIII of the Rules of the
House of Representatives, the Committee states that H.R. 5424
will modernize aspects of the Investment Advisers Act (IAA) by
removing duplicative burdens, address practical concerns with
the IAA, and help facilitate capital formation. H.R. 5424 will
also help the SEC prioritize its limited resources towards the
protection of less sophisticated investors who invest through
an Investment Adviser.
New Budget Authority, Entitlement Authority, and Tax Expenditures
In compliance with clause 3(c)(2) of rule XIII of the Rules
of the House of Representatives, the Committee adopts as its
own the estimate of new budget authority, entitlement
authority, or tax expenditures or revenues contained in the
cost estimate prepared by the Director of the Congressional
Budget Office pursuant to section 402 of the Congressional
Budget Act of 1974.
Committee Cost Estimate
The Committee adopts as its own the cost estimate prepared
by the Director of the Congressional Budget Office pursuant to
section 402 of the Congressional Budget Act of 1974.
Congressional Budget Office Estimates
Pursuant to clause 3(c)(3) of rule XIII of the Rules of the
House of Representatives, the following is the cost estimate
provided by the Congressional Budget Office pursuant to section
402 of the Congressional Budget Act of 1974:
U.S. Congress,
Congressional Budget Office,
Washington, DC, July 12, 2016.
Hon. Jeb Hensarling,
Chairman, Committee on Financial Services,
U.S. House of Representatives, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office has
prepared the enclosed cost estimate for H.R. 5424, the
Investment Advisers Modernization Act of 2016.
If you wish further details on this estimate, we will be
pleased to provide them. The CBO staff contact is Stephen
Rabent.
Sincerely,
Keith Hall.
Enclosure.
H.R. 5424--Investment Advisers Modernization Act of 2016
Under current law, the Securities and Exchange Commission
(SEC) enforces rules and requirements for advertising,
transferring, and selling funds and securities by investment
advisers. H.R. 5424 would provide investment advisers several
exemptions from certain of those requirements. It also would
prohibit the SEC from applying its rules to private funds that
provide sales literature about their securities offerings.
On the basis of information provided by the SEC, CBO
estimates that implementing H.R. 5424 would cost $2 million
over the 2017-2021 period for increased administrative
activities related to revising current agency rules. However,
the SEC is authorized to collect fees sufficient to offset its
annual appropriation; therefore, CBO estimates that the net
effect on discretionary spending would be negligible, assuming
appropriations actions consistent with that authority.
Enacting H.R. 5424 would not affect direct spending or
revenues; therefore, pay-as-you-go procedures do not apply. CBO
estimates that enacting H.R. 5424 would not increase net direct
spending or on-budget deficits in any of the four consecutive
10-year periods beginning in 2027.
H.R. 5424 contains no intergovernmental mandates as defined
in the Unfunded Mandates Reform Act (UMRA) and would not affect
the budgets of state, local, or tribal governments.
If the SEC increases fees to offset any costs of
implementing the bill, H.R. 5424 would increase the cost of an
existing mandate on private entities required to pay those
fees. Based on information from the SEC, CBO estimates that the
aggregate cost of the mandate, if imposed, would be minimal and
would fall well below the annual threshold for private-sector
mandates established in UMRA ($154 million in 2016, adjusted
annually for inflation).
The CBO staff contact for this estimate is Stephen Rabent.
The estimate was approved by H. Samuel Papenfuss, Deputy
Assistant Director for Budget Analysis.
Federal Mandates Statement
The Committee adopts as its own the estimate of Federal
mandates prepared by the Director of the Congressional Budget
Office pursuant to section 423 of the Unfunded Mandates reform
Act.
Advisory Committee Statement
No advisory committees within the meaning of section 5(b)
of the Federal Advisory Committee Act were created by this
legislation.
Applicability to Legislative Branch
The Committee finds that the legislation does not relate to
the terms and conditions of employment or access to public
services or accommodations within the meaning of the section
102(b)(3) of the Congressional Accountability Act.
Earmark Identification
H.R. 5424 does not contain any congressional earmarks,
limited tax benefits, or limited tariff benefits as defined in
clause 9 of rule XXI.
Duplication of Federal Programs
Pursuant to section 3(g) of H. Res. 5, 114th Cong. (2015),
the Committee states that no provision of H.R. 5424 establishes
or reauthorizes a program of the Federal Government known to be
duplicative of another Federal program, a program that was
included in any report from the Government Accountability
Office to Congress pursuant to section 21 of Public Law 111-
139, or a program related to a program identified in the most
recent Catalog of Federal Domestic Assistance.
Disclosure of Directed Rulemaking
Pursuant to section 3(i) of H. Res. 5, 114th Cong. (2015),
the Committee states that H.R. 5424 directs the SEC to both
revise and amend certain rules as directed by the legisaltion.
Section-by-Section Analysis of the Legislation
Section 1: Short title
This section cites H.R. 5424 as the ``Investment Advisers
Modernization Act of 2016.''
Section 2: Modernizing certain requirements relating to investment
advisers
This section makes the following changes:
1) Removes Overly-Broad Restrictions on Assignments:
Updates the definition of ``assignment'' to clarify that an
assignment shall not be deemed to result from the death,
withdrawal, sale or transfer of minority interests. Allows
qualified clients to consent to transfer of interests at the
time they enter into an advisory contract.
2) Adjusts Outdated and Duplicative Requirements Regarding
Any Change in Membership:
Allows advisers organized as partnerships to change the
composition of the partnership without providing notice every
time there is a change in the partnership.
3) Modifies Advertising Rule:
This section would remove the applicability of Rule 206(4)-
1(a)(1) & (a)(2) for advisers who advertise exclusively to
accredited investors, qualified clients, qualified purchasers,
or knowledgeable employees. It is important to note that the
basic anti-fraud provisions for private funds remain in place
under Rule 206(4)-8, and the other portions of the advertising
rule will remain in effect.
Section 3: Removing duplicative burdens and appropriately tailoring
certain requirements
This section makes the following changes:
1) Appropriately Tailors Brochure Requirements on Part 2 of
Form ADV:
Exempts private fund sponsors from requirement to complete
and deliver Part 2A & 2B, provided that the private placement
memorandum contains the information required by the form (to
the extent such information is material to the offering by the
private fund). Private fund sponsors could still complete and
deliver Part 2A & 2B if they so choose.
2) Appropriately Tailors Form PF:
Removes the special section (Part 4) on Form PF for private
equity funds and their portfolio companies and places them on
the same reporting basis as other private fund sponsors who are
not large hedge fund or liquidity fund sponsors. Advisers to
private equity firms would still report all of the information
required in Part 1 of Form PF, which will provide the Financial
Stability Oversight Council the information that it needs to
assess the financial system as required by the Dodd-Frank Act.
3) Updates the Custody Rule:
The SEC has already limited application of the Custody Rule
for private equity firms through interpretive guidance in two
separate instances--acknowledging that the Custody Rule in many
respects places unfair costs and burdens on private equity
firms. The proposed legislation further develops the guidance
already issued by the SEC by expanding the ``privately offered
securities'' exemption so that it applies to both certificated
and uncertificated securities and providing an exemption for
special purpose vehicles (SPV) managed by private fund sponsors
and co-investment funds that hold only one investment.
4) Adjusts Proxy Voting Rule in a Common Sense Way
Provides an exemption from the rule where an investment
adviser exercises voting authority only with respect to non-
public securities.
Section 4: Facilitating robust capital formation by preventing
regulatory mismatch
This section would prevent the misapplication of Rule 156
in the private funds space, thereby enabling both regulators
and investors alike to understand that private funds and mutual
funds are significantly different types of investment vehicles.
Changes in Existing Law Made by the Bill, as Reported
In compliance with clause 3(e) of rule XIII of the Rules of
the House of Representatives, changes in existing law made by
the bill, as reported, are shown as follows (existing law
proposed to be omitted is enclosed in black brackets, new
matter is printed in italic, and existing law in which no
change is proposed is shown in roman):
INVESTMENT ADVISERS ACT OF 1940
TITLE II--INVESTMENT ADVISERS
* * * * * * *
definitions
Sec. 202. (a) When used in this title, unless the context
otherwise requires, the following definitions shall apply:
(1) ``Assignment'' includes any direct or indirect
transfer or hypothecation of an investment advisory
contract by the assignor or of a controlling block of
the assignor's outstanding voting securities by a
security holder of the assignor[; but if the investment
adviser is a partnership, no assignment of an
investment advisory contract shall be deemed to result
from the death or withdrawal of a minority of the
members of the investment adviser having only a
minority interest in the business of the investment
adviser, or from the admission to the investment
adviser of one or more members who, after such
admission, shall be only a minority of the members and
shall have only a minority interest in the business.];
but no assignment of an investment advisory contract
shall be deemed to result from the death or withdrawal,
or the sale or transfer of the interests, of a minority
of the members, partners, shareholders, or other equity
owners of the investment adviser having only a minority
interest in the business of the investment adviser, or
from the admission to the investment adviser of one or
more members, partners, shareholders, or other equity
owners who, after such admission, shall be only a
minority of the members, partners, shareholders, or
other equity owners and shall have only a minority
interest in the business.
(2) ``Bank'' means (A) a banking institution
organized under the laws of the United States or a
Federal savings association, as defined in section 2(5)
of the Home Owners' Loan Act, (B) a member bank of the
Federal Reserve System, (C) any other banking
institution, savings association, as defined in section
2(4) of the Home Owners' Loan Act, or trust company,
whether incorporated or not, doing business under the
laws of any State or of the United States, a
substantial portion of the business of which consists
of receiving deposits or exercising fiduciary powers
similar to those permitted to national banks under the
authority of the Comptroller of the Currency, and which
is supervised and examined by State or Federal
authority having supervision over banks or savings
associations, and which is not operated for the purpose
of evading the provisions of this title, and (D) a
receiver, conservator, or other liquidating agent of
any institution or firm included in clauses (A), (B),
or (C) of this paragraph.
(3) The term ``broker'' has the same meaning as given
in section 3 of the Securities Exchange Act of 1934.
(4) ``Commission'' means the Securities and Exchange
Commission.
(5) ``Company'' means a corporation, a partnership,
an association, a joint-stock company, a trust, or any
organized group of persons, whether incorporated or
not; or any receiver, trustee in a case under title 11
of the United States Code, or similar official, or any
liquidating agent for any of the foregoing, in his
capacity as such.
(6) ``Convicted'' includes a verdict, judgment, or
plea of guilty, or a finding of guilt on a plea of nolo
contendere, if such verdict, judgment, plea, or finding
has not been reversed, set aside, or withdrawn, whether
or not sentence has been imposed.
(7) The term ``dealer'' has the same meaning as given
in section 3 of the Securities Exchange Act of 1934,
but does not include an insurance company or investment
company.
(8) ``Director'' means any director of a corporation
or any person performing similar functions, with
respect to any organization, whether incorporated or
unincorporated.
(9) ``Exchange'' means any organization, association,
or group of persons, whether incorporated or
unincorporated, which constitutes, maintains, or
provides a market place or facilities for bringing
together purchasers and sellers of securities or for
otherwise performing with respect to securities the
functions commonly performed by a stock exchange as
that term is generally understood, and includes the
market place and the market facilities maintained by
such exchange.
(10) ``Interstate commerce'' means trade, commerce,
transportation, or communication among the several
States, or between any foreign country and any State,
or between any State and any place or ship outside
thereof.
(11) ``Investment adviser'' means any person who, for
compensation, engages in the business of advising
others, either directly or through publications or
writings, as to the value of securities or as to the
advisability of investing in, purchasing, or selling
securities, or who, for compensation and as part of a
regular business, issues or promulgates analyses or
reports concerning securities; but does not include (A)
a bank, or any bank holding company as defined in the
Bank Holding Company Act of 1956, which is not an
investment company, except that the term ``investment
adviser'' includes any bank or bank holding company to
the extent that such bank or bank holding company
serves or acts as an investment adviser to a registered
investment company, but if, in the case of a bank, such
services or actions are performed through a separately
identifiable department or division, the department or
division, and not the bank itself, shall be deemed to
be the investment adviser; (B) any lawyer, accountant,
engineer, or teacher whose performance of such services
is solely incidental to the practice of his profession;
(C) any broker or dealer whose performance of such
services is solely incidental to the conduct of his
business as a broker or dealer and who receives no
special compensation therefor; (D) the publisher of any
bona fide newspaper, news magazine or business or
financial publication of general and regular
circulation; (E) any person whose advice, analyses, or
reports relate to no securities other than securities
which are direct obligations of or obligations
guaranteed as to principal or interest by the United
States, or securities issued or guaranteed by
corporations in which the United States has a direct or
indirect interest which shall have been designated by
the Secretary of the Treasury, pursuant to section
3(a)(12) of the Securities Exchange Act of 1934, as
exempted securities for the purposes of that Act; (F)
any nationally recognized statistical rating
organization, as that term is defined in section
3(a)(62) of the Securities Exchange Act of 1934, unless
such organization engages in issuing recommendations as
to purchasing, selling, or holding securities or in
managing assets, consisting in whole or in part of
securities, on behalf of others;; (G) any family
office, as defined by rule, regulation, or order of the
Commission, in accordance with the purposes of this
title; or (H) such other persons not within the intent
of this paragraph, as the Commission may designate by
rules and regulations or order.
(12) ``Investment company'', affiliated person, and
``insurance company'' have the same meanings as in the
Investment Company Act of 1940. ``Control'' means the
power to exercise a controlling influence over the
management or policies of a company, unless such power
is solely the result of an official position with such
company.
(13) ``Investment supervisory services'' means the
giving of continuous advice as to the investment of
funds on the basis of the individual needs of each
client.
(14) ``Means or instrumentality of interstate
commerce'' includes any facility of a national
securities exchange.
(15) ``National securities exchange'' means an
exchange registered under section 6 of the Securities
Exchange Act of 1934.
(16) ``Person'' means a natural person or a company.
(17) The term ``person associated with an investment
adviser'' means any partner, officer, or director of
such investment adviser (or any person performing
similar functions), or any person directly or
indirectly controlling or controlled by such investment
adviser, including any employee of such investment
adviser, except that for the purposes of section 203 of
this title (other than subsection (f) thereof), persons
associated with an investment adviser whose functions
are clerical or ministerial shall not be included in
the meaning of such term. The Commission may by rules
and regulations classify, for the purposes of any
portion or portions of this title, persons, including
employees controlled by an investment adviser.
(18) ``Security'' means any note, stock, treasury
stock, security future, bond, debenture, evidence of
indebtedness, certificate of interest or participation
in any profit-sharing agreement, collateral-trust
certificate, preorganization certificate or
subscription, transferable share, investment contract,
voting-trust certificate, certificate of deposit for a
security, fractional undivided interest in oil, gas, or
other mineral rights, any put, call, straddle, option,
or privilege on any security (including a certificate
of deposit) or on any group or index of securities
(including any interest therein or based on the value
thereof), or any put, call, straddle, option, or
privilege entered into on a national securities
exchange relating to foreign currency, or, in general,
any interest or instrument commonly known as a
``security'', or any certificate of interest or
participation in, temporary or interim certificate for,
receipt for, guaranty of, or warrant or right to
subscribe to or purchase any of the foregoing.
(19) ``State'' means any State of the United States,
the District of Columbia, Puerto Rico, the Virgin
Islands, or any other possession of the United States.
(20) ``Underwriter'' means any person who has
purchased from an issuer with a view to, or sells for
an issuer in connection with, the distribution of any
security, or participates or has a direct or indirect
participation in any such undertaking, or participates
or has a participation in the direct or indirect
underwriting of any such undertaking; but such term
shall not include a person whose interest is limited to
a commission from an underwriter or dealer not in
excess of the usual and customary distributor's or
seller's commission. As used in this paragraph the term
``issuer'' shall include in addition to an issuer, any
person directly or indirectly controlling or controlled
by the issuer, or any person under direct or indirect
common control with the issuer.
(21) ``Securities Act of 1933'', ``Securities
Exchange Act of 1934'', and ``Trust Indenture Act of
1939'', mean those Acts, respectively, as heretofore or
hereafter amended.
(22) ``Business development company'' means any
company which is a business development company as
defined in section 2(a)(48) of title I of this Act and
which complies with section 55 of title I of this Act,
except that--
(A) the 70 per centum of the value of the
total assets condition referred to in sections
2(a)(48) and 55 of title I of this Act shall be
60 per centum for purposes of determining
compliance therewith;
(B) such company need not be a closed-end
company and need not elect to be subject to the
provisions of sections 55 through 65 of title I
of this Act; and
(C) the securities which may be purchased
pursuant to section 55(a) of title I of this
Act may be purchased from any person.
For purposes of this paragraph, all terms in sections
2(a)(48) and 55 of title I of this Act shall have the
same meaning set forth in such title as if such company
were a registered closed-end investment company, except
that the value of the assets of a business development
company which is not subject to the provisions of
sections 55 through 65 of title I of this Act shall be
determined as of the date of the most recent financial
statements which it furnished to all holders of its
securities, and shall be determined no less frequently
than annually.
(23) ``Foreign securities authority'' means any
foreign government, or any governmental body or
regulatory organization empowered by a foreign
government to administer or enforce its laws as they
relate to securities matters.
(24) ``Foreign financial regulatory authority'' means
any (A) foreign securities authority, (B) other
governmental body or foreign equivalent of a self-
regulatory organization empowered by a foreign
government to administer or enforce its laws relating
to the regulation of fiduciaries, trusts, commercial
lending, insurance, trading in contracts of sale of a
commodity for future delivery, or other instruments
traded on or subject to the rules of a contract market,
board of trade or foreign equivalent, or other
financial activities, or (C) membership organization a
function of which is to regulate the participation of
its members in activities listed above.
(25) ``Supervised person'' means any partner,
officer, director (or other person occupying a similar
status or performing similar functions), or employee of
an investment adviser, or other person who provides
investment advice on behalf of the investment adviser
and is subject to the supervision and control of the
investment adviser.
(26) The term ``separately identifiable department or
division'' of a bank means a unit--
(A) that is under the direct supervision of
an officer or officers designated by the board
of directors of the bank as responsible for the
day-to-day conduct of the bank's investment
adviser activities for one or more investment
companies, including the supervision of all
bank employees engaged in the performance of
such activities; and
(B) for which all of the records relating to
its investment adviser activities are
separately maintained in or extractable from
such unit's own facilities or the facilities of
the bank, and such records are so maintained or
otherwise accessible as to permit independent
examination and enforcement by the Commission
of this Act or the Investment Company Act of
1940 and rules and regulations promulgated
under this Act or the Investment Company Act of
1940.
(27) The terms ``security future'' and ``narrow-based
security index'' have the same meanings as provided in
section 3(a)(55) of the Securities Exchange Act of
1934.
(28) The term ``credit rating agency'' has the same
meaning as in section 3 of the Securities Exchange Act
of 1934.
(29) The term ``private fund'' means an issuer that
would be an investment company, as defined in section 3
of the Investment Company Act of 1940 (15 U.S.C. 80a-
3), but for section 3(c)(1) or 3(c)(7) of that Act.
(30) The term ``foreign private adviser'' means any
investment adviser who--
(A) has no place of business in the United
States;
(B) has, in total, fewer than 15 clients and
investors in the United States in private funds
advised by the investment adviser;
(C) has aggregate assets under management
attributable to clients in the United States
and investors in the United States in private
funds advised by the investment adviser of less
than $25,000,000, or such higher amount as the
Commission may, by rule, deem appropriate in
accordance with the purposes of this title; and
(D) neither--
(i) holds itself out generally to the
public in the United States as an
investment adviser; nor
(ii) acts as--
(I) an investment adviser to
any investment company
registered under the Investment
Company Act of 1940; or
(II) a company that has
elected to be a business
development company pursuant to
section 54 of the Investment
Company Act of 1940 (15 U.S.C.
80a-53), and has not withdrawn
its election.
(29) The terms ``commodity pool'', ``commodity pool
operator'', ``commodity trading advisor'', ``major swap
participant'', ``swap'', ``swap dealer'', and ``swap
execution facility'' have the same meanings as in
section 1a of the Commodity Exchange Act (7 U.S.C. 1a).
(b) No provision in this title shall apply to, or be deemed
to include, the United States, a State, or any political
subdivision of a State, or any agency, authority, or
instrumentality of any one or more of the foregoing, or any
corporation which is wholly owned directly or indirectly by any
one or more of the foregoing, or any officer, agent, or
employee of any of the foregoing acting as such in the course
of his official duty, unless such provision makes specific
reference thereto.
(c) Consideration of Promotion of Efficiency, Competition,
and Capital Formation.--Whenever pursuant to this title the
Commission is engaged in rulemaking and is required to consider
or determine whether an action is necessary or appropriate in
the public interest, the Commission shall also consider, in
addition to the protection of investors, whether the action
will promote efficiency, competition, and capital formation.
* * * * * * *
investment advisory contracts
Sec. 205. (a) No investment adviser registered or required to
be registered with the Commission shall enter into, extend, or
renew any investment advisory contract, or in any way perform
any investment advisory contract entered into, extended, or
renewed on or after the effective date of this title, if such
contract--
(1) provides for compensation to the investment
adviser on the basis of a share of capital gains upon
or capital appreciation of the funds or any portion of
the funds of the client[;]; or
(2) fails to provide, in substance, that no
assignment of such contract shall be made by the
investment adviser without the consent of the other
party by the contract, except that if such other party
is a qualified client (as defined in section 275.205-3
of title 17, Code of Federal Regulations, or any
successor thereto), such other party may provide such
consent at the time the parties enter into, extend, or
renew such contract [; or].
[(3) fails to provide, in substance, that the
investment adviser, if a partnership, will notify the
other party to the contract of any change in the
membership of such partnership within a reasonable time
after such change.]
(b) Paragraph (1) of subsection (a) shall not--
(1) be construed to prohibit an investment advisory
contract which provides for compensation based upon the
total value of a fund averaged over a definite period,
or as of definite dates, or taken as of a definite
date;
(2) apply to an investment advisory contract with--
(A) an investment company registered under
title I of this Act, or
(B) any other person (except a trust,
governmental plan, collective trust fund, or
separate account referred to in section
3(c)(11) of title I of this Act), provided that
the contract relates to the investment of
assets in excess of $1 million,
if the contract provides for compensation based on the
asset value of the company or fund under management
averaged over a specified period and increasing and
decreasing proportionately with the investment
performance of the company or fund over a specified
period in relation to the investment record of an
appropriate index of securities prices or such other
measure of investment performance as the Commission by
rule, regulation, or order may specify;
(3) apply with respect to any investment advisory
contract between an investment adviser and a business
development company, as defined in this title, if (A)
the compensation provided for in such contract does not
exceed 20 per centum of the realized capital gains upon
the funds of the business development company over a
specified period or as of definite dates, computed net
of all realized capital losses and unrealized capital
depreciation, and the condition of section
61(a)(3)(B)(iii) of title I of this Act is satisfied,
and (B) the business development company does not have
outstanding any option, warrant, or right issued
pursuant to section 61(a)(3)(B) of title I of this Act
and does not have a profit-sharing plan described in
section 57(n) of title I of this Act;
(4) apply to an investment advisory contract with a
company excepted from the definition of an investment
company under section 3(c)(7) of title I of this Act;
or
(5) apply to an investment advisory contract with a
person who is not a resident of the United States.
(c) For purposes of paragraph (2) of subsection (b), the
point from which increases and decreases in compensation are
measured shall be the fee which is paid or earned when the
investment performance of such company or fund is equivalent to
that of the index or other measure of performance, and an index
of securities prices shall be deemed appropriate unless the
Commission by order shall determine otherwise.
(d) As used in [paragraphs (2) and (3) of subsection (a)]
subsection (a)(2), ``investment advisory contract'' means any
contract or agreement whereby a person agrees to act as
investment adviser to or to manage any investment or trading
account of another person other than an investment company
registered under title I of this Act.
(e) The Commission, by rule or regulation, upon its own
motion, or by order upon application, may conditionally or
unconditionally exempt any person or transaction, or any class
or classes of persons or transactions, from subsection (a)(1),
if and to the extent that the exemption relates to an
investment advisory contract with any person that the
Commission determines does not need the protections of
subsection (a)(1), on the basis of such factors as financial
sophistication, net worth, knowledge of and experience in
financial matters, amount of assets under management,
relationship with a registered investment adviser, and such
other factors as the Commission determines are consistent with
this section. With respect to any factor used in any rule or
regulation by the Commission in making a determination under
this subsection, if the Commission uses a dollar amount test in
connection with such factor, such as a net asset threshold, the
Commission shall, by order, not later than 1 year after the
date of enactment of the Private Fund Investment Advisers
Registration Act of 2010, and every 5 years thereafter, adjust
for the effects of inflation on such test. Any such adjustment
that is not a multiple of $100,000 shall be rounded to the
nearest multiple of $100,000.
(f) Authority to Restrict Mandatory Pre-dispute
Arbitration.--The Commission, by rule, may prohibit, or impose
conditions or limitations on the use of, agreements that
require customers or clients of any investment adviser to
arbitrate any future dispute between them arising under the
Federal securities laws, the rules and regulations thereunder,
or the rules of a self-regulatory organization if it finds that
such prohibition, imposition of conditions, or limitations are
in the public interest and for the protection of investors.
* * * * * * *
MINORITY VIEWS
H.R. 5424 seeks to provide regulatory relief to investment
advisers to private funds, particularly private equity funds,
which would reduce transparency and make it harder for the
Securities and Exchange Commission (SEC) to protect investors
in those funds. The bill also fails to address the needs of
investors for greater protections and disclosures, as evidenced
by recent SEC exams and enforcement actions.
In the Dodd-Frank Act, we sought to bring transparency and
oversight over the shadow banking system, particularly for
private equity funds and hedge funds. Specifically, we required
advisors to these funds with more than $150 million in assets
to register with the SEC, comply with new recordkeeping,
reporting, and audit requirements, and file systemic risk
reports with the Financial Stability Oversight Council (FSOC).
H.R. 5424 would change this new regime by removing
important investor protections including the requirements that
such advisers: notify clients of a change in ownership or
control of the adviser; deliver a plain language narrative
brochure to clients each year; and disclose to the FSOC certain
information on large private equity funds. Worse, H.R. 5424
would create a Madoff loophole by providing a broad exemption
from the annual audit requirement for funds owned by investors
who may have a tangential relationship with the adviser, such
as a caterer or building manager.
H.R. 5424 is also problematic because it fails to address
the problems that the SEC has uncovered as a result of its new
oversight of private fund advisers. In 2013, the SEC found that
in cases where it examined how fees and expenses are handled,
it identified violations of law or material weaknesses in
controls over 50% of the time. In 2014 and 2015, the SEC
brought numerous enforcement actions against private equity
fund managers for: misallocating expenses to funds; failing to
disclose loans from clients; using funds to pay their operating
expenses without authorization and disclosure; and failing to
disclose fees and discounts from service providers. Finally,
last month, the SEC Director of Enforcement highlighted a need
for greater transparency into fees and expenses.
Considering that one-quarter of the equity in private
equity funds comes from public pension funds--who invest on
behalf of our nation's teachers, police officers and
firefighters--we should not be repealing important protections
and failing to address the need for additional protections.
CalPERS, the largest public pension fund in the U.S.; CalSTRS,
which provides retirement benefits to California's public
school teachers; and the Institutional Limited Partners
Association, which represents a large swath of investors in
private equity funds, agree and oppose H.R. 5424.
For all of these reasons, we oppose H.R. 5424.
Maxine Waters.
Emanuel Cleaver.
Stephen Lynch.
Keith Ellison.
Gwen Moore.
Al Green.
Wm. Lacy Clay.
[all]