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Dodd-Frank: Outlook for U.S. and Foreign Investment Advisers, Private Funds, and Family Offices August 17, 2010 On July 21, 2010 President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law. This act will change the regulation of U.S. and foreign investment advisers, private funds and family offices. For a detailed description of these changes, please click here. Key changes affecting investment advisers, private funds and family offices include:
WUERSCH & GERING LLP 100 Wall Street, 21st Fl. | New York, New York 10005 | www.wg-law.com ___________________________________________________ IMPORTANT TAX UPDATE – IRS MOVING FORWARD WITH INTERNATIONAL JOINT AUDITS August 18, 2010 Commissioner of Internal Revenue Douglas Shulman recently announced that the IRS is developing a protocol for joint audits with other countries. A joint audit would be a coordinated enforcement action utilizing the resources of the IRS and personnel from other countries. The Service is anticipated to select its first case for a joint audit during 2010, which would be conducted as a pilot program.___________________________________________________________ Impact of Change to “Accredited Investor” Definition for Natural Persons on Existing Investment Funds The accredited investor standard (as set forth in Rule 501 of Regulation D, the private placement safe harbor promulgated under Section 4(2) of the Securities Act of 1933, as amended) was modified under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), so that a natural person is no longer permitted to include the value of his or her primary residence in determining whether such person meets the $1 million net worth test. According to guidance from the Securities and Exchange Commission (the “SEC”), the investor may exclude the amount of any indebtedness secured by the primary residence, up to the fair market value of the primary residence (indebtedness in excess of the fair market value should be considered a liability and deducted from the investor’s net worth). The new net worth standard only applies to subscriptions occurring after the enactment of the Act on July 21, 2010. Accordingly, subscriptions for interests in investment funds made on or after July 21, 2010, must comply with the new standard to the extent the offer and sale is made under Regulation D and the investor is relying on the net worth standard. Funds do not need to obtain new certifications from existing investors, unless the existing investor is making an additional subscription. The Act permits the SEC to undertake an initial review of the accredited investor standard as it applies to natural persons and modify the standard as it deems appropriate for the protection of investors, other than the net worth standard (which may not be modified during the four-year period that begins on the date of enactment, but must be increased to more than $1 million after such time period). Following the four-year period that begins on the date of enactment of the Act, the SEC must review (and may adjust) the accredited investor standard as it applies to natural persons in its entirety at least once every four years. We recommend that fund managers amend their offering documentation to ensure compliance with the amended net worth test for accredited investors who are natural persons. This summary is intended to provide general information only on the matters presented. It is not a comprehensive analysis of these matters and should not be relied upon as legal advice. _________________________________________________________ U.S. FINANCIAL MARKET REFORM AT THE HALF-WAY POINT: OUTLOOK FOR INVESTMENT ADVISERS AND PRIVATE FUNDSMay 28, 2010 On May 20, 2010 the United States Senate passed the Restoring Financial Stability Act of 2010 (the “Senate Bill”). Like its counterpart approved in the U.S. House of Representatives on December 11, 2009, the Wall Street Reform and Consumer Protection Act 2009 (the “House Bill”), the Senate Bill includes amendments to the Investment Advisers Act of 1940, as amended (the “Advisers Act”). These amendments change the registration requirements for fund managers and other investment advisers and increase the compliance obligations for private funds. The proposed changes affect domestic and foreign investment advisers and funds. The amendments to the Advisers Act contained in the Senate Bill and the House Bill are similar in concept, but differ in a number of details that will have to be resolved in the upcoming reconciliation proceeding. As the debate is expected to focus on more controversial aspects of the two financial market reform bills, it is likely that a compromise on these differences will be found during this process. The following provides an overview of the key provisions affecting private funds and their advisers in the Senate Bill and the House Bill. Private Funds Both bills reintroduce the concept of a private fund to the regulation of investment advisers. This concept was first adopted by the Securities and Exchange Commission (“SEC”) in its 2004 hedge fund regulations, which were struck down two years later by the United States Court of Appeals, District of Columbia Circuit. In the Senate Bill and the House Bill, a private fund is defined as an issuer who would be an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”), but for the exceptions provided in Sections 3(c)(1) and 3(c)(7) of the Investment Company Act. These exceptions are generally relied upon by domestic and foreign venture capital funds, private equity funds, hedge funds and private funds of funds in order to avoid registration under the Investment Company Act. Consequently, these funds are currently not subject to SEC oversight. The bills propose to bring these funds under SEC supervision by requiring advisers and managers of certain private funds - notably most hedge funds and funds of hedge funds - to register as investment advisers with the SEC and by authorizing the SEC to adopt recordkeeping and reporting requirements for unregistered private fund advisers. Under current law, domestic private fund advisers and managers can avoid SEC registration if they advise less than 15 funds, and foreign private fund advisers and managers can avoid such registration if they advise less than 15 funds in the United States. Foreign Advisers The Senate Bill requires foreign investment advisers with 15 or more U.S. clients, or $25 million or more in assets under management attributable to U.S. clients and U.S. investors in private funds to register with the SEC. The House Bill would also require foreign advisers with 15 or more U.S. investors in private funds advised by the foreign adviser to register with the SEC. Under both bills, SEC registration would also be required for foreign advisers who have a place of business in the United States, hold themselves out generally to the public in the United States as an investment adviser, or advise a registered investment company or a business development company pursuant to Section 54 of the Investment Company Act. These changes would affect foreign investment advisers generally and not just foreign private fund advisers and managers. Domestic Advisers Under both bills, the registration exemption for investment advisers with clients in a single state would no longer be available to advisers or managers of private funds, and the exemption for investment advisers with less than 15 clients would be abolished for all domestic advisers. In the Senate Bill, the threshold for federal registration of investment advisers would be raised from $25 million in assets under management to $100 million in assets under management. In the Senate Bill, the exemption for investment advisers with less than 15 clients would be replaced with an exemption for advisers and managers of venture capital funds, private equity funds and private equity funds-of-funds from SEC registration irrespective of the size of these funds. The House Bill would only exempt advisers to venture capital funds from registration irrespective of the size of the fund. All other private fund advisers would be exempt from registration if the funds advised by them have assets under management in the United States of less than $150 million. Therefore, under the Senate Bill, hedge fund advisers and advisers to funds of hedge funds would be required to register with the SEC if they advise funds with at least $100 million under management. Under the House Bill, these advisers would only be required to register with the SEC if the funds advised by them have at least $150 million under management. New Disclosure and Recordkeeping Requirements for Private Funds The Senate Bill requires registered private fund advisers to maintain the following records and reports for inspection by the SEC: • Assets under management and use of leverage; The House Bill contains a less comprehensive enumeration of record keeping and reporting requirements than the Senate Bill. However, the difference appears to be in style, rather than substance, as the House Bill confers broad rulemaking authority to the SEC. SEC Rulemaking Authority Both bills leave many key definitions and important details to regulation by the SEC and in some cases to the Commodity Futures Trading Commission (CFTC). Both bills authorize the SEC to expand the scope of the proposed changes to the Advisers Act by requiring registered private fund advisers to report additional information, including information necessary to assess systemic risk, and to maintain records necessary for the protection of investors, public interests, or the assessment of systemic risks. Both bills also require the SEC to issue record keeping and reporting requirements for private equity fund advisers exempt from registration. The House Bill would further authorizes the SEC to require private fund advisers to provide periodic reports to investors, prospective investors, counterparties and creditors to protect public interests, investors, or permit the assessment of systemic risk. Because of these and other matters deferred to regulatory rulemaking in both bills, the full impact on investment advisers and private funds of the final version of the amendments to the Advisers Act will depend on the rules and regulations that will implement the proposed changes. Both bills limit the SEC’s rulemaking authority insofar as they instruct the SEC to differentiate based on the type of fund, its business model, and the risks a fund may pose when adopting certain rules. The Senate Bill also specifically limits the SEC’s rulemaking authority with respect to the scope of the anti-fraud rule contained in Sections 206(1) and (2) of the Advisers Act for private fund advisers by providing that the SEC could not deem investors in private funds to be clients of the private fund adviser if the adviser has an advisory agreement with the fund. Accredited Investor and Qualified Client Standards The Senate Bill would eliminate the current income thresholds for individual accredited investors under Regulation D promulgated by the SEC under the Securities Act of 1933, as amended (“Regulation D”) and SEC Rule 215. In its current version, the Senate Bill would also require the SEC to review the accredited investor standard under Rule 215 at least every 4 years. To qualify as an accredited investor under the Senate Bill, an individual must have a net worth (excluding the value of his or her primary residence) or joint net worth with his or her spouse of $1 million. If adopted, this measure would reduce the number of individual investors who could qualify as accredited investors for purposes of Rule 506 under Regulation D, which enables issuers to conduct private placements with limited information if only accredited investors participate in such offerings. The House Bill does not provide for a similar change to the accredited investor qualification. However, it would require the SEC to adjust for inflation the income and net asset thresholds for qualified clients under Rule 205-3 under the Advisers Act. Because fund advisers may not charge performance fees to clients who are not qualified clients under Rule 205-3, this change would over time increase the bar for a private fund adviser’s ability to charge performance fees. _____ Wuersch & Gering LLP is keeping abreast of the further development with respect to these changes and intends to periodically publish updates on the proposed legislation discussed herein. This summary is intended to provide general information only on the matters presented. It is not a comprehensive analysis of these matters and should not be relied upon as legal advice. If you have any questions about the matters covered by this publication, please contact: Daniel A. Wuersch:
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| (212) 509 4722 Circular 230 Disclosure: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained herein is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer. ___________________________________________________
FOREIGN ACCOUNT TAX COMPLIANCE ACT - EXPANSION OF US TAX COMPLIANCE FOR FOREIGN FINANCIAL AND NON-FINANCIAL INSTITUTIONSOn March 18, 2010, President Barack Obama signed into law a statute which incorporates certain provisions of the Foreign Account Tax Compliance Act of 2009 (“FATCA”). FATCA will require a non-US financial institution (“FFI”) such as a bank, private equity fund or hedge fund to enter into an agreement with the Internal Revenue Service (“IRS”) to identify US account holders and to provide certain information about them annually. If the FFI does not enter into such an agreement, US withholding tax at the rate of 30% will be imposed on, among other things, dividends and interest from the FFI’s US portfolio securities paid to the FFI after December 31, 2012 (subject to a grandfather rule). An FFI which satisfies prescribed procedures to ensure that it does not maintain accounts held by US persons may be exempted from the requirement to identify US account holders. FATCA also imposes information reporting burdens on non-US non-financial entities (“NFIs”). An NFI will need to certify that certain US persons do not own a specified level of interest in the NFI or will have to furnish some information about US persons that do, in order to avoid the 30% US withholding tax described previously. Interpretation and implementation of the new rules will largely depend on regulations that have yet to be issued. Qualified Intermediaries (“QIs”) will need to satisfy the new information reporting rules in addition to existing QI requirements. Rules for Foreign Financial Institutions An FFI includes entities: (a) that accept deposits in the ordinary course of a banking or similar business; (b) a substantial part of whose business consists of holding financial assets for the account of others; and (c) primarily engaged in the business of investing, reinvesting or trading in securities, partnership interests, commodities or any interest in such securities, partnership interests or commodities (including futures, forwards or options). Thus the term includes foreign investment vehicles such as private equity funds, hedge funds and family investment vehicles. The extent to which a foreign insurance company is an FFI will be the subject of regulations. To avoid the 30% withholding tax, an FFI will need to enter into an agreement with the IRS, pursuant to which the FFI will be required to:
A “US account” is a depository or custodial account maintained by the FFI or a non-publicly traded equity or debt interest in the FFI that is held by one or more “specified US persons” or “US owned foreign entities.” A “specified US person” means any US person other than, among others: (a ) a publicly traded corporation; (b) a tax-exempt organization or individual retirement plan; (c)a REIT; (d) a bank; or (e) a mutual fund. A”US owned foreign entity “is an entity in which at least one specified US person has a greater–than- 10% interest or in which a US investment vehicle such as a hedge fund or a private equity fund has any interest. Unless the FFI elects otherwise, a “US account” does not include a depositary account maintained solely by individuals which does not exceed $50,000. The information that an FFI will need to furnish to the IRS annually about a US account includes:
Rules for Foreign Non-Financial Institutions With the exceptions noted below, payments to NFIs will be subject to withholding of the 30% tax unless the NFI provides to the withholding agent a certification that the beneficial owner of the payment involved has no substantial US owners or provides the name, address and TIN of each substantial US owner. A “substantial US owner” is a specified US person that owns: (a) directly or indirectly, more than 10% of the stock of a corporation, the capital or profits interests in a partnership or the beneficial interests in a trust or (b) any interest in a foreign grantor trust. For US investment vehicles such as a private equity fund or hedge fund, any level of ownership in the NFI will make the vehicle a “substantial US owner.” The reference to indirect ownership of the NFI could make determining the existence of a substantial US owner a complicated exercise. This 30% withholding tax will not apply to a payment beneficially owned by: (a) a publicly traded corporation or a member of its expanded affiliate group; (b) a foreign government, any political subdivision of same or any agency or instrumentality of either; (c) an entity organized under the laws of a US possession which is wholly owned by residents of that possession; (d) an international organization or an agency or instrumentality thereof; (e) a foreign central bank of issue; or (f) any other class of persons identified by the US Treasury Secretary or his delegate. The withholding tax also will not apply to any class of payments identified by the US Treasury Secretary or his delegate as posing a low risk of tax evasion. Payments Subject to Withholding Tax Payments that will be subject to the 30% withholding tax include US source interest, dividends, royalties or other “fixed or determinable annual or periodical” gains, profits and income. The withholding tax will also apply to the gross proceeds from the sale or other disposition of property which produces US source interest or dividends. Income effectively connected with the conduct of a US trade or business will not be subject to the tax. Should you have any questions about the new information reporting and withholding tax rules, please contact Charles Chromow, Senior Counsel with Wuersch & Gering LLP. ______________________________________________________ IMPORTANT TAX UPDATE: |