December 20, 2010

Year-End Investment Adviser Compliance Review

Arnold & Porter Advisory

We are providing this year-end review as a service to our investment adviser clients. As a general matter, we presume that your firm is taking the steps necessary to comply with the requirements outlined below. If you would like assistance with any of these matters, please contact us.


California Assembly Bill 1743 ("AB 1743"), which takes effect January 1, 2011, will require placement agents and others who solicit business from a state public pension plan in California to register as lobbyists under the California Political Reform Act of 1974 (the "Reform Act").1 The following are some questions about how this new law impacts investment advisers.

1.  How are investment advisers generally affected by AB 1743?

Any investment adviser (including a manager of hedge funds or private equity funds) who solicits advisory business (whether or not ultimately hired) from California state public pension plans (i.e., CalPERS and CalSTRS) either through:

  • in-house sales staff or 
  • an outside placement agent

will be subject to registration and reporting requirements as well as other restrictions under the Reform Act, as discussed in question 3 below.

2.  Are there any exceptions for in-house sales staff?

There are two exceptions that in-house sales staff may qualify for:

  • An employee who spends 1/3 of more of his or her time "managing money" is not required to register as a lobbyist.
  • An employee of an investment advisory firm that: (1) is registered with SEC; (2) the California state public pension plan selects through a competitive bidding process; and (3) has agreed to a fiduciary standard of care (for example, in an investment advisory agreement), is not required to register as a lobbyist.

Please contact us if you would like to discuss whether your sales staff may qualify for these exceptions.

3.  Our firm employs in-house sales staff who do not qualify for an exception. What immediate steps must we take?

  • Your firm must register as a "Lobbyist Employer." To do so, complete and file Form 6032 – the "Lobbyist Employer or Lobbying Coalition Registration Statement" – no later than January 10, 2011
  • Each of your employees who solicits California state pension plan money must:
    • Complete and file a Form 604 – "Lobbyist Certification Statement"– as an attachment to your Form 603 no later than January 10, 2011
    • Pay a $25 registration fee; and
    • Submit a recent photograph with the Form 604 (head and shoulders only).
  • Each of your employees who solicits California state pension plan money must also attend a "lobbyist ethics orientation course" conducted by the California legislature. Each employee must:
    • Complete the course within 12 months of January 1, 2011. The course is two hours long and is scheduled every few months. Course dates and an online sign-up form are available at
    • File an amendment to Form 604 on Form 605 – "Amendment to Registration, Lobbying Firm, Lobbyist Employer, Lobbying Coalition" – within 20 days following the completion of the course.

4.  Our firm (also) employs an outside placement agent to solicit state pension plan money. What immediate steps must we take?

Your firm must complete and file Form 602 - the "Lobbyist Firm Activity Authorization." You should deliver the Form 602 to the outside placement agent and ensure that the placement agent files it (as an attachment to the placement agent's Form 601) no later than January 10, 2011.

5.  What are the ongoing requirements related to the Reform Act?

  • If you hire a new employee who solicits California state pension plan money, you must complete and file a Form 604 for that person within 10 days of the hire date, and that person must also attend an ethics course. 
  • Your firm must file a quarterly disclosure statement on Form 635 – "Report of Lobbyist Employer and Report of Lobbying Coalition." The Form 635 for the first quarter of 2011 is due April 30, 2011
  • Each of your employees who has registered as a lobbyist on Form 604 must file a quarterly disclosure statement on Form 615 – "Lobbyist Report." The Forms 615 are attached to your firm's Form 635. The Forms 615 for the first quarter of 2011 are due April 30, 2011
  • Forms 635 and 615 must be completed and filed on April 30, July 31, October 31 and January 31 for the previous calendar quarter, whether or not the firm actually engaged in any solicitation of California state pension plan money during that quarter.

6.  What are the renewal requirements?

  • Your firm must renew the Form 603 between November 1 and December 31 of each even-numbered year. 
  • Your employees (if applicable) must renew their Forms 604 between November 1 and December 31 of each even-numbered year and repeat the ethics course no later than June 30 of the following year.

7.  What are the other implications of the Reform Act on our business?

The Reform Act restricts certain activities of registered lobbyists and firms that employ lobbyists. For example, registered lobbyists cannot give gifts or make campaign contributions to state officials and candidates. The Reform Act also prohibits an investment adviser from compensating an in-house sales person with a payment (such as a bonus) that is contingent on successfully soliciting state pension plan business.

Your firm should adopt internal policies addressing these requirements. Please let us know if you would like our assistance.

8.  What if our firm solicits local retirement funds within California?

You will need to determine the lobbying rules and restrictions of each local agency from whom you solicit advisory business. We recommend that you start by asking the local agency what its requirements are and then research any such requirements. Please let us know if we can be of assistance with this process.

The above is only meant to be a brief introduction to the Reform Act's requirements. There are other rules and restrictions not discussed here that may affect your firm. Please contact us if you would like to discuss these requirements further.

In addition, you may recall that on June 30, 2010, the SEC adopted a new "pay to play" rule. Any obligations you may have under the SEC's rule are in addition to those under the Reform Act. Click here to view our earlier Client Alert on the SEC's pay to play rule.


As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), as of July 21, 2011, many investment advisers who are currently exempt from registration3 will be required to register as an investment adviser. In addition, some advisers who are currently registered with the SEC will be required to withdraw that registration and instead register with one or more state regulatory authorities. Because many states, including California, have not yet amended their investment adviser registration requirements in response to the passage of the Dodd-Frank Act, it is still unclear what registration requirements, if any, many investment advisers will be subject to after July 21, 2011. However, investment advisers who may need to register with the SEC or a state should begin preparing for the registration process well in advance.

Potential Registration Venues

Depending on your advisory firm's assets under management, if your principal place of business is in California  the registration requirements that apply to your firm are as follows:

Assets Under ManagementRegistration Venue (California vs. SEC)
Under $100 millionUnless California creates an applicable exemption (such as an exemption mirroring the SEC's proposed "smaller fund managers" exemption, described below), advisers with less than $100 million under management will be required to register with the California Department of Corporations (and withdraw from their existing registration with the SEC, if applicable).
Over $100 millionAdvisers with over $100 million under management will be required to register with the SEC, unless their firm qualifies for one of the SEC's new exemptions from registration (see below). Unless California creates an applicable exemption, if an adviser is exempt from registration with the SEC (and chooses not to register with the SEC), it will be required to register with California.

Exemptions/exclusion from SEC registration

The Dodd-Frank Act creates two new exemptions and a new exclusion from SEC registration for certain investment advisers that would otherwise be required to register with the SEC.  For U.S.-based advisers, the most relevant of these are:

  • Exemption for Smaller Fund Managers. Any investment adviser who: (i) acts solely as an adviser to one or more private funds;6 and (ii) has assets under management in the United States of less than $150 million (effectively, between $100 million and $150 million).
  • Exemption for Managers to Venture Capital Funds. Any investment adviser who acts solely as an investment adviser to one or more "venture capital funds."7
  • Exclusion for Family Offices. The Dodd-Frank Act excludes "family offices"8 from the definition of investment adviser, and therefore family offices are not subject to registration and regulation as investment advisers under the Advisers Act.

Unfortunately, the scope of these exemptions and the exclusion will not be certain until the SEC adopts final rules to implement them. Further, precisely how the SEC defines "assets under management in the United States" for purposes of the exemption for smaller fund managers will be critical to U.S. managers to offshore funds with foreign investors.9 In addition, the requirement that the manager act solely as an adviser to one or more funds presumably means that those fund managers who also manage separate accounts will not be able to rely on these exemptions.

The above is only intended to provide a brief summary of the potential registration requirements resulting from the Dodd-Frank Act. We will provide more information as it becomes available. We would, of course, be happy to discuss with you in detail what impact (if any) the new registration requirements will have on your firm.


The SEC has adopted major amendments to Part 2 (previously known as Part II) of the Form ADV.10 Investment advisers use the Form ADV to register with the SEC and state securities regulators and to satisfy their disclosure requirements to clients under the Advisers Act.

The amendments transform Part 2 from the prior "check the box" format to a narrative response format. The amended Part 2 consists of two sub-parts: a "brochure" (Part 2A) and one or more "brochure supplements" (Part 2B). Part 2A will include information about the adviser and its business. Advisers must file Part 2A electronically through the Investment Adviser Registration Depository (IARD) and Part 2A will be publicly available on the SEC website. Part 2B is comprised of disclosure about the personnel of the adviser who provide investment advice. Registered advisers must provide Part 2B to clients, but are not required to file it electronically.

Investment advisory firms that register with a state or the SEC after January 1, 2011 will be required to use the new Form ADV Part 2. Currently registered investment advisers will need to prepare their new Form ADV Part 2, including the narrative disclosure, in connection with their next annual update. For registered advisers with a fiscal year ending December 31, 2010, this update is due March 31, 2011.

Part 2A – "The Brochure"

Part 2A includes 18 separate disclosure topics, each of which must be addressed in a "plain English" narrative format. Some of the main topics covered by Part 2A include:

Item 2 – Material Changes: An adviser must provide a description of any material changes since its last annual update.

Item 4 – Advisory Business: An adviser must describe its advisory business, including the type of advisory services offered, whether the adviser specializes in a particular type of advisory service and its total assets under management.

Item 6 – Performance Based Fees and Side-by-Side Management: An adviser that charges a performance based fee to some accounts but not to others must describe the conflicts of interest that may result (such as the adviser's incentive to take greater risks in accounts for which it charges a performance fee).

Item 8 – Methods of Analysis: An adviser must describe its significant investment strategies and explain the material risks that each strategy presents.

Item 12 – Brokerage Practices: An adviser must describe how it selects brokers, its soft dollar practices, its directed brokerage and trade aggregation policies and how it addresses the conflicts of interest created by those policies and practices.

Item 17 – Voting Client Securities: An adviser must disclose its proxy voting practices and whether it has or will accept authority to vote client securities.

Part 2B – The "Supplemental Brochure"

Part 2B of Form ADV provides clients with background information about the adviser's personnel who provide its clients with investment advice. The adviser must respond to each item of Part 2B with respect to each portfolio manager who formulates investment advice for client assets and has direct contact with clients or makes discretionary investment decisions for client assets.

The topics covered under Part 2B include information about each portfolio manager's: (i) educational background and business experience; (ii) history of legal or disciplinary events; (iii) other investment-related business activities and any other business activities that involve a "substantial" amount of the manager's time or pay; (iv) additional compensation (such as sales awards); and (v) supervision by the adviser.

Filing and Delivery Requirements

The SEC has also revised an adviser's ongoing requirements to update and deliver its Form ADV. The new requirements are as follows:

  • Each adviser must deliver to a client:11 (i) a current Form ADV Part 2A at or before the time it enters into an advisory agreement with the client; and (ii) a Part 2B covering each of the adviser's personnel who provides advisory services to that client at or before the time that the person begins to provide advisory services to that client.12
  • Each year, after an adviser files its annual update to Form ADV, the adviser must provide to each client either a copy of its current Form ADV or a description of the material changes from the prior version and an offer to provide a new copy. 
  • An adviser must provide an update to clients promptly whenever it amends Part 2 to add or update a disciplinary event.

The above is only intended to provide a brief summary of some of the changes to Form ADV. We would, of course, be happy to discuss with you the changes in detail and assist you in preparing the new Part 2 to your Form ADV.


The following are reminders of some of the regulatory and compliance matters that advisers should bear in mind each year.

All advisers:

  • Amendments to Form D – For each private fund that an adviser manages that continues to offer interests, the adviser must file an amended Form D with the SEC no later than the anniversary of the most recent filing.
  • State Private Placement Exemption Notice Filings – An adviser must evaluate potential "notice" filing requirements each time the adviser admits an investor to a fund in a state not already represented among its clients. 
  • OFAC Reviews – On a continuous basis, advisers should compare investors' names against the Office of Foreign Assets Control list of prohibited persons. 
  • Annual notice of privacy policy – An adviser must deliver a privacy notice to each of the firm's clients at least once in every period of 12 consecutive months in which the adviser has a relationship with the client.

All registered advisers (state and SEC):

  • Annual Amendment to Form ADV – As discussed above, advisers must file an annual amendment to Form ADV within 90 days of the end of the adviser's fiscal year. 
  • Delivery of Form ADV – Each year, after an adviser files its annual update to Form ADV, the adviser must provide to each client either a copy of its current Form ADV or a description of the material changes from the prior version and an offer to provide a new copy.

All SEC registered advisers:

  • Audited Financial Statements of Private Funds – SEC registered investment advisers that manage private investment funds organized as limited partnerships of which the adviser or an affiliate is the general partner (or limited liability company of which the adviser or an affiliate is managing member) must send to each limited partner (or member) audited financial statements by May 30 of each year.13
  • Review of Compliance Program – SEC registered advisers must, no less frequently than annually, conduct a review of the adviser's compliance program (including portfolio trading and best execution policies and procedures, code of ethics, and insider trading policy and procedures). This should be documented and the report kept in the adviser's records.

1 AB 1743 amends the definition of "lobbyist" under the Reform Act to include "placement agents." "Placement Agent" is defined as: an individual hired, engaged, or retained by, or serving for the benefit of or on behalf of, an external manager, or on behalf of another placement agent, who acts or has acted for compensation as a finder, solicitor, marketer, consultant, broker, or other intermediary in connection with the offer or sale of securities, assets, or services of an external manager to a state public retirement system in California or an investment vehicle, either directly or indirectly.
An "external manager" means either one of the following: (1) a person who is seeking to be, or is, retained by a state public retirement system in California to manage a portfolio of securities or other assets for compensation; or (2) a person who is engaged in the business of investing, reinvesting, owning, holding, or trading securities or other assets, and who offers or sells, or has offered or sold, securities to a state public retirement system in California.
2 All of the forms referred to in this memo can be found on the California Secretary of State website at:
3 Many firms currently rely on the "private advisers exemption" provided by Section 203(b)(3) of the Investment Advisers Act of 1940 (the "Advisers Act"). Under that exemption, fund managers that have had fewer than 15 clients in the preceding 12 months (and who do not "hold themselves out" to the public as "investment advisers") are not required to register with the SEC. The Dodd-Frank Act eliminates the private advisers exemption and replaces it with a new set of exemptions, which may not apply.
4 If you have a place of business in another state (and you are not registered with the SEC), you may be required to register in that state even if you are not required to register in California.
5 Advisers that qualify for an exemption from registration will still be subject to SEC reporting requirements. The SEC has proposed rules that would require exempt advisers to complete and file certain sections of the Form ADV.
6 The Dodd-Frank Act defines a "private fund" as a fund exempt from registration as an investment company under either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940, as amended.
7 The SEC has proposed rules defining a venture capital fund, in part, as a fund that: (i) only invests in equity securities of private operating companies; (ii) acquires 80% of the equity securities of such portfolio companies directly from the private offering companies; (iii) provides significant management assistance to the portfolio companies in which it invests; (iv) does not borrow more than 50% of the capital that it invests; (v) only offers redemption rights to its investors in extraordinary circumstances; and (vi) represents itself to investors as a venture capital fund.
8 The SEC has proposed a rule that would define a family office as any firm that (i) has no clients other than "family clients"; (ii) is wholly owned and controlled (directly or indirectly) by family members; and (iii) does not hold itself out to the public as an investment adviser. "Family clients" include (a) family members, (b) key employees of the family office, (c) charities (foundations, organizations or trusts) established and funded exclusively by family members and former family members, (d) trusts or estates that exist for the sole benefit of family clients, (e) entities wholly owned and controlled (directly or indirectly) exclusively by, and operated for the sole benefit of, family clients (with certain exceptions) and, (f) under certain circumstances, former family members and former key employees. The exclusion would not extend to family offices that serve multiple families.
9 The SEC has recently proposed a rule under which all of a U.S. adviser's private fund assets would be considered to be "in the United States" for purposes of the exemption if its principal office and place of business is in the United States.
10 See Final Rule: Amendments to Form ADV, Rel. No. IA-3020 (July 28, 2010); 75 FR 49234 (August 12, 2010).
11 The new rule clarifies that the "client" of an adviser who manages a private fund is the fund itself, not the individual investors in the fund.
12 The former rule that required an adviser to deliver a Form ADV within 48 hours of entering into an advisory agreement has been eliminated.
13 This requirement arises from the "custody rule" of the Advisers Act (Rule 206(4)-2). If your firm is an SEC-registered adviser to a hedge fund or other pooled investment vehicle — AND the fund's assets are held by an independent "qualified custodian" — then you will be in compliance with the custody rule so long as the fund's investors receive, within 120 days of each fiscal year-end, financial statements prepared in accordance with generally accepted accounting principles and audited by an independent public accountant registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board.

If you have any questions or you would like our assistance with any of the matters described in this Year-End Investment Adviser Compliance Review, please contact one of the attorneys below:

André W. Brewster
Ellen Kaye Fleishhacker
Benjamin Berk
Gary P. Kaplan
Charlotte M. Saxon
Jennifer Starkey

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