Policy Considerations And Potential Business Impact
Perhaps the two most relevant provisions of the Investment Modernization Act of 2016 are the changes to restrictions on advertising in sections 2(b)(1)-(2), and the reduction in reporting requirements on the Form PF for many investment advisers in section 3(a).1 The bill passed the House on September 9, 2016.2
The act instructs the SEC to amend its Rule 206(4)-1.3 Currently, this rule makes it fraudulent for a registered investment adviser to advertise with reference to testimonials or misleading past performance records.4 Historically, the definition of ‘advertisement’ was interpreted liberally.5
The proposed changes would amend the rule so that the restrictions would not apply to persons that are ‘sophisticated’ clients. Four categories of exempted persons are provided: a qualified client, knowledgeable employee, qualified purchaser, and an accredited investor.6 The definition of these categories is further elaborated upon in other sections of the code.
The proposed changes are limited to a specific set of individuals– persons that meet certain requirements in terms of their access to information, understanding and knowledge, and experience. These clients, typically institutional investors, are more likely to rely on their own due diligence and have more sophisticated investigative procedures in place. However, the changes may impact the reporting incentives of investment advisers. Currently, the fund advisors themselves are responsible for ensuring that their reporting to is not misleading. The proposed changes shift the burden to the sophisticated investors, rather than advisors, to investigate and ensure the accuracy of reported statistics.
Another key change stemming from the Investment Modernization Act of 2016 is a reduction in reporting requirements. In particular, section 3(a) of the bill instructs the SEC to amend Rule 204(b)-1. (17 C.F.R. § 275.204(b)-1 (2016).)) The amendment would remove all reporting requirements beyond those listed in section 1(a) and 1(b) of the Form PF.7 This is perhaps the more worrisome and potentially dangerous modification the bill proposes.
Section 1(a) requires information about advisers and their related persons, and section 1(b) requires information about the private fund of that advisor.8 However, the changed rule would no longer require information about the hedge funds or liquidity funds the advisor operates.9 Because it relaxes the reporting requirements for small and medium-sized funds, the ability of the SEC to regulate these funds will be greatly diminished. A possible consequence of this change is that the SEC will no longer have access to detailed information about risk exposure for many private funds. Originally, the purpose of the Form PF was to “identify systemic trends in the private fund industry and to assist in monitoring systemic risks to the U.S. financial markets.”10 Removing the ability of the SEC to analyze data about the risks of many funds could be a significant limitation to the Dodd Frank initiative of “improving accountability and transparency in the financial system.”11.
H.R. 5424 114th Cong. (2d Sess. 2016). ↩
17 C.F.R. § 275.206(4)(1) (2016). ↩
JENNIFER L. KLASS, SEC REGULATION OF ADVERTISING BY INVESTMENT ADVISORS 2 (2012), https://www.morganlewis.com/documents/seiregofadvertising_sep2012.pdf. ↩
H.R. 5424, supra note 1. ↩
H.R. 5424, supra note 1. ↩
SEC, FORM PF, https://www.sec.gov/rules/final/2011/ia-3308-formpf.pdf. ↩
H.R. 5424, supra note 1, at §§ 1(c), 2, 3. ↩
Nabil Sabki & Nadia Sager, Five Lessons for Form PF, in PRACTICAL COMPLIANCE AND RISK MANAGEMENT FOR THE SECURITIES INDUSTRY, 35, 35 (2013). ↩
H.R. 4173 111th Cong. (2d Sess. 2010 ↩