Primary Residence Now Excluded from “Accredited Investor” Test
Non-U.S. Managers relying on Regulation D under the U.S. Securities Act of 1933 (“Regulation D”) to offer securities to high net worth individuals in the U.S. on a private placement basis without registering the offering with the SEC will be impacted by changes to the “accredited investor” test. An “accredited investor”, as defined in Regulation D, includes among others, individual investors with a net worth, or joint net worth with their spouse, that exceeds US$1 million (“Net Worth Threshold”). The Reform Act, effective upon enactment, prohibits including the value of individuals’ primary residence in determining whether they have sufficient net worth, or joint net worth with their spouse, to meet the Net Worth Threshold. At the same time, the SEC has taken the position that any indebtedness secured by an individual investor’s primary residence (up to its fair market value) may be excluded from the calculation of the Net Worth Threshold.
The Reform Act requires the SEC to maintain the Net Worth Threshold at US$1 million (excluding the value of the investor’s primary residence) until 2014. Starting in 2014, the SEC is authorized to review the definition of “accredited investor” as it applies to natural persons, and to make any necessary changes at least once every four years.
Non-U.S. Managers may need to revise their offering and subscription documents for private funds they manage to address these changes.
Adjusting the “Qualified Client” Test for Inflation
The Advisers Act generally prohibits SEC registered investment advisers
from charging performance fees. However, an exemption is available that generally permits registered investment advisers to charge performance fees to“qualified clients”, which are defined to include natural persons or companies (a) with at least US$750,000 under management with the adviser immediately after entering into such advisory relationship, (b) with a net worth of more than US$1.5 million (including assets held jointly with a spouse), and (c) that are“qualified purchasers” under the 1940 Act. The Reform Act amends the Advisers Act to require the SEC, within one year after the enactment of the Reform Act and every 5 years thereafter, to adjust the US$750,000 and US$1.5 million thresholds for inflation when determining a client’s status as a “qualified client”. Non-U.S. Managers who are registered with the SEC may need to revise their offering and subscription documents for private funds they manage to address these provisions.
Derivatives
The Reform Act replaces the handsoff approach to OTC derivatives previously found in U.S. laws with requirements for regulation of products, markets and market participants. The new laws and implementing regulations will impact products defined generally as “swaps” that include swaps, options forwards and similar products the value of which relate to, among other things, rates, currencies, commodities, indices and other financial or economic interests. “Securities-based swaps”, defined as swaps based on narrow-based indices, single securities or events related to single issuers or narrow groups of issuers also will be impacted.
The Commodity Futures Trading Commission (“CFTC”) will regulate swaps, the SEC will regulate securities-based swaps, and “mixed swaps” with characteristics of both will be regulated according to rules adopted jointly, in consultation with the FED.
The regulatory scheme for swap activities, once rulemaking is completed, will include centralized clearing for swaps and securitiesbased swaps designated by the CFTC and SEC. In addition, swap dealers and major swap dealers will be required to disclose to counterparties material risks, conflicts of interest, incentives and assigned values for swaps and securities-based swaps.
The Reform Act excludes from CFTC jurisdiction swaps and swap activities outside the U.S., unless they have a “direct and significant”connection with activities in or effect on U.S. commerce, and excludes from SEC jurisdiction securitiesbased swap activities outside the U.S. unless the transactions were in contravention of rules prescribed to prevent evasion of the Reform Act. The Reform Act nevertheless likely will affect Non-U.S. Managers that use swaps and securitiesbased swaps. In the U.S., Non-U.S. Managers likely will find that many OTC products will become centrally cleared and will begin to trade like other market-based products. Furthermore, outside the U.S. similar changes are likely in other money-centre jurisdictions, resulting in fundamental global changes in the way that derivatives are purchased and traded.
Conclusion
The Reform Act has the potential to increase significantly the compliance obligations of Non-U.S. Managers. Non-U.S. Managers should consider the potential impact of the Reform Act on their businesses and in particular, should assess if they are required to register with the SEC or take other steps to comply with the requirements of the new regime.
Whilst every effort has been made to ensure the accuracy of this article, it is for general guidance only and should not be treated as a substitute for specific legal advice
The Impact of The DODD-FRANK Reform and Consumer Protection Act on Non-U.S. Managers
