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Investment Advisers Included as Accredited Investors in SEC Proposal

 

The SEC has proposed expanding the definition of “accredited investor” to include investment advisers and licensed professionals, among other new categories.  The SEC did not propose changing or indexing the $200,000 income or $1,000,000 net worth test.  The proposal includes the estimated 13,400 SEC-registered investment advisers and approximately 17,500 state-registered advisers in the definition of accredited investors, but the proposal does not include exempt reporting advisers.  The proposal also includes financial professionals who have their Series 7 or 65 licenses.  Additional new categories include knowledgeable employees of private funds, certain family offices, and a catch-all category for entities owning at least $5 Million in investments.

This proposal is a good start, but we urge the SEC to go further.  The income and net worth tests unduly restrict lower net worth, but knowledgeable, individuals from investment opportunities, while failing to protect  wealthy, but unsophisticated investors. Rather than the income and net worth tests, the SEC should consider knowledge, background and financial sophistication as litmus tests for accredited investor.  We believe that the burden should be on the investor to make representations, upon which an issuer could rely, to determine whether s/he is sophisticated enough.  Alternatively, the SEC could develop a financial quiz that potential investors would have to complete before becoming accredited. 

SEC Says that RIAs and BDs Can Only Have One Form CRS

 

The staffs of two SEC divisions published Form CRS FAQs that apprised advisers and broker-dealers that they can only use one Form CRS even if the firm offers multiple products and services.  The newly adopted Customer Relationship Summary or Form CRS will require RIAs and BDs to provide retail customers with a description of the relationship including fees, services, standard of conduct, and firm information.  The FAQs declare that a firm cannot deliver a separate CRS for each service but must prepare a comprehensive Form including all services.  However, a dual registrant can prepare a separate Form CRS for its advisory and broker-dealer services.  The FAQs also clarify that private fund sponsors need not deliver a Form CRS to retail investors in the funds.  Also notable is that delivery of the Form CRS can be included with other document delivery so long as the Form CRS is “the first among any documents delivered…at that time” or are “presented prominently in the electronic medium.” The Divisions of Investment Management and Trading and Markets jointly issued the FAQs. 

Time to start drafting.  Call your lawyers and compli-pros to craft the Form CRS before the experts fill up their dance cards.  After all, there are approximately 13,000 registered investment advisers and over 3,000 broker-dealers out there, most of whom have to prepare a Form CRS. 

Adviser Barred for Failing to Register as BD for Private Fund Sales

A financial adviser was barred from the industry and ordered to pay over $400,000 in disgorgement and interest for failing to register as a broker-dealer while selling interests in a private fund.  According to the SEC, the respondent identified investors, communicated with them (including in person), advised prospective investors on the merits of the investment, assisted handling funds, and collected transaction-based commissions.  The adviser sold notes issued by a third party fund that ultimately defaulted.  The SEC charges that the respondent’s activities violated Section 15(a)(1) of the Exchange Act, which requires registration as a broker-dealer to sell securities.

OUR TAKE: Over the last couple of years, the SEC has increased enforcement efforts to prosecute individuals and firms who sell private funds without registering as, or becoming affiliated with, a broker-dealer.

 

SEC Uses Anti-Fraud Rules to Prosecute Unregistered Fund Manager

The SEC has charged an unregistered fund manager with stealing nearly $4 Million in client funds by commingling assets and siphoning off investment funds for personal and business expenses.  The SEC asserts that the respondents hid their nefarious activities by providing false account statements that failed to show that the assets were heavily leveraged with margin accounts.  Although the respondent was not registered with the SEC or any state, the SEC charges violations of Section 10(b) (fraud in connection with purchase/sale of securities); Section 17(a) (fraud in the offering of securities); Sections 206(1) and 206(2) of the Advisers Act (investment adviser fraud); and Rule 206(4)-8 of the Advisers Act (fraud in pooled investment vehicles).

OUR TAKE: All this talk about repealing Dodd-Frank will not stop the SEC from using the anti-fraud rules against fund managers even if they are not registered.  The SEC used the anti-fraud rules to pursue private fund manager wrongdoing long before enactment of the Dodd-Frank Act (See e.g. SEC v. Lawton (2009)).