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Delaware LLLPs: A Viable Option for Private Investment Funds?

1 MARCO V. MASOTTI, LOUIS G. HERING, MICHAEL S. HONG AND ADAM B. HAHN

Introduction INSIDE: Historically, private investment funds (such as onshore hedge funds and private equity funds) have relied on the limited partnership as the primary organizational form of choice, despite the exis- tence of a number of different organizational forms through which a private investment fund could, aÉä~ï~êÉ=iiimëW=^=sá~ÄäÉ=léíáçå=Ñçê in theory, conduct its activities. The limited liability company, for example, exhibits characteristics that mêáî~íÉ=fåîÉëíãÉåí=cìåÇë\ make it both similar to and more attractive than the limited partnership. A limited liability company oÉÖáëíê~íáçå=~åÇ=oÉéçêíáåÖ can be structured to mimic the centralized management of a limited partnership, yet it can also pro- fãéäáÅ~íáçåë=çÑ=íÜÉ=mêáî~íÉ=cìåÇ tect all of its members (including its managing member) from personal liability for the obligations of fåîÉëíãÉåí=^ÇîáëÉêë=oÉÖáëíê~íáçå=^Åí the company solely by virtue of being members. Given that in the limited partnership context the eçï=eáÖÜ=pÜçìäÇ=vçìê=eáÖÜ=t~íÉê general partner (i.e., the fund sponsor or manager) faces unlimited liability for the debts and obliga- j~êâ=_É\ tions of the partnership, the additional liability shield provided by a limited liability company solves the unlimited liability problem and, thus, alleviates the need for a fund sponsor to establish a separate oÉëéçåëáÄáäáíó=áå=mêáî~íÉ=bèìáíó limited liability entity to serve as a general partner in order to gain liability protection. fåîÉëíáåÖ flp`l=eÉÇÖÉ=cìåÇ=oÉéçêíáåÖ=íç Despite the potential benefits of the limited liability company form, private investment funds _ÉÖáå=áå=pÉéíÉãÄÉê have continued to opt for the limited partnership for two reasons. First, unlike the limited liability company, the fundamental nature of a limited partnership as a "partnership" means that it is more réÇ~íÉ=çå=íÜÉ=br=aáêÉÅíáîÉ=çå=^fcj likely to be afforded pass-through tax treatment with respect to its equity holders in a variety of mêçéçëÉÇ=iÉÖáëä~íáçå=^ÑÑÉÅíáåÖ= foreign (non-U.S.) jurisdictions. Second, and perhaps more importantly, the limited partnership is a mêáî~íÉ=cìåÇë relatively well-established business form and is one with which fund sponsors, investors and courts 2 kÉïäó=bå~ÅíÉÇ=i~ïë=^ÑÑÉÅíáåÖ= alike have become well accustomed. Accordingly, there are significant marketing advantages associat- mêáî~íÉ=cìåÇë ed with fund raising through an organizational form that prospective investors are more likely to understand and therefore accept as the entity in which to invest their capital.

Investment Management Group Recent trends in the market for private investment fund formation, however, warrant another look into whether the limited partnership is, indeed, the optimal organizational form. The advent and qÜÉ= m~ìäI= tÉáëë= fåîÉëíãÉåí= j~å~ÖÉãÉåí= dêçìé development of the modern limited partner advisory committee, as well as the increased public and ÑçÅìëÉë= çå= íÜÉ= çêÖ~åáò~íáçåI= ÑìåÇ= ê~áëáåÖ= ~åÇ regulatory scrutiny of fund sponsors, make the search for an organizational form with more of the ã~áåíÉå~åÅÉ=çÑ=éêáî~íÉ=áåîÉëíãÉåí=ÑìåÇë=çÑ=ÉîÉêó benefits of both the limited partnership and the limited liability company all the more relevant today íóéÉI=áåÅäìÇáåÖ=Äìóçìí=ÑìåÇëI=ÜÉÇÖÉ=ÑìåÇëI=îÉåíìêÉ than it was perhaps a few years ago. One particular form that is likely to achieve this is the Delaware Å~éáí~ä=ÑìåÇëI=ÜóÄêáÇ=ÑìåÇëI=ÇáëíêÉëëÉÇ=ÑìåÇëI=ãÉòJ limited liability limited partnership (the "LLLP"). The LLLP is essentially a limited partnership, but ò~åáåÉ= ÑìåÇëI= ëéçåëçêëÜáé= ÑìåÇëI= áåÑê~ëíêìÅíìêÉ offers limited liability protection for its general partners similar to the limitation on liability offered to ÑìåÇëI= ÅçJáåîÉëíãÉåí= ÑìåÇë= = ~åÇ= ÑìåÇë= çÑ= ÑìåÇëK managing members of a limited liability company. In addition, (continued on page 2) qÜÉ= Öêçìé= áë= ~äëç= áåîçäîÉÇ= áå= ~ÅèìáêáåÖI= ãÉêÖáåÖ

~åÇ=~ÇîáëáåÖ=áåîÉëíãÉåí=ã~å~ÖÉãÉåí=ÄìëáåÉëëÉëK 1 Mr. Hering is a partner with Morris, Nichols, Arsht & Tunnell LLP in Wilmington, Delaware. få=~ÇÇáíáçåI=íÜÉ=Öêçìé=êÉéêÉëÉåíë=~=ÇáîÉêëÉ=Öêçìé

çÑ= ÇçãÉëíáÅ= ~åÇ= ÑçêÉáÖå= áåîÉëíçêë= áå= ÅçååÉÅíáçå 2 There is a relative lack of jurisprudence on the liability of members of a limited liability company, for example, when com- ïáíÜ=íÜÉáê=áåîÉëíãÉåíë=áå=éêáî~íÉ=áåîÉëíãÉåí=ÑìåÇëK= pared to the extensive case law examining the liability of limited partners of a limited partnership.

© 2010 Paul, Weiss, Rifkind, Wharton & Garrison LLP. In some jurisdictions, this brochure may be considered attorney advertising. Past represenations are no guarantee of future outcomes.

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Delaware LLLPs: A Viable Option for Private Investment Funds? (continued from page 1) the conversion of an existing limited partnership this additional liability protection for limited Further Comparisons to Similar into an LLLP is a relatively straightforward pro- partners means that the governance structure of Forms cedure. This article offers a simple introduction the LLLP can be substantively, if not significant- The DRULPA provides that, with the to the LLLP and explores its relative advantages ly, different from that of a limited partnership. exception of LLLP-specific registration and lia- and disadvantages in comparison to other busi- Advisory board members once reluctant to ren- bility shield provisions, LLLPs are governed by ness organizational forms. der binding determinations may be willing to (or the same statutory provisions that apply to lim- may in fact desire to) assume greater oversight ited partnerships. As such, there are a few sig- LLLP Defined – A Different responsibilities in exchange for adopting an Liability Shield nificant differences between limited partnerships organizational form that limits the liability of the and limited liability limited partnerships, apart As its name suggests, the limited liability general partner. from those referenced above, as a matter of limited partnership is a special form of limited Delaware law. From that perspective, LLLPs are partnership in much the same way that a limited "Formation" (or, at least, should be) more familiar to lawyers liability partnership is a special form of general In order to become an LLLP, a limited part- and business people in the private investment partnership. In fact, neither the Delaware limit- nership must satisfy the four requirements of funds world than at first glance. Similarly, the ed liability partnership nor the LLLP can be §17-214 of the DRULPA. First, the limited registration of a limited partnership as an LLLP found in independent statutory regimes, but partnership's partnership agreement must per- has no impact on the membership requirements rather, both are based on supplements to exist- mit it to become an LLLP, or if such a transfor- or governance of the partnership in question. ing statutes (the Delaware Revised Uniform mation is not expressly permitted, it must be Partnership Act, in the case of the limited liabil- approved by all of the general partners and by a Furthermore, both limited partnerships and ity partnership, and the Delaware Revised majority-in-interest of the limited partners (or LLLPs require at least two partners (one general Uniform Limited Partnership Act (the "DRUL- each class of limited partners if more than one partner and one limited partner). The general PA"), in the case of the LLLP). As such, the class exists). Second, the limited partnership partner is responsible for managing the business fundamental characteristics of limited liability must file a Statement of Qualification contain- of the partnership (and is the only partner partnerships and LLLPs (such as governance) ing: (i) the name of the partnership; (ii) the authorized to bind the partnership), while the are consistent with their underlying general part- address of its registered office; (iii) the name and limited partner largely does not participate in the nership and limited partnership organizational address of its registered agent for service of management or business of the partnership (in forms, respectively. process; (iv) the number of partners at the time order to avoid the risk of assuming the liability of a general partner). This limitation is moot as Unlike a limited partnership, however, the statement is effective; (v) a statement that the a practical matter upon registration as an LLLP, under §17-214(c) of the DRULPA there is no partnership elects to be a limited liability limited however, as the additional liability shield protec- unlimited liability exposure for a general partner partnership; and (vi) the date or time upon tion ensures that even if a limited partner partic- of an LLLP. Importantly, this additional liabili- which the statement is to be effective (if it is not ipates in the management or business of the ty shield prevents each general partner of the to be effective upon filing). Third, the limited 3 partnership, that partner would not face unlimit- LLLP from being personally liable, on an unlim- partnership must pay certain filing fees. Fourth, ed liability for the obligations of the partnership. ited liability basis, for the debts and obligations the limited partnership must include as the last words or letters in its name "Limited Liability of the LLLP. This shield also provides an extra General partnerships and limited liability Limited Partnership," "L.L.L.P." or "LLLP." layer of liability protection for the limited part- partnerships, of course, also require at least two The limited partnership's status as an LLLP and ners. That is, in addition to having their person- partners (although all partners are general part- the protection provided by the additional liabili- al liability limited to the amount of their capital ners). Under these forms of partnerships, each ty shield are effective upon the filing of the investments while remaining passive limited partner is an agent of the partnership and any Statement of Qualification (or future effective partners, the additional liability shield provided act engaged in by one partner that appears to by the LLLP would also extend to limited part- date, if one is specified). advance the interests of the partnership can ners who have participated in the control of the bind the partnership. Each of the foregoing business of the partnership and who may have In order to retain its status as an LLLP, by forms can be distinguished easily from the limit- exposed themselves to unlimited liability as gen- June 1 of each calendar year following the year ed liability company, which only requires a single eral partners. in which a limited partnership becomes an member. The limited liability company can be LLLP, the LLLP must file an Annual Report managed either by an appointed manager (or Although Delaware limited partnership law (setting out its name, the number of partners, management team) or by the members them- enumerates a number of management activities the address of its registered office and the name selves, and all members and managers, individu- in which limited partners can be engaged with- and address of its registered agent for service of ally, have the ability to bind the company, unless out being considered as participating in the con- process) and remit the applicable fee. Failure to the company's operating agreement specifies trol of the business (such as advising the gener- file the Annual Report or pay the required filing otherwise. al partner with respect to matters of the limited fee authorizes the Secretary of State of the State partnership's business or making determinations of Delaware to revoke the limited partnership's With respect to U.S. tax treatment, general part- in connection with investments), the prospect of status as an LLLP. 4 nerships, limited partnerships, (continued on page 3)

3 There can be a significant difference in the annual filing fees charged to limited liability partnerships and LLLPs in comparison to other organizational forms. While general partnerships, limited partnerships and limited liability companies are subject to annual filing fees of $200 regardless of the number of partners or members, limited liability partnerships and LLLPs are required to pay fees of $200 per general partner per year (up to a maximum of $120,000 per year). 4 A limited partnership whose status as an LLLP has been revoked may apply to the Secretary of State of the State of Delaware for reinstatement of that status by, among other things, stat- ing in its application that grounds for revocation did not exist or have been corrected.

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Delaware LLLPs: A Viable Option for Private Investment Funds? (continued from page 2) limited liability partnerships and LLLPs are all Second, as the additional liability shield Second, the presence of an additional liabil- subject to tax treatment as partnerships (i.e., nei- builds upon the established limited partnership ity shield may be disruptive to the traditional bal- ther the registration of a general partnership as framework, the certainty for investors with ance of liability exposure that delineates the role a limited liability partnership nor the registration respect to their traditional liability protection as of the general partner (i.e., management) relative of a limited partnership as an LLLP will change limited partners is unlikely to change. While to the role of the limited partner (i.e., capital). the tax rules applicable to the underlying part- there may be uncertainty surrounding the scope On the one hand, the presence of the addition- nership). As such, income generated by each of of the additional liability protection in an LLLP al shield could increase the extent to which these partnerships is generally not subject to due to the minimal case law on the subject to major limited partner investors desire to inter- entity-level tax and the character of such income date, registration as an LLLP (although involving vene (or have the right to intervene) in the man- (which is determined at the entity level) passes a higher fee) poses no downside liability risk and agement of the fund. In a traditional limited through to the individual partners to be includ- only the potential of additional protection in partnership, the potential cost to an investor of ed in their personal tax returns. The default U.S. comparison to the traditional limited partnership intervention (i.e., the risk of losing limited liabil- tax treatment for limited liability companies with form. ity protection) may have outweighed the poten- two or more members is the same as that applied tial benefits. With the additional liability protec- to partnerships. It must be noted, however, that Third, by obtaining limited liability protec- tion for limited partners, however, these costs, each of these organizational forms has the abil- tion for the general partner through registration and thus the disincentive to intervene, may be ity to elect to be treated as a separate corporate as an LLLP, sponsors, when forming new funds, mitigated. entity (and thus subject itself to entity-level tax). would no longer necessarily have to incur the cost, time and effort involved with establishing On the other hand, granting such enhanced The Pros and Cons of LLLPs for and maintaining a separate limited liability entity management rights could give rise to inter- Private Investment Funds to serve as the general partner in order to investor conflicts, pitting major limited partners Although there is no legal restriction under achieve this protection. who may desire such rights against other limited Delaware law on the potential use of the LLLP partners who may have little to no desire to see form by a private investment fund (other than Despite these advantages, there are two pri- fellow investors taking on a management role. the restriction on its use for the business of mary disadvantages associated with the LLLP One would also expect major limited partners to banking), there are a number of advantages and form. First, the liability shield of an LLLP may resist assuming unwanted fiduciary obligations disadvantages that should be considered before encounter difficulties as the partnership engages relative to their fellow investors – a factor that an established or prospective private investment in activities in states outside of the State of itself might mitigate the desire to obtain those fund chooses to register as or become an LLLP. Delaware. While all states have adopted foreign enhanced rights in the first place (unless the Three advantages are as follows. First, at its recognition laws enabling foreign limited liability fund sponsor and other investors are willing to core, the LLLP is essentially still a limited part- partnerships to register, engage in business (in limit contractually those obligations). The nership. Thus, the limited partnership agree- some instances, in certain professions only)5 and dynamics of such conflicts are likely to play out ment that lies at the heart of most private invest- apply the laws of state registration for the pur- differently depending on the relative bargaining ment funds will retain the "look and feel" of the poses of determining partner liability, similar power of each fund constituency. vast majority of its operative provisions, with the recognition laws have not been adopted exception perhaps of its exculpatory and indem- throughout the United States with respect to Conclusion nification provisions which might run to both LLLPs. As a result, there is uncertainty about The foregoing discussion of the LLLP the general partner and any limited partner that the treatment that a Delaware LLLP would face form, its key differences from other forms of fulfills a "management" role. Moreover, by filing in states other than Delaware or the ability of a business entities and its applicability to private the election to become an LLLP, the partners Delaware LLLP to qualify to do business in such investment funds, attempts to provide readers can obtain the benefits of the additional liability states. Other states, such as the State of New with an introduction to LLLPs and the signifi- protection while still retaining the business form York, appear to specifically deny foreign limited cant issues surrounding their use. This discus- with which they are familiar (rather than having partnerships – and Delaware LLLPs qualify as sion is not, however, intended to be exhaustive. to convert to another form, such as a limited lia- foreign limited partnerships – the benefits of Factors and considerations unique to each private bility company or limited liability partnership). the additional liability shield. Under such cir- investment fund (or any other business) will be In addition, even if the election filings for LLLP cumstances, a Delaware LLLP would only be important to the decision-making process that status are made improperly or are subject to afforded the status of a foreign limited partner- results in the selection of the appropriate form other complications that result in the status ship (or could only seek to qualify to do business of legal entity. Given the potential benefits, how- being revoked, the investors would still be pro- as a foreign limited partnership), thus eliminat- ever, existing and prospective private investment tected from unlimited liability as they would ing the benefits of the additional liability shield funds are encouraged to strongly consider the retain the traditional liability shield attributable for both general and limited partners.6 possibility of this form of entity as an alternative to limited partners of a limited partnership. to the traditional limited partnership.

5 The State of California, for instance, recognizes foreign limited liability partnerships for registration purposes only to the extent they or their partners (or related partnerships) are engaged in certain professional activities (such as architecture, public accountancy or the practice of law). The State of New York also requires that foreign limited liability partnerships applying for foreign qualification also state their profession, although the State does not specifically enumerate what professions apply. As of today, foreign LLLPs may use (or at least have used) the application for authority form intended for foreign limited liability companies, which does not require a statement of profession, in order to seek foreign qualification in the State of New York. 6 Adoption of the LLLP form, however, still offers the prospective benefit of an additional liability shield in states where it is less clear whether or not they would be recognized. One might also expect the prospective loss of the shield to provide a mutual disciplining effect on general partners and limited partners alike, providing a disincentive against risky conduct that could amplify their liability exposure if the shield were ever disregarded.

PAUL, WEISS, RIFKIND, WHARTON & GARRISON LLP 3 fksbpqjbkq=j^k^dbjbkq=kbtp prjjbo==OMNM Registration and Reporting Implications of the Private Fund Investment Advisers Registration Act KAREN J. HUGHES, STEPHANIE R. MCCAVITT AND GITANJALI WORKMAN

On July 21, 2010, President Obama signed 203(b)(3) of the Advisers Act for investment es of the $150 million threshold test will be the Dodd-Frank Wall Street Reform and advisers that do not hold themselves out to the determined. Will the SEC look to the princi- Consumer Protection Act (the "Dodd-Frank public as investment advisers and have fewer pal place of business of the investment advis- Act") into law. Set forth in Title IV of the than 15 clients; and (ii) the "intrastate exemp- er, the jurisdiction in which the private fund is Dodd-Frank Act is the Private Fund tion" from SEC registration (applicable to organized, the domicile of individual investors Investment Advisers Registration Act of 2010 investment advisers with clients that are all res- or the location of the portfolio investments of (the "Registration Act"). The purpose of the idents of the state in which the adviser main- the private funds?2 Importantly, investment Registration Act is to close a "regulatory gap" tains its principal place of business) where the advisers that avail themselves of this exemp- and create a more cohesive and robust regula- investment adviser advises any private fund. tion will remain subject to such recordkeeping tory regime that will address the perceived lack As a result of the foregoing, many investment and reporting requirements as the SEC "deter- of effective monitoring and examination of advisers to private funds will be required to mines necessary or appropriate in public inter- investment advisers to hedge funds and certain register with the SEC, unless they fall within est or for the protection of investors." other private funds. Broadly speaking, the one of the specified exemptions. Registration Act: (i) eliminates the "private Venture Capital Fund Advisers. An invest- adviser exemption" from the Investment Certain Private Fund Advisers. The ment adviser will also qualify for an exemption Advisers Act of 1940 (the "Advisers Act"), Registration Act provides that an investment from SEC registration if it acts as an invest- thereby requiring many investment advisers adviser that solely advises private funds and ment adviser solely to one or more venture that were previously exempt from registration has aggregate assets under management capital funds. Within the next year, the SEC to register with the Securities and Exchange ("AUM") in the United States of less than must define the term "venture capital fund." Commission (the "SEC"); (ii) requires certain $150 million is exempt from registration with A Senate report on the Registration Act smaller investment advisers that were previ- the SEC. A "private fund" is defined as any released earlier this year described venture cap- ously eligible to register with the SEC to tran- issuer that would be an investment company ital funds as a subset of private investment sition to state registration; and (iii) imposes under Section 3 of the Investment Company funds specializing in long-term equity invest- additional recordkeeping and reporting obliga- Act of 1940 (the "Investment Company Act"), ments in small or start-up businesses. This has tions on registered, as well as certain non-reg- but for the exception provided by either been the only attempt thus far to define ven- istered, investment advisers that advise "pri- Section 3(c)(1) or Section 3(c)(7) thereunder. ture capital funds and implies that the defini- vate funds" (as defined below). While invest- Most private investment funds1 commonly rely tion will focus on the types of investments ment advisers that are no longer exempt from on these provisions of the Investment that these funds make. In any event, one SEC registration will be required to make sig- Company Act to avoid regulation as an invest- would expect that the definition will be nar- nificant changes in order to comply with the ment company and will therefore qualify as a rowly construed so as not to capture private new regime, the Registration Act will also have "private fund." Note, however, that based equity funds. Also note that similar to the an impact on many investment advisers that upon a plain reading of this exemption, if an reporting requirements described above, such are exempt from SEC registration. The investment adviser advises private funds, but advisers will be required to maintain records Registration Act becomes effective on July 21, the adviser also advises separately managed and provide to the SEC reports that the SEC 2011. During this one-year period, the SEC is accounts or other types of investment vehicles "determines necessary or appropriate in public expected to adopt rules and regulations pro- that do not fall within the definition of a pri- interest or for the protection of investors." viding procedures for registration and report- vate fund, such an adviser would not be eligi- ing and clarifications with respect to certain ble to rely on this exemption. In order for cer- Foreign Private Advisers. The Registration ambiguous provisions of the Registration Act. tain advisers to avail themselves of this exemp- Act provides a limited exemption for a "for- tion, there may be a trend in the future where- eign private adviser," which is defined as an Do I Need to Register with the by separately managed accounts are structured investment adviser that: (i) has no place of SEC? as "private funds" rather than as managed business in the United States; (ii) has, in total, The Registration Act eliminates both (i) accounts. In addition, no guidance is provided fewer than 15 clients and investors in the the "private adviser exemption" from SEC reg- with respect to how "aggregate assets under United States in private funds advised by the istration previously contained in Section management in the United States" for purpos- investment adviser; (continued on page 5)

1 Note that certain types of real estate funds rely on the exception provided in Section 3(c)(5) of the Investment Company Act, and, as a result, will not fall within the definition of a "pri- vate fund" for purposes of the Registration Act. Although an investment adviser that advises such real estate funds may have to register under the Registration Act (because it may not fall within one of the enumerated exemptions from registration), it appears that such an adviser would not be subject to the heightened recordkeeping and reporting requirements applicable to "private funds" with respect to any fund relying on Section 3(c)(5) of the Investment Company Act. 2 By comparison, the Registration Act provides that in calculating AUM for purposes of the "foreign private adviser" exemption (discussed below), the aggregate AUM "attributable to clients in the United States and investors in the United States in private funds" must be taken into account.

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Registration and Reporting Implications of the Private Fund Investment Advisers Registration Act (continued from page 4)

(iii) has aggregate AUM attributable to clients Small Business Investment Company $25 million and $30 million may elect to register and investors in the United States in private Advisers. An investment adviser that solely with the SEC. funds advised by such adviser of less than $25 advises small business investment companies, million (or such higher amount as the SEC which are regulated by the Small Business What are my Recordkeeping and may, by rule, determine); and (iv) neither holds Administration, is also exempt from SEC reg- Reporting Obligations? itself out generally to the public in the United istration. States as an investment adviser nor acts as an The Registration Act will subject certain investment adviser to any investment company Mid-Sized Private Fund Advisers. With registered investment advisers to enhanced registered under the Investment Company Act respect to "mid-sized private funds," the recordkeeping, examination, reporting and dis- or any business development company. Registration Act requires the SEC to provide closure requirements. In addition, the records registration and examination procedures that of any private fund advised by an SEC-regis- Family Offices. The Registration Act reflect the level of systemic risk posed by such tered investment adviser are "deemed to be the excludes from the definition of "investment funds taking into account the size, governance records and reports of the investment advis- adviser" contained in Section 202(a)(11) of the and investment strategy of such funds. For er." SEC-registered investment advisers to pri- Advisers Act investment advisers that advise these purposes, the Registration Act does not vate funds are required to maintain records only "family offices," consequently exempting define "mid-sized funds;" however, in the pro- regarding each private fund they advise, includ- such advisers from SEC registration. The visions of the Registration Act delineating the ing a description of the following: amount of Registration Act requires the SEC to define the AUM thresholds for state and federal regula- AUM; use of leverage; counterparty credit risk term "family office" for purposes of this tion of investment advisers (discussed below), exposures; trading and investment positions; exclusion, and the SEC must do so in a man- mid-sized investment advisers are character- valuation policies and practices of the fund; ner that: (i) is consistent with its existing ized as those with AUM between $25 million types of assets held; side arrangements or side exemptive orders on family offices and the and $100 million. It is unclear whether the letters; trading practices; and other informa- grandfathering provisions set forth in clause same standard will be applied here. tion relevant to determining potential systemic (iii) below; (ii) recognizes the range of organi- risk. There is currently no guidance as to what zational, management and employment struc- Do I Need to Register with State types of other information the SEC will deem tures employed by family offices; and (iii) does relevant to determining potential systemic risk. not exclude certain "grandfathered" invest- Securities Regulators? SEC-registered investment advisers will also be ment advisers (i.e., persons that were not regis- The Registration Act prohibits an investment subject to ongoing periodic reporting require- tered or required to be registered under the adviser from registering with the SEC if the ments which could be expanded beyond the Advisers Act on January 1, 2010, solely adviser: (i) has AUM between $25 million and current requirements under Form ADV. because such persons provide investment $100 million (or such higher amount as the SEC advice to, and were engaged, prior to January may, by rule, determine); and (ii) is required to be Certain investment advisers not subject to 1, 2010, in providing investment advice to, cer- registered as an investment adviser with the secu- registration with the SEC will also be subject tain natural persons and entities associated rities regulator of the state in which it maintains to recordkeeping and reporting requirements. with a family office). Notwithstanding the its principal office and place of business and, if Specifically, investment advisers that solely foregoing, family offices excluded from the advise (i) private funds and have AUM in the registered, would be subject to examination as an definition of the term "investment adviser" by United States of less than $150 million; and (ii) investment adviser by such state regulator (unless virtue of this grandfathering provision will venture capital funds are, in each case, required the investment adviser is an adviser to a regis- nevertheless be deemed investment advisers to maintain records and provide to the SEC for purposes of certain antifraud provisions of tered investment company or business develop- reports that the SEC "determines necessary or the Advisers Act, specifically, Sections 206(1), ment company). If any investment adviser appropriate in public interest or for the protec- (2) and (4) thereunder. would be required to register with 15 or more tion of investors." Although this broad stan- states, it may instead register with the SEC. As a dard creates uncertainty as to the extent of the CFTC Registered Advisers that Advise result, some investment advisers that are current- recordkeeping and reporting requirements that Private Funds. The Registration Act provides ly registered with the SEC must de-register with will be promulgated by the SEC, practitioners a conditional exemption from registration for the SEC and, instead, register with their home expect that the SEC may adopt a "registration- investment advisers registered with the state(s). This change will allow the SEC to focus lite" form applicable to this category of invest- Commodity Futures Trading Commission as its time and resources on larger investment advis- ment advisers. commodity trading advisers that advise private ers. Importantly, advisers located in states that funds. If the "business of the advisor should The SEC will report annually to Congress do not have registration and examination require- become predominately the provision of secu- on how the SEC uses the data collected to ments are still subject to the SEC's current regis- rities-related advice," however, then such monitor the markets for the protection of adviser must register with the SEC. There is tration threshold, specifically, advisers with AUM investors and the integrity of the markets. The currently no guidance as to how this standard of more than $30 million must generally register SEC will share with the Financial Stability will be measured. with the SEC, and advisers with AUM between Oversight Council (continued on page 6)

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Registration and Reporting Implications of the Private Fund Investment Advisers Registration Act (continued from page 5)

(the "Council") such reports and other docu- uled a hearing for September 23, 2010, to Act, including appointing a chief compli- ments provided to it by investment advisers as examine whether the scope of the SEC's ance officer and reviewing compliance the Council considers necessary for the pur- exemption from FOIA requests should be nar- policies on an annual basis; poses of assessing the systemic risk of private rowed. In letters submitted to Chairman Investment and Trading Practices - funds. Confidentiality protection is provided Frank and Senate Banking Committee complying with the anti-fraud rules for any proprietary information submitted to Chairman Christopher Dodd, SEC Chairman under the Advisers Act and complying the government, including sensitive, non-pub- Mary Schapiro stated, "The Dodd-Frank Act with substantive requirements of the lic information regarding the investment advis- mandates a number of new responsibilities for Advisers Act, including rules relating to er's investment or trading strategies, analytical the SEC to protect investors, including new performance fees, custody arrangements, or research methodologies, trading data, com- authority over hedge funds, private equity pay to play prohibitions, agency-cross puter hardware or software containing intellec- funds and venture capital funds....Fulfilling transactions, principal transactions, etc.; tual property. Also note that Section 210(c) of these responsibilities will require the SEC to Record Retention - maintaining and the Advisers Act has been amended to permit expand and improve our examination and sur- retaining corporate, accounting and per- the SEC to require an investment adviser to veillance capabilities in order to provide the formance records, client related corre- disclose the identity, investments or affairs of type of risk-focused regulatory oversight spondence and trade confirmations for at any client "for purposes of assessment of investors deserve. In order for our efforts to least five years; potential systemic risk." be successful, it is important that registered Code of Ethics - adopting standards of entities be able to provide us with access to conduct covering the adviser's employ- As per the Registration Act, reports filed confidential information without concern that ees, including personal securities trading with the SEC3 by investment advisers are not the information will later be made public." by such employees; subject to disclosure pursuant to Freedom of Rules on Advertising - complying with Information Act ("FOIA") requests. In addi- What will SEC Registration the advertising restrictions and prohibi- tion, pursuant to Section 9291 of the Dodd- entail? tions contained in the Advisers Act; Frank Act, the SEC "shall not be compelled to Once registered with the SEC, investment Additional Disclosure Obligations - disclose records or information" if that infor- advisers are subject to routine and surprise disclosing financial or disciplinary mation was obtained for "surveillance, risk examinations by the SEC staff. SEC-registered actions; and assessments or other regulatory and oversight investment advisers must also comply with Filings - filing, updating and amending activities." Since the passage of the Dodd- various substantive requirements of the Form ADV as required by the Advisers Frank Act, a number of bills have been pro- Advisers Act. Some of the key areas of Act. posed to amend Section 9291 over concerns responsibility include: 3 that the exemption is too broad, does not serve Note, however, that under existing law, Part 1 of Form ADV will continue to be publicly available on the SEC's web- the public interest and is inconsistent with the Compliance Policies and Procedures - site. In addition, on July 21, 2010, the SEC adopted amend- goal of greater transparency for consumers adopting and implementing a compliance ed rules (see http://www.sec.gov/rules/final/2010/ia- and investors. House Financial Services program reasonably designed to prevent 3060.pdf) which will also make Part 2 of Form ADV publicly available on the SEC's website. Committee Chairman Barney Frank has sched- and detect any violation of the Advisers

SEC Announces Open Process for Regulatory Reform Rulemaking

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How High Should Your High Water Mark Be? JENNIFER A. SPIEGEL

In the wake of the recent financial crisis, On the one hand, Fund B's general partner many hedge funds are still struggling to climb could take an incentive allocation on the back to their "high water marks"-the prior As the hedge fund market has amount by which the returns of the fund highest point of profitability, or the prior high- exceeded the benchmark return. Under the est net asset value ("NAV"), of a hedge fund. matured and evolved over the last facts described above, Investor X's capital Some hedge fund firms have lost talented account has decreased by 30%, but had investment professionals, traders and portfolio decade, so have the approaches to Investor X made its investment in the securi- managers along the way, as the prospect of implementing the high water mark. ties comprising the S&P Investortools future profits and a share of the incentive allo- Municipal Bond Index, Investor X would have cation or carried interest becomes too remote lost 40%. Therefore, in relative terms, for some to wait out the downturn. The fol- Investor X's account compares favorably to lowing summarizes different approaches to the the incentive allocation taken, $40,000 in this the benchmark bond index and Fund B has traditional high water mark mechanism, some case, so that the fund does not have to earn "outperformed" the index. Fund B's general motivated by the current economic climate, back the amount deducted as incentive alloca- partner, however, may have difficulty paying and provides an analysis of each approach. tion). itself an incentive allocation on the $100,000 of "profits" ($100,000 being the difference The Traditional High Water Variations on a Theme between $700,000, the actual value of Investor Mark As the hedge fund market has matured and X's account, and $600,000, the value the Assuming that a hedge fund is structured evolved over the last decade, so have the account would have had had it been invested in as a limited partnership, in the traditional high approaches to implementing the high water the securities comprising the bond index). The water mark regime, the general partner of the mark. The following outlines some of these underlying philosophy of this approach is that partnership is not entitled to an incentive allo- approaches. if the fund sponsor has targeted a return (the cation – typically a 20% share of net profits – performance of the bond index) the sponsor until the fund has recovered prior losses and The Benchmark High Water Mark. Under should be rewarded for having exceeded the generated additional profits. Because investors this approach, an independent benchmark- performance of that index. are periodically subscribing for new interests such as the performance of the S&P 500 and withdrawing existing interests, the high Index-substitutes for the high water mark. On the other hand, Fund B's general part- water mark is measured on an investor-by- Thus, the general partner is entitled to its ner may not take any incentive allocation. investor basis.1 The following example illus- incentive allocation in any given year only if Although Fund B has outperformed the bond trates how the traditional high water mark the profits for that year in respect of an index, Investor X's capital account has lost mechanism works, in its simplest form. investor's capital account exceed that predeter- value. The underlying philosophy of this mined benchmark. This approach may be approach is that the fund sponsor should not Assume Investor X invests $1 million in most appropriate where a fund's performance be rewarded unless it generates profits for its Fund A on January 1, 2008. Further assume is strongly correlated with a particular market investors. that, as of December 31, 2008, Investor X's and a published index for such market exists. capital account balance has declined in value to The following example illustrates how a If Investor X's capital account increases to $700,000. Under these facts, Fund A's general benchmark high water mark might work. $1.2 million by the end of 2009, Fund B's gen- partner is not entitled to any incentive alloca- eral partner will have several choices over how tion in respect of Investor X's investment until Assume that Fund B invests primarily in the benchmark high water mechanism might Investor X's capital account balance exceeds U.S. municipal bonds. An appropriate bench- work. Assuming that over the year 2009, the $1 million – the high water mark for Investor mark might be the performance of the S&P weighted average value of the bond index was X's capital account as of December 31, 2008. Investortools Municipal Bond Index. Further, 1%, there are four possibilities. First, Fund B's If we further assume that Investor X's capital assume that Investor X invests $1 million in general partner could take an incentive alloca- account balance increases to $1.2 million by Fund B on January 1, 2008, and that, as of tion on $500,000, because Investor X's December 31, 2009, Fund A's general partner December 31, 2008, Investor X's capital account has increased in value by $500,000 then is entitled to 20% of the $200,000 that account balance has declined in value to since the last year end (the excess of $1.2 mil- exceeds the $1 million high water mark. $700,000. Assuming that the weighted average lion over $700,000). Also, $500,000 clearly Therefore, as of January 1, 2010, the high value of the S&P Investortools Municipal exceeds a 1% return on the capital account bal- water mark in respect of Investor X's capital Bond Index over 2008 was -40%, there are two ance as of the start of the year, which was account would now be $1.16 million (typically possible ways to employ a benchmark high $700,000 (1% of $700,000 being only $7,000). the new high water mark is measured net of water mark mechanism based on that index. Second, Fund B's general (continued on page 8)

1 For example, a hedge fund's NAV as of September 1, 2010 may represent the high water mark for an investor who invested in March of 2010, but may not represent the high water mark for an investor who invested in March of 2008.

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How High Should Your High Water Mark Be? (continued from page 7) partner could take an incentive allocation on turns pose unique challenges to fund sponsors Under this approach, Fund C's general $493,000, or $500,000 less a 1% return on the and investors. When a fund experiences signif- partner actually earns slightly less in aggregate $700,000 capital account balance as of the icant losses, as many funds did from 2000 to incentive compensation. Because it is able to beginning of the year. Under this approach, 2002 and more recently during the financial reap some modest profits over the period dur- Fund B's general partner is entitled to a share crisis, fund sponsors may have difficulty retain- ing which Fund C is below its traditional high of only those profits that exceed the bench- ing investment professionals, traders and port- water mark, however, it is better able to incen- mark. Third, Fund B's general partner could folio managers who may look to a share of the tivize and reward its investment professionals, take an incentive allocation on $200,000. This incentive allocation as a significant part of traders and portfolio managers. Furthermore, approach combines the traditional high water their overall compensation.2 Under these cir- because Investor X would bear less incentive mark feature and the benchmark and allows cumstances, a fund could implement a modi- allocation over the long run, Investor X has an the general partner to a share of profits only if fied high water mark mechanism that enables it incentive to remain invested during this period two conditions are satisfied: (x) the profits to take a share of profits even when the fund and wait until Fund C has generated the full exceed the previous high water mark ($1 mil- is below its traditional high water mark. Under 2.5x of losses that were incurred. lion) and (y) the profits exceed the benchmark this approach, the general partner would bene- for the year in which the incentive allocation is fit from a reduced high water mark on any Private Equity Style High Water Mark. calculated ($7,000). Finally, Fund B's general profits generated while the fund is below its More recently, a select minority of institution- partner could take an incentive allocation on traditional high water mark until the fund has al investors have succeeded in negotiating cer- $193,000. This assumes that the two condi- generated an amount of profits sufficiently in tain private equity style protections to modify tions above under the third approach above are excess (usually by some multiple) of its tradi- the traditional high water mark. Under this satisfied and that the general partner shares tional high water mark. approach, a general partner clawback is grafted only in profits that actually exceed the bench- onto the high water mark mechanism such that mark return (again, $7,000). For example, assume Investor X invests $1 if an investor's capital account balance remains million in Fund C on January 1, 2008 and that, below its traditional high water mark at the end If the S&P Investortools Municipal Bond as of December 31, 2008, Investor X's capital of each defined period (e.g., successive three- Index's performance had been 1% in 2008, account balance has declined in value to year periods), then the fund's general partner rather than -40%, one would face the addition- $700,000 (meaning Investor X has a loss recov- must refund any incentive allocation taken ear- al decision as to whether the benchmark is ery account balance of $300,000). Under these lier within such period. This approach ensures cumulative or is applied only for the year in facts, Fund C's general partner is not entitled to that the fund's general partner receives no which the incentive allocation is taken. Thus, any incentive allocation as of the year end 2008 more than 20% of the profits over any period by tweaking our original factual assumptions because the Fund has generated only losses. of time that is longer than one year. This claw- and assuming that the bond index was 1% for Further assume that, as of December 31, 2009, back protection may be appropriate for a fund 2008 and 1% for 2009, under the approach Investor X's capital account balance has seeking to impose more restrictive liquidity outlined in the last option above, the incentive increased to $800,000. Now Fund C has gener- terms on its investors. allocation would be 20% of $183,000 (the ated $100,000 of new profits, although Investor excess of $200,000 over $10,000 (for 2008) X's account is still below its traditional high and $7,000 (for 2009)) rather than $193,000 Conclusion water mark ($1 million). On December 31, Designing a high water mark that best fits (the excess of $200,000 over $7,000 (for 2009) 2009, Fund C's general partner could be entitled a hedge fund involves consideration of numer- only). to an incentive allocation of 10%, for example, ous factors, including fund liquidity, the nature In determining which benchmark is the on the new profits attributable to Investor X's of the investor base, the correlation between best fit, a hedge fund sponsor must weigh the account, but would not be entitled to take its full the fund's strategy and the relevant market(s) need to incentivize its investment profession- 20% profit share until new profits in respect of for the asset classes in which the fund invests, als, traders and portfolio managers against a Investor X's account equals a certain multiple and the need to provide appropriate incentives need to present an equitable economic deal to (say, 2.5x) of the losses that were sustained. to investment professionals, traders and port- its investors and a proper alignment of Thus, If Investor X's capital account balance folio managers while ensuring appropriate investor interests with the general partner's were to equal $1.2 million on December 21, alignment of the general partner's interests interests. 2010, Fund C's general partner would still only with those of the fund investors. Reaching the be entitled to a 10% share of the $400,000 in appropriate balance may involve a moving tar- Modified High Water Mark. Unlike the profits (the excess of $1.2 million over get that changes with market conditions and occasional dips that characterize relatively sta- $800,000), even though Investor X's account is investor confidence generally. ble market activity, prolonged market down- once again above its traditional high water mark.

2 A portfolio manager, for example, may be faced with the prospect of waiting a two to three year period before the fund returns to its high water mark. The prospect of any incentive allocation may be even more bleak because poor returns for existing fund investors usually means no new capital is flowing into the fund. That portfolio manager, then, may find it more advantageous to pursue opportunities elsewhere, which might include joining a different firm where he or she can benefit from the profits of a fund that may be in a different part of its life cycle and may be able to capitalize on a market swing within a shorter time frame.

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Responsibility in Private Equity Investing AMRAN HUSSEIN AND LINDSEY L. WIERSMA

Private fund managers are accustomed to ties in which it invests; (iv) to promote accept- ble national, state and local labor laws in the addressing traditional social responsibility con- ance and implementation of the PRI principles countries in which they invest; support the pay- cerns of investors focused on avoiding invest- within the investment industry; (v) to work to ment of competitive wages and benefits to ments in "sin" industries (such as alcohol, enhance its effectiveness in implementing the employees; provide a safe and healthy work- tobacco, gambling and firearms) or "bad actor" PRI principles; and (vi) to report on its activities place in conformance with national and local countries (such as Cuba, Iran and Sudan). and progress towards implementing the PRI law; and respect the rights of employees to Recently, however, the focus of many investors principles. Although the PRI does not impose decide whether or not to join a union and is shifting beyond negative restrictions on engage in collective bargaining; (vi) maintain investment to the integration of environmental, strict policies that prohibit bribery and other social and corporate governance ("ESG") con- improper payments to public officials consis- siderations into investment activities. Although In today’s world, investors are tent with the U.S. Foreign Corrupt Practices many fund managers have often taken certain focused on ESG issues Act, similar laws in other countries and the ESG considerations into consideration when OECD Anti-Bribery Convention; (vii) respect evaluating investment risk, as more pension not solely for altruistic reasons, the human rights of those affected by their plans and other institutional investors increas- investment activities and seek to confirm that ingly incorporate ESG principles as core com- but because they believe that their investments do not flow to companies that ponents of their business practices (including as ESG-sensitive investing utilize child or forced labor or maintain discrim- criteria for fund manager selection), managers inatory policies; (viii) provide timely informa- are facing increasing pressure from investors to can have a positive impact tion to their limited partners on the matters include ESG considerations as primary consid- addressed in the guidelines and work to foster erations in their investment decision-making on investment returns. transparency about their activities; and (ix) rather than as isolated risk management or eth- encourage their portfolio companies to advance ical considerations. In today's world, investors these same principles. are focused on ESG issues not solely for altru- legal or regulatory sanctions for non-compli- istic reasons, but because they believe that ESG- ance, before a fund manager or investor decides In July 2009, the PRI initiative published a sensitive investing can have a positive impact on to become a signatory to the PRI, it should rec- guide entitled Responsible Investment in investment returns. ognize that there may be reputational risks asso- Private Equity: A Guide for Limited Partners3 ciated with signing up and failing to take action. to help signatories apply the PRI principles to The increased focus on ESG considerations their investments in private equity. The guide in the private equity market has been driven in In February 2009, the members of the outlines actions that an investor can take to large part by institutional investors and fund Private Equity Council (the "PEC")2 adopted a incorporate ESG considerations into their due managers that are signatories to the United set of comprehensive guidelines intended to diligence processes and in their ongoing Nations Principles for Responsible Investment encourage private equity industry participants engagement with managers. A fund manager (the "PRI"), an initiative launched in 2006 by to discuss principles of ESG investing more should be careful to ensure that any representa- the United Nations Global Compact and the formally. Specifically, the PEC guidelines call tions to investors in offering memoranda, fund United Nations Environment Programme for its members to: (i) consider environmental, documents or due diligence questionnaires Finance Initiative, together with an internation- public health, safety and social issues associated about the manager's commitment to ESG prin- al group of institutional investors. The PRI with target companies and portfolio companies; ciples accurately reflect the manager's invest- provides a framework for investors and asset (ii) seek to be accessible to, and engage with, rel- ment policies and practices. managers to incorporate ESG considerations evant stakeholders either directly or through into their investment process, with the intended representatives of portfolio companies; (iii) As investors in private investment funds pay goal that doing so will achieve better long-term seek to grow and improve the companies in increased attention to ESG considerations and returns and more sustainable markets. A signa- which they invest for long-term sustainability use their relative negotiating power in the tory1 to the PRI pledges to apply the following and to benefit multiple stakeholders, including current market to put additional pressure on six principles to its investment activities, subject on environmental, public health, social and gov- private fund managers to consider ESG consid- at all times to the signatory's fiduciary responsi- ernance issues; (iv) seek to use governance erations in their investment activities, it has bilities: (i) to incorporate ESG considerations structures that provide appropriate levels of become increasingly important for fund man- into its investment analysis and decision-making oversight in the areas of audit, risk management agers to understand the nature of ESG processes; (ii) to be an active owner and incor- and potential conflicts of interest and to imple- concerns and to be prepared to discuss with porate ESG considerations into its ownership ment compensation and other policies that align potential and existing investors their firms' ESG policies and practices; (iii) to seek appropriate the interests of owners and management; (v) philosophy and commitment to dealing with disclosure on ESG considerations by the enti- remain committed to compliance with applica- such concerns.

1 According to the 2009 PRI Annual Report, as of May 2009, the PRI had more than 500 signatories from 32 countries representing $18 trillion of assets under management (as of July 2010, the PRI website (www.unpri.org) reports nearly 800 signatories). Signatories include pension funds, government funds, foundations, endowments, insurance companies, investment managers and professional service providers. 2 The members of the PEC at the time the guidelines were adopted included Apax Partners, Apollo Global Management LLC, Bain Capital Partners, the Blackstone Group, the Carlyle Group, Hellman and Friedman LLC, Kohlberg Kravis Roberts & Co., Madison Dearborn Partners, Permira, Providence Equity Partners, Silver Lake, THL Partners and TPG Capital. 3 A copy of the guide is available at http://www.unpri.org/files/PE%20LP%20Guide%20FINAL.pdf.

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IOSCO Hedge Fund Reporting to Begin in September PHILIP A. HEIMOWITZ

Securities regulators are expected to begin 1 General Partner and Adviser Information collecting data from hedge funds in an effort to assist them in assessing possible systemic risks hÉó=éêáåÅáé~äëI=êÉÖáëíÉêÉÇ=~ÇÇêÉëëI=åìãÄÉê=çÑ=ÉãéäçóÉÉëI=åìãÄÉê=çÑ=ÑìåÇëI=å~ãÉ=çÑ=Åçãéäá~åÅÉ arising from the hedge fund sector. The tem- çÑÑáÅÉêI=çîÉêëÉ~ë=çÑÑáÅÉëI=êÉÖìä~íçêó=ëí~íìëI=êÉä~íÉÇ=~ÑÑáäá~íÉëI=Éèìáíó=çïåÉêë=~åÇ=êÉäÉî~åí=áåÑçêã~íáçå 1 ~Äçìí=íÜÉ=Ñáå~åÅá~ä=ÜÉ~äíÜ=çÑ=íÜÉ=~ëëÉí=ã~å~ÖÉãÉåí=Åçãé~åó=áåÅäìÇáåÖI=áÑ=~ééäáÅ~ÄäÉI=~åó=Öì~ê~åJ plate for the global collection of hedge fund- íÉÉë=çê=~ÖêÉÉãÉåíë=ïáíÜ=é~êÉåí=Åçãé~åáÉë related information was published by the tech- hÉó=ëÉêîáÅÉ=éêçîáÇÉêë nical committee of the International Organization of Securities Commissions 2 Performance and Investor Information Related to Covered Funds 2 ("IOSCO") in February 2010. The technical oÉÅÉåí=éÉêÑçêã~åÅÉ=ÇÉí~áäë=EåÉí=~åÇ=ÖêçëëF= committee recommended that data gathering oÉÅÉåí=áåîÉëíçê=êÉÇÉãéíáçåëLëìÄëÅêáéíáçåë= begin in September 2010. kÉí=~ëëÉí=î~äìÉ=îëK=ÜáÖÜ=ï~íÉê=ã~êâ= Commissioners of the Securities and fåîÉëíçê=Åä~ëëáÑáÅ~íáçåë=EáKÉKI=áåëíáíìíáçå~äI=ÑìåÇ=çÑ=ÑìåÇëI=ÜáÖÜ=åÉí=ïçêíÜF mêáã~êó=ã~êâÉíáåÖ=ÅÜ~ååÉäë Exchange Commission (the "SEC"), in recent speeches and in testimony before Congress, 3 Assets Under Management have expressed their view that cooperation dêçìé=ïáÇÉ=~ëëÉíë=ìåÇÉê=ã~å~ÖÉãÉåí=E?^rj?F=EáKÉKI=íçí~ä=^rj=~åÇ=ÜÉÇÖÉ=ÑìåÇ=^rjF among securities regulators is vital to effective oversight of cross-border entities and to pre- 4 Gross and Net Product Exposure and Asset Concentration vent international securities fraud. They have j~íÉêá~ä=éçëáíáçåë=áå=î~êáçìë=~ëëÉí=Åä~ëëÉë=EÑçê=ëÉÅìêáíáÉëW=î~äìÉ=çÑ=äçåÖ=~åÇ=ëÜçêí=éçëáíáçåë=áå=ÉèìáíáÉëI commented that information sharing among ìåäáëíÉÇ=ÉèìáíáÉëI=Åçêéçê~íÉ=ÄçåÇëI=ëçîÉêÉáÖå=ÄçåÇëI=ÅçåîÉêíáÄäÉ=ÄçåÇëI=äç~åëI=ëÉÅìêáíáÉë=ÅêÉÇáí=éêçÇJ securities regulators and having access to the ìÅíë=~åÇ=çíÜÉê=ëíêìÅíìêÉÇ=éêçÇìÅíëX=Ñçê=ÇÉêáî~íáîÉëW=äçåÖ=~åÇ=ëÜçêí=ÅêÉÇáí=ÇÉÑ~ìäí=ëï~é=éçëáíáçåëI=íÜÉ right type of information for risk monitoring Öêçëë=î~äìÉ=çÑ=ÑçêÉáÖå=ÉñÅÜ~åÖÉI=áåíÉêÉëí=ê~íÉ=~åÇ=çíÜÉê=ÇÉêáî~íáîÉë=~åÇ=íÜÉ=ÖÉçÖê~éÜáÅ=ëéäáí=çÑ=~ëëÉíë purposes is critical. ïáíÜáå=íÜÉëÉ=Åä~ëëÉëF 5 Gross and Net Geographic Exposure IOSCO IOSCO is the leading international policy eáÖÜ=äÉîÉä=êÉÖáçå~ä=áåîÉëíãÉåí=ÑçÅìë=E=ÉKÖKI=råáíÉÇ=pí~íÉëI=bìêçéÉI=^ëá~=EÉñJg~é~åFI=g~é~åI=däçÄ~ä=~åÇ däçÄ~ä=bãÉêÖáåÖ=j~êâÉíF forum for securities regulators. The securities ^ëëÉíë=Äó=íÜÉ=ìåÇÉêäóáåÖ=ÅìêêÉåÅó= regulators that are members of IOSCO regu- late more than 95% of the world's securities 6 Trading and Turnover Issues markets in over 100 jurisdictions. The IOSCO qìêåçîÉê=áå=î~êáçìë=~ëëÉí=Åä~ëëÉë= members aim to: (i) protect investors; (ii) ensure `äÉ~êáåÖ=ãÉÅÜ~åáëãë=Ñçê=Ä~ä~åÅÉ=ëÜÉÉí=áåëíêìãÉåíë=~åÇ=ÇÉêáî~íáîÉë that markets are fair, efficient and transparent; Asset/Liability Issues and (iii) reduce systemic risk. 7 iáèìáÇáíó=çÑ=~ëëÉíë= Information Template fåîÉëíçê=äáèìáÇáíó=ÇÉã~åÇë= The template sets forth 11 categories of bñíÉåí=çÑ=íÉêã=Ñáå~åÅáåÖ= rëÉ=çÑ=ëáÇÉ=éçÅâÉíë= information that securities regulators expect to ^Äáäáíó=íç=Ö~íÉ=çê=ëìëéÉåÇ=ÑìåÇë=~åÇ=~åó=êÉëíêáÅíáçåë=ÅìêêÉåíäó=áå=éä~ÅÉ= collect which incorporates both supervisory and systemic data. The template is not meant 8 Borrowing to be a comprehensive list of all types of infor- s~äìÉ=çÑ=ÄçêêçïáåÖë=Äó=ëçìêÅÉ=EéêáãÉ=ÄêçâÉêI=êÉéçI=ëíçÅâ=äÉåÇáåÖI=çÑÑ=Ä~ä~åÅÉ=ëÜÉÉí=~åÇ=ìåëÉÅìêÉÇF= mation and data that regulators might seek and _çêêçïáåÖ=Ñêçã=êÉÖìä~íÉÇ=îëK=ìåêÉÖìä~íÉÇ=ÉåíáíáÉë= regulators are not restricted from requiring Risk Issues additional information at the domestic level. 9 The categories of information include: råÉåÅìãÄÉêÉÇ=Å~ëÜ= s~êáçìë=êáëâ=ãÉ~ëìêÉë=ìëÉÇ=Äó=ÜÉÇÖÉ=ÑìåÇ=ã~å~ÖÉêë= aÉëÅêáéíáçå=çÑ=ãÉÅÜ~åáëãë=íç=~ëëÉëë=êáëâ=EÉKÖKI=ëíêÉëë=íÉëíëF=

1 10 Credit Counterparty Exposure The template may be found at: http://www.iosco.org/news/pdf/IOSCONEWS179.pdf. kÉí=ÅêÉÇáí=ÅçìåíÉêé~êíó=êáëâI=áÇÉåíáÑóáåÖ=éêáã~êó=ÅçìåíÉêé~êíáÉë=~åÇ=áÇÉåíáíáÉë=~åÇ=äçÅ~íáçåë=çÑ=íÜçëÉ 2 ÅçìåíÉêé~êíáÉë= The Technical Committee is a specialized working group bñíÉåí=çÑ=êÉÜóéçíÜÉÅ~íáçå= within IOSCO that is made up of 18 agencies that regulate some of the world's larger, more developed and interna- Other tionalized markets. Its objective is to review major regula- 11 tory issues related to international securities and futures `çãéäÉñáíó=EÉKÖKI=Öêçëë=ëáòÉ=çÑ=çéíáçåë=Äççâ=~åÇ=åìãÄÉê=çÑ=çéÉå=éçëáíáçåëF transactions and to coordinate practical responses to these concerns. The members of the Technical Committee are `çåÅÉåíê~íáçå=çÑ=éçëáíáçåë=~ë=~=éÉêÅÉåí~ÖÉ=çÑ=Öêçëë=ã~êâÉí=î~äìÉ the securities regulatory authorities of Australia, Brazil, China, France, Germany, Hong Kong, India, Italy, Japan, Mexico, the Netherlands, Ontario, Quebec, Spain, The technical committee has recommended that the first data-gathering Switzerland, United Kingdom and the United States. exercise should be carried out on a best efforts basis. (continued on page 11)

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IOSCO Hedge Fund Reporting to Begin in September (continued from page 10)

Practical Limitations The SEC Proposed Legislation IOSCO does not have the ability to promul- The Private Fund Investment Advisers gate regulations and depends on its member Registration Act of 2010 requires the SEC to Affecting Private Funds securities regulators to adopt regulations in issue rules which require investment advisers to private funds to file such reports as the SEC accordance with the governing law of their deems necessary for the protection of investors Federal Taxation of Carried home jurisdiction. The ability of a securities reg- and for the assessment of systemic risks. ulator in a particular country to adopt rules and Having played an active role as a lead member of Interest the reach of the disclosure required under those IOSCO, it is likely that the rules that the SEC adopts will require such reports to contain much rules will be subject to many factors, including For several years, there has been interest on the the political climate in that jurisdiction. of the information proposed by IOSCO to be included in the template. part of Congress and, more recently, the Obama administration in changing the taxation of income derived from a partner's carried interest in certain investment funds organized as part- Update on the EU Directive on AIFM nerships. In May, the House of Representatives passed legislation that would change substantial- ly the treatment of income from partnership JYOTI SHARMA AND LYUDMILA BONDARENKO carried interests by characterizing a portion of it as ordinary income. For individual taxpayers, få= ^éêáä= OMMVI= íÜÉ= `çããáëëáçå= çÑ= íÜÉ êÉëìäí= áå= íÜÉ= rKpKJÇçãáÅáäÉÇ= ÑìåÇë= ÄÉáåÖ once it has been fully phased in by 2013, the bìêçéÉ~å= råáçå= EíÜÉ= ?`çããáëëáçå?F= éêçJ ìå~ÄäÉ=íç=~ÅÅÉëë=íÜÉ=br=ã~êâÉíëK House legislation would treat 75% of carried éçëÉÇ= ~= aáêÉÅíáîÉ= çå= ^äíÉêå~íáîÉ= fåîÉëíãÉåí interest as ordinary income and the remaining 25% as it is treated under current law (i.e., based cìåÇ= j~å~ÖÉêë= EíÜÉ= ?aáêÉÅíáîÉ?FK= = fÑ= áí qÜÉ=`çìåÅáä=çÑ=íÜÉ=br=EíÜÉ=?`çìåÅáä?F=~åÇ=íÜÉ on the underlying income of the fund in ques- ÄÉÅçãÉë=ä~ïI=íÜÉ=aáêÉÅíáîÉ=Ü~ë=íÜÉ=éçíÉåíá~ä m~êäá~ãÉåí=çÑ=íÜÉ=br=EíÜÉ=?m~êäá~ãÉåí?F=ãìëí tion). Until 2013, the percentages would be íç=áãéçëÉ=ÑìåÇ~ãÉåí~ä=ÅÜ~åÖÉë=~åÇ=ÄìêÇÉåë ~ÖêÉÉ= çå= ~å= áÇÉåíáÅ~ä= íÉñí= çÑ= íÜÉ= aáêÉÅíáîÉ 50% and 50%, respectively. A version of the çå=áåîÉëíãÉåí=áåÇìëíêó=é~êíáÅáé~åíë=äçÅ~íÉÇ=áå ÄÉÑçêÉ= áí= ÄÉÅçãÉë= ä~ïI= ïáíÜ= íÜÉ= îçíÉ= çÑ= Ñìää legislation, with slightly different provisions, is íÜÉ= bìêçéÉ~å= råáçå= EíÜÉ= ?br?F= çê= ëÉêîáåÖ m~êäá~ãÉåí=ÄÉáåÖ=íÜÉ=Ñáå~ä=ëíÉéK=qÜÉ=`çìåÅáä ÅäáÉåíë= Ñêçã= íÜÉ= brI= áåÅäìÇáåÖ= ÜÉÇÖÉ= ÑìåÇë currently stalled in the Senate. As the Senate will ~åÇ= ~= ÅçããáííÉÉ= çÑ= íÜÉ= m~êäá~ãÉåí= É~ÅÜ be in recess from August 9 through September ~åÇ= éêáî~íÉ= Éèìáíó= ÑìåÇë= êÉÖ~êÇäÉëë= çÑ= íÜÉ é~ëëÉÇ=áíë=çïå=îÉêëáçå=çÑ=íÜÉ=aáêÉÅíáîÉ=áå=j~ó ÇçãáÅáäÉ= çÑ= ëìÅÜ= ÑìåÇëK= = ^= rKpKJÇçãáÅáäÉÇ 12, it is unlikely that there will be further devel- OMNMK==qÜÉ=`çããáëëáçåI=íÜÉ=`çìåÅáä=~åÇ=íÜÉ opments with respect to this legislation until áåîÉëíãÉåí= ÑìåÇ= ã~å~ÖÉê= ïçìäÇ= ÄÉ= ëìÄàÉÅí m~êäá~ãÉåíDë= êÉéêÉëÉåí~íáîÉë= Ü~îÉ= ÄÉÉå mid-September. íç=íÜÉ=aáêÉÅíáîÉ=áÑ=áí=ïÉêÉ=íç=ã~êâÉí=áåîÉëíãÉåí ÉåÖ~ÖÉÇ=áå=~=íêáJé~êíó=Çá~äçÖìÉ=áå=~å=~ííÉãéí ÑìåÇë=áå=íÜÉ=brI=êÉÖ~êÇäÉëë=çÑ=íÜÉ=ÑìåÇëD=àìêáëJ íç=êÉÅçåÅáäÉ=íÜÉ=íïç=îÉêëáçåë=çÑ=íÜÉ=aáêÉÅíáîÉK ÇáÅíáçå=çÑ=Éëí~ÄäáëÜãÉåíK ^ë=çÑ=íÜÉ=ÉåÇ=çÑ=gìåÉ=OMNMI=íÜÉ=é~êíáÉë=Ü~îÉ New York State Abandons ÄÉÉå=ìå~ÄäÉ=íç=êÉ~ÅÜ=~å=~ÖêÉÉãÉåí=~åÇ=íÜÉ Proposal to Tax Non-Resident qÜÉ= âÉó= êÉÖìä~íçêó= ÅçãéçåÉåíë= çÑ= íÜÉ m~êäá~ãÉåí~êó=îçíÉ=çå=íÜÉ=aáêÉÅíáîÉ=Ü~ë=ÄÉÉå Carried Interest at Ordinary aáêÉÅíáîÉ=áåÅäìÇÉ=çÄäáÖ~íáçåë=Ñçê=ã~å~ÖÉêë=çÑ ÇÉä~óÉÇ=ìåíáä=íÜÉ=ëÉÅçåÇ=m~êäá~ãÉåí~êó=ëÉëJ Income Rates ?~äíÉêå~íáîÉ=áåîÉëíãÉåí=ÑìåÇë?=íçW=EáF=êÉÖáëíÉêX ëáçå= áå= pÉéíÉãÄÉê= OMNMK= = fÑ= íÜÉ= aáêÉÅíáîÉ= áë EááF= ÇáëÅäçëÉ= íÜÉáê= ~ÅíáîáíáÉë= íç= êÉÖìä~íçêë= ~åÇ é~ëëÉÇ=Äó=íÜÉ=m~êäá~ãÉåí=áå=pÉéíÉãÄÉêI=íÜÉ áåîÉëíçêëX= EáááF= áåëíáíìíÉ= êçÄìëí= ÖçîÉêå~åÅÉ On August 3, 2010, the New York State `çããáëëáçå=ïáää=Çê~Ñí=ÇÉí~áäÉÇ=áãéäÉãÉåíáåÖ Åçåíêçä= ~åÇ= äáèìáÇáíó= ã~å~ÖÉãÉåí= ëóëíÉãëX Assembly and Senate unanimously voted down êÉÖìä~íáçåë= íÜ~í= ïáää= Éñé~åÇ= ~åÇ= Åä~êáÑó= íÜÉ EáîF=ÉåÖ~ÖÉ=íÜáêÇ=é~êíáÉë=~ë=ÅìëíçÇá~åëX=~åÇ=EîF a measure that would have taxed carried interest Åçãéäó=ïáíÜ=êÉëíêáÅíáçåë=çå=äÉîÉê~ÖÉI=ÅçåÇìÅí aáêÉÅíáîÉK==b~ÅÜ=ãÉãÄÉê=ëí~íÉ=çÑ=íÜÉ=br=ïáää as ordinary income for non-New York residents çÑ= ÄìëáåÉëë= çÄäáÖ~íáçåë= ~åÇ= Å~éáí~ä= êÉèìáêÉJ ÄÉ= çÄäáÖ~íÉÇ= íç= í~âÉ= ~Åíáçå= çå= íÜÉ= å~íáçå~ä who work in New York State. ãÉåíëK= = qÜÉ= aáêÉÅíáîÉ= ~äëç= Éåîáëáçåë= ÅäçëÉ äÉîÉä=íç=íê~åëéçëÉ=íÜÉ=aáêÉÅíáîÉ=áåíç=å~íáçå~ä áåíÉêå~íáçå~ä= ÅççéÉê~íáçå= ÄÉíïÉÉå= íÜÉ= br ä~ï=ïáíÜáå=íïç=óÉ~êë=çÑ=íÜÉ=aáêÉÅíáîÉDë=~ÇçéJ êÉÖìä~íçêë= ~åÇ= íÜÉáê= ÅçìåíÉêé~êíë= áå= çíÜÉê íáçåI=~åÇ=íÜÉ=aáêÉÅíáîÉ=ïáää=í~âÉ=ÉÑÑÉÅí=çåÅÉ=áí ÅçìåíêáÉëI= ~åÇ= ÉñéÉÅíë= äÉÖáëä~íáçå= çÑ= çíÜÉê Ü~ë= ÄÉÉå= íê~åëéçëÉÇ= áåíç= å~íáçå~ä= ä~ïK= = fÑ ÅçìåíêáÉë= íç= ãÉÉí= ÅÉêí~áå= ëí~åÇ~êÇëI= ~ë= ~ Éå~ÅíÉÇ= áå= áíë= ÅìêêÉåí= ÑçêãI= é~êíáÅìä~êäó= ~ë éêÉJêÉèìáëáíÉ= Ñçê= éÉêãáííáåÖ= ÑìåÇë= Ñêçã= ëìÅÜ éêçéçëÉÇ= Äó= íÜÉ= m~êäá~ãÉåíI= áåîÉëíãÉåí ÅçìåíêáÉë= íç= çéÉê~íÉ= ïáíÜáå= íÜÉ= brK= = pìÅÜ ã~å~ÖÉêë=äçÅ~íÉÇ=áå=íÜÉ=br=çê=ëÉêîáåÖ=ÅäáÉåíë ÅççéÉê~íáçå=~åÇ=äÉÖáëä~íáçå=ã~ó=ÄÉ=áãéê~ÅíáJ Ñêçã= íÜÉ= br= ïáää= åÉÉÇ= íç= ÅçåëáÇÉê= íÜÉ Å~ÄäÉ=ïáíÜ=êÉëéÉÅí=íç=íÜÉ=rKpKI==ïÜáÅÜ=ÅçìäÇ aáêÉÅíáîÉDë=áãé~Åí=çå=íÜÉáê=ÄìëáåÉëëK=

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Newly Enacted Laws Affecting Private Funds Recent Litigation Affecting Private Funds Dodd-Frank Wall Street qualifications applicable to a "qualified client" Reform and Consumer under the Advisers Act. FIDUCIARY DUTY TO INVESTORS Protection Act Other than as specifically noted above, the råáíÉÇ=pí~íÉë=îK=j~êâ=aK=i~óN Private Fund Investment Advisers Registration Act becomes effective on July 21, lå=gìäó=NQI=OMNMI=íÜÉ=páñíÜ=`áêÅìáí=^ééÉ~äë=`çìêí Registration Act 2011, during which time the SEC is expected to ìéÜÉäÇ= íÜÉ= ÅçåîáÅíáçå= çÑ= ÜÉÇÖÉ= ÑìåÇ= ã~å~ÖÉêI adopt rules and regulations providing proce- j~êâ=aK=i~óI=çå=çåÉ=Åçìåí=çÑ=áåîÉëíãÉåí=~ÇîáëÉê On July 21, 2010, President Obama signed the dures for registration and reporting. Ñê~ìÇ=~åÇ=ãìäíáéäÉ=Åçìåíë=çÑ=ã~áä=~åÇ=ïáêÉ=Ñê~ìÇK Investment advisers to private funds may volun- _~ëÉÇ= çå= íÉëíáãçåó= éêÉëÉåíÉÇ= ~í= Üáë= íêá~äI= ~ Dodd-Frank Wall Street Reform and Consumer aáëíêáÅí= `çìêí= àìêó= ÑçìåÇ= jêK= i~ó= Öìáäíó= çå= ~ää tarily register with the SEC during this one-year Protection Act (the "Dodd-Frank Act") into Åçìåíë=Ñçê=Ñê~ìÇ=áå=îáçä~íáçå=çÑ=pÉÅíáçå=OMS=çÑ=íÜÉ law. Included in Title IV of the Dodd-Frank period. fåîÉëíãÉåí= ^ÇîáëÉêë= ^Åí= çÑ= NVQM= EíÜÉ= ?^ÇîáëÉêë Act is the Private Fund Investment Advisers ^Åí?FI= ïÜáÅÜ= ÖÉåÉê~ääó= éêçÜáÄáíë= ~å= áåîÉëíãÉåí Registration Act of 2010 (the "Registration Please see our June 30, 2010 client memoran- ~ÇîáëÉê=Ñêçã=ìëáåÖ=íÜÉ=ã~áäë=çê=áåëíêìãÉåí~äáíáÉë=çÑ Act"), which eliminates (i) the "private adviser dum entitled "House-Senate Conference Committee áåíÉêëí~íÉ=ÅçããÉêÅÉ=Ñçê=éìêéçëÉë=çÑ=ÉåÖ~ÖáåÖ=áå exemption" from Securities and Exchange Approves Private Fund Investment Advisers ~=ëÅÜÉãÉ=íç=ÇÉÑê~ìÇ=~åó=ÅäáÉåíK==^ë=~=êÉëìäí=çÑ=Üáë Commission (the "SEC") registration currently Registration Act" for further information on this ÅçåîáÅíáçåI= jêK=i~ó= ï~ë= çêÇÉêÉÇ= íç= EáF= é~ó= AONO contained in Section 203(b)(3) of the topic. ãáääáçå= áå= êÉëíáíìíáçå= EêÉÑäÉÅíáåÖ= äçëëÉë= Å~ìëÉÇ= Äó Investment Advisers Act of 1940 (the jêK=i~óDë=çîÉêJäÉîÉê~ÖáåÖFX=EááF=ÑçêÑÉáí=ARVMIROSKOP The Volcker Rule EêÉéêÉëÉåíáåÖ= ~ãçìåíë= çÄí~áåÉÇ= Ñêçã= jêK= i~óDë "Advisers Act") for investment advisers who do ã~áä=~åÇ=ïáêÉ=Ñê~ìÇFX=~åÇ=EáááF=ëÉêîÉ=NQQ=ãçåíÜë=çÑ not hold themselves out to the public as invest- áãéêáëçåãÉåíK== ment advisers and have fewer than 15 clients; Section 619 of the Dodd-Frank Act contains and (ii) the intrastate exemption from SEC reg- the so called "Volcker Rule" which prohibits any jêK= i~óDë= Ñê~ìÇ= ÅçåîáÅíáçåë= áå= íÜÉ= aáëíêáÅí= `çìêí istration for investment advisers with any pri- "banking entity" from engaging in proprietary ïÉêÉ= êÉä~íÉÇ= íç= íÜÉ= äçëë= Äó= íÜÉ= lÜáç= _ìêÉ~ì= çÑ vate fund client. As a result of the foregoing, trading or sponsoring or investing in hedge tçêâÉêëD=`çãéÉåë~íáçå=EíÜÉ=?fåîÉëíçê?F=çÑ=AONQ many investment advisers to private funds (with funds or private equity funds, subject to limited ãáääáçå=çÑ=áíë=AOOR=ãáääáçå=áåîÉëíãÉåí=áå=~=ÜÉÇÖÉ some exceptions) will be required to register exceptions. "Banking entity" is defined to ÑìåÇ=îÉÜáÅäÉI=íÜÉ=^ÅíáîÉ=aìê~íáçå=cìåÇI=ÅêÉ~íÉÇ=Äó with the SEC. For a description of the registra- include any insured depository institution, any jêK=i~ó=áå=NVVU=EíÜÉ=?^ac=cìåÇ?FK==qÜÉ=éêçëÉÅìJ tion and reporting requirements under the company that controls an insured depository íáçå=~êÖìÉÇ=íÜ~í=AONO=ãáääáçå=çÑ=íÜÉ=AONQ=ãáääáçå=áå institution or that is regulated as a bank holding äçëëÉë=ïÉêÉ=ëìëí~áåÉÇ=~ë=~=êÉëìäí=çÑ=jêK=i~ó=áÖåçêJ Registration Act, please see our article entitled áåÖ= ~= NRMB= äÉîÉê~ÖÉ= ÖìáÇÉäáåÉ= Åçåí~áåÉÇ= áå= íÜÉ company, and any affiliate or subsidiary of any "Registration and Reporting Implications of the Private ^ac=cìåÇDë=ÖçîÉêåáåÖ=ÇçÅìãÉåíë=~åÇ=jêK=i~óDë Fund Investment Advisers Registration Act" begin- such entity. Ñ~áäìêÉ= íç= ÇáëÅäçëÉ= íÜÉ= ÑêÉèìÉåÅó= ~åÇ= ÉñíÉåí= çÑ ning on page 4. äÉîÉê~ÖÉ= ÉãéäçóÉÇ= áå= Üáë= ÅçããìåáÅ~íáçåë= ïáíÜ The Volcker Rule generally prohibits a banking íÜÉ=fåîÉëíçêK== Immediately upon enactment of the entity from acquiring or retaining any equity, Registration Act, the net worth standard for an partnership or other ownership interest in or jêK=i~ó= ÄÉÖ~å= ëÉêîáåÖ= ~ë= áåîÉëíãÉåí= ~ÇîáëÉê= íç "accredited investor" that is a natural person, as sponsoring any hedge fund or private equity íÜÉ=fåîÉëíçê=áå=NVVO=áå=ÅçååÉÅíáçå=ïáíÜ=áíë=áåîÉëíJ set forth in Rules 215 and 501(a)(5) of the fund. "Sponsoring" is defined broadly as (i) ãÉåí=áå=~=äçåÖ=íÉêã=ÄçåÇ=ÑìåÇ=EíÜÉ=?içåÖ=cìåÇ?FK Securities Act of 1933 (the "Securities Act"), serving as a general partner, managing member få=ä~íÉ=OMMPI=íÜÉ=fåîÉëíçê=ëÜáÑíÉÇ=ANMM=ãáääáçå=çÑ=áíë or trustee of a fund; (ii) selecting or controlling áåîÉëíãÉåí= áå= íÜÉ= içåÖ= cìåÇ= íç= íÜÉ= ^ac= cìåÇ was adjusted to exclude from the calculation of ÄÉÅçãáåÖ=íÜÉ=^ac=cìåÇDë=Ñáêëí=~åÇ=çåäó=áåîÉëíçêK a majority of the directors, trustees or manage- net worth the "value of the primary residence" ^ÑíÉê=ÉñéÉêáÉåÅáåÖ=~=AT=ãáääáçå=äçëë=áå=É~êäó=OMMQI of the investor. Pending implementation of the ment of the fund; or (iii) sharing with a fund, íÜÉ= fåîÉëíçê= ~ééêç~ÅÜÉÇ= jêK=i~ó= íç= ÇáëÅìëë= íÜÉ changes to the SEC's rules required by the for corporate, marketing, promotional or other äçëë=~åÇ=ìäíáã~íÉäó=ÇÉÅáÇÉÇ=íç=áåîÉëí=~å=~ÇÇáíáçåJ Registration Act, the SEC issued Compliance purposes, the same name or a variation of the ~ä=ANMM=ãáääáçå=áå=íÜÉ=^ac=cìåÇK==qÜÉêÉ~ÑíÉêI=íÜÉ and Disclosure Interpretations clarifying that same name. "Hedge fund" and "private equity ^ac= cìåÇ= ÅçåíáåìÉÇ= íç= äçëÉ= î~äìÉ= ~åÇI= áå= ä~íÉ the related amount of indebtedness secured by fund" are defined to include any issuer that OMMQI= íÜÉ= fåîÉëíçê= íÉêãáå~íÉÇ= áíë= áåíÉêÉëí= áå= íÜÉ the primary residence up to its fair market value would be an investment company subject to ^ac=cìåÇ=~ÑíÉê=áåîÉëíáåÖ=~å=~ÇÇáíáçå~ä=AOR=ãáääáçå may also be excluded. Indebtedness secured by registration under the Investment Company Act áå=~å=~ííÉãéí=íç=~îçáÇ=äçëáåÖ=áíë=ÉåíáêÉ=áåîÉëíãÉåíK of 1940, but for an exemption provided by the residence in excess of the value of the O Section 3(c)(1) or Section 3(c)(7) thereunder, få=êÉäá~åÅÉ=çå=dçäÇëíÉáå=îK=pb`I jêK=i~óDë=éêáã~êó home, however, should be considered a liability ~êÖìãÉåí=ÄçíÜ=áå=íÜÉ=aáëíêáÅí=`çìêí=~åÇ=çå=~ééÉ~ä and any other issuer that the regulators deter- and deducted from the investor's net worth. As ï~ë=íÜ~íI=~ë=~=ÜÉÇÖÉ=ÑìåÇ=~ÇîáëÉêI=ÜÉ=ÇáÇ=åçí=çïÉ a result, investment advisers should update their mine, by rule, should be subject to the Volcker ~=ÑáÇìÅá~êó=Çìíó=íç=íÜÉ=fåîÉëíçêI=Äìí=ê~íÜÉê=íÜ~í=Üáë subscription booklets to reflect this change. Rule. ÑáÇìÅá~êó= Çìíó= ê~å= ëçäÉäó= íç= íÜÉ= ^ac= cìåÇK= = qÜÉ The SEC is required to review and modify such ^ééÉ~äë= `çìêí= ÇáëãáëëÉÇ= íÜáë= ~êÖìãÉåí= çå= íÜÉ definition periodically. The Dodd-Frank Act provides exceptions for Ä~ëáë= íÜ~í= íÜ~í= jêK= i~óDë= áåíÉêéêÉí~íáçå= çÑ the following permitted activities: dçäÇëíÉáå=ï~ë=íçç=Äêç~ÇI==(continued on page 13)

Within one year after July 21, 2010 (and period- 1 ically thereafter), the SEC is required to adjust organizing and offering a hedge fund or 2010 WL 2757123 (6th Cir. July 14, 2010). 2 for inflation the net worth and/or asset-based private equity fund, (continued on page 13) 451 F. 3d 873 (D.C. Cir. 2006).

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Newly Enacted Laws Affecting Private Funds (continued from page 12) Recent Litigation Affecting Private Funds (continued from page 12) including sponsoring such a fund, as long as investing in small business investment com- all of the following conditions are met: panies or certain other investments that are åçíáåÖ=íÜ~í=íÜÉ=Åçìêí=áå=dçäÇëíÉáå=ÇáÇ=åçí=ÜçäÇ=íÜ~í (i) the banking entity provides bona fide designed to promote the "public welfare" or ~=ÜÉÇÖÉ=ÑìåÇ=áåîÉëíçê=ÅçìäÇ=åÉîÉê=ÄÉ=~=ÅäáÉåí=çÑ=~ trust, fiduciary or investment advisory that are qualified rehabilitation expenditures; ÜÉÇÖÉ=ÑìåÇ=~ÇîáëÉêI=çê=ÄÉ=çïÉÇ=~=ÑáÇìÅá~êó=Çìíó=Äó ëìÅÜ= ~ÇîáëÉêI= Ñçê= éìêéçëÉë= çÑ= Åêáãáå~ä= äá~Äáäáíó services; investing in or sponsoring a hedge fund or (ii) the fund is organized and offered only in private equity fund solely outside the United ìåÇÉê=íÜÉ=Ñê~ìÇ=éêçîáëáçåë=çÑ=íÜÉ=^ÇîáëÉêë=^ÅíK==få ìéÜçäÇáåÖ=jêK=i~óDë=ÅçåîáÅíáçå=~åÇ=ÑáåÇáåÖ=íÜ~í=íÜÉ connection with the provision of such States, provided that the banking entity is not services and is only offered to customers ÅÜ~ê~ÅíÉêáëíáÅë=çÑ=~å=~ÇîáëÉêJÅäáÉåí=êÉä~íáçåëÜáé=ÇáÇ directly or indirectly controlled by a banking Éñáëí= ~ë= ÄÉíïÉÉå= jêK= i~ó= ~åÇ= íÜÉ= fåîÉëíçê= ïáíÜ of such services of the banking entity; entity organized in the United States and the êÉëéÉÅí= íç= íÜÉ= ^ac= cìåÇI= íÜÉ= ^ééÉ~äë= `çìêí (iii) the banking entity does not have an equi- interests in the fund are not offered or sold ÉãéÜ~ëáòÉÇ=íÜÉ=~íóéáÅ~ä=å~íìêÉ=çÑ=íÜÉ=êÉä~íáçåëÜáé ty or other ownership interest in the to a resident of the United States; and íÜ~í=ÉñáëíÉÇ=ÄÉíïÉÉå=jêK=i~ó=~åÇ=íÜÉ=fåîÉëíçê=ïáíÜ fund except for the following de minimis engaging in such other activities as the appro- êÉëéÉÅí= íç= íÜÉ= içåÖ= cìåÇ= ~åÇ= íÜÉ= ^ac= cìåÇK investments: priate federal banking agencies, the SEC and péÉÅáÑáÅ~ääóI=íÜÉ=^ééÉ~äë=`çìêí=åçíÉÇ=íÜ~í=jêK=i~ó seed investments to establish the fund the Commodity Futures Trading ÇáÇ=åçí=ÇáëéìíÉ=íÜÉ=ÉñáëíÉåÅÉ=çÑ=~å=~ÇîáëÉêJÅäáÉåí and provide the fund with sufficient Commission determine, by rule, would "pro- êÉä~íáçåëÜáé=ïáíÜ=êÉëéÉÅí=íç=íÜÉ=içåÖ=cìåÇ=ïÜáÅÜ initial equity for investment to attract mote and protect" the safety and soundness éêÉJÇ~íÉÇ= íÜÉ= fåîÉëíçêDë= áåîÉëíãÉåí= áå= íÜÉ= ^ac cìåÇK= = pÉÅçåÇI= Ä~ëÉÇ= çå= jêK=i~óDë= éêÉJÉñáëíáåÖ unaffiliated investors; and of the banking entity and the financial stabil- ~ÇîáëÉêJÅäáÉåí= êÉä~íáçåëÜáé= ïáíÜ= íÜÉ= fåîÉëíçê= áå other de minimis investments; ity of the United States. êÉëéÉÅí= çÑ= íÜÉ= içåÖ= cìåÇI= ~= ê~íáçå~ä= íêáÉê= çÑ= Ñ~Åí provided that, in making either of the ÅçìäÇ=ÑáåÇ=íÜ~í=~=ëÉÅçåÇ=~ÇîáëÉêJÅäáÉåí=êÉä~íáçåëÜáé above investments, (x) the banking enti- These exceptions for permitted activities are ï~ë=Éëí~ÄäáëÜÉÇ=ïáíÜ=êÉëéÉÅí=íç=íÜÉ=^ac=cìåÇK==få ty must actively seek unaffiliated subject to the same limitations contained in the Ñ~ÅíI=~=êÉéêÉëÉåí~íáîÉ=çÑ=íÜÉ=fåîÉëíçê=íÉëíáÑáÉÇ=íÜ~í investors to reduce its ownership interest Volcker Rule with respect to proprietary trad- çåÉ=çÑ=íÜÉ=éêáã~êó=êÉ~ëçåë=Ñçê=áåîÉëíáåÖ=áå=íÜÉ=^ac to not more than 3% of the total owner- ing, i.e., such transactions must not give rise to cìåÇI= ïÜáÅÜ= áåÅäìÇÉÇ= ëÜáÑíáåÖ= ANMM= ãáääáçå= çÑ= áíë material conflicts of interest, involve high-risk ÉñáëíáåÖ=áåîÉëíãÉåí=áå=íÜÉ=içåÖ=cìåÇ=íç=íÜÉ=^ac ship interest of the fund within one year cìåÇI=ï~ë=íç=ÇáîÉêëáÑó=áíë=ÉñáëíáåÖ=áåîÉëíãÉåí=ïáíÜ of the establishment of the fund (which assets or strategies or pose a threat to the bank- ing entity or the U.S. financial system. jêK=i~óK==qÜáêÇI=íÜÉ=fåîÉëíçê=ï~ë=íÜÉ=ëçäÉ=áåîÉëíçê period of time may be extended for up áå=íÜÉ=^ac=cìåÇ=~åÇI=íÜêçìÖÜ=áíë=êÉÖìä~ê=~åÇ=ÇáêÉÅí to two additional years upon application ÅçããìåáÅ~íáçå=ïáíÜ=jêK=i~óI=~ëëìãÉÇ=~å=~ÅíáîÉ to the Federal Reserve); and (y) the The Dodd-Frank Act also requires the Federal êçäÉ=áå=ÅçååÉÅíáçå=ïáíÜ=ëìÅÜ=áåîÉëíãÉåíK banking entity's aggregate interests in all Reserve to adopt rules imposing additional cap- qÜÉ= ^ééÉ~äë= `çìêí= ~äëç= ÑçìåÇ= åç= ãÉêáí= áå= jêK funds in which it is permitted to invest ital requirements and quantitative limits on sys- i~óDë=~êÖìãÉåí=íÜ~í=íÜÉ=NRMB=äáãáí=çå=äÉîÉê~ÖáåÖ may not exceed 3% of its Tier 1 capital; temically important nonbank financial compa- nies that engage in proprietary trading or spon- ï~ë=ëáãéäó=~=ÖìáÇÉäáåÉ=ê~íÜÉê=íÜ~å=~=ëíêáÅí=äáãáí~J (iv) the banking entity does not enter into íáçåI= åçíáåÖ= íÜ~í= áí= åçåÉíÜÉäÉëë= ÇáÇ= åçí= ÅçåíÉãJ sor or invest in hedge funds or private equity covered transactions (as defined in éä~íÉ= íÜÉ= ìëÉ= çÑ= äÉîÉê~ÖÉ= áå= ÉñÅÉëë= çÑ= NRMB= áå Section 23A of the Federal Reserve Act, funds. íïçJíÜáêÇë=çÑ=íê~ÇÉë=~åÇ=áå=ÉñÅÉëë=çÑ=NIMMMB=áå these transactions generally include pro- çåÉJÑáÑíÜ=çÑ=íê~ÇÉëK==_~ëÉÇ=çå=íÜÉëÉ=ÑáåÇáåÖëI=íÜÉ viding loans or guarantees to funds and Please see our July 14, 2010 client memoran- ^ééÉ~äë=`çìêí=êÉ~ëçåÉÇ=íÜ~í=~=ê~íáçå~ä=íêáÉê=çÑ=Ñ~Åí purchasing fund assets or securities) with dum entitled "The Volcker Rule" for further ÅçìäÇ=Ü~îÉ=ÑçìåÇ=jêK=i~ó=Öìáäíó=çÑ=Ñê~ìÇ=Ä~ëÉÇ=çå the funds it organizes and offers and information on this topic. íÜÉ=ãáëêÉéêÉëÉåí~íáçå=çÑ=áíë=äÉîÉê~ÖáåÖ=~Åíáîáíó=~åÇ complies with the requirements of íÜÉ=Ñ~áäìêÉ=íç=ÇáëÅäçëÉ=ëìÅÜ=~Åíáîáíó=íç=íÜÉ=fåîÉëíçêK Section 23B of the Federal Reserve Act, Reg D Offerings táíÜ=êÉëéÉÅí=íç=jêK=i~óDë=ÅçåîáÅíáçå=Ñçê=ã~áä=~åÇ which imposes restrictions on transac- ïáêÉ=Ñê~ìÇI=íÜÉ=^ééÉ~äë=`çìêí=~äëç=ÑçìåÇ=íÜÉ=ÉîáJ tions between banks and their affiliates; Rule 506 of Regulation D of the Securities Act ÇÉåÅÉ=ëìÑÑáÅáÉåí=íç=Éëí~ÄäáëÜ=íÜ~í=jêK=i~ó=Ü~Ç=ìëÉÇ (v) the banking entity does not guarantee, creates a safe harbor allowing issuers to make áåíÉêëí~íÉ=ã~áä=çê=ïáêÉë=áå=ÑìêíÜÉê~åÅÉ=çÑ=~=ëÅÜÉãÉ assume or otherwise insure the obliga- private placements under Section 4(2) without ïáíÜ=íÜÉ=áåíÉåí=íç=ÇÉéêáîÉ=íÜÉ=fåîÉëíçê=çÑ=ãçåÉó=Äó tions or performance of the fund or any the offering being deemed "public" and without ãáëêÉéêÉëÉåíáåÖ=íÜÉ=ÉñíÉåí=çÑ=Üáë=çîÉêJäÉîÉê~ÖáåÖ other hedge fund or private equity fund having to comply with the securities laws of ~åÇ=çãáííáåÖ=ã~íÉêá~ä=áåÑçêã~íáçå=êÉä~íÉÇ=íÜÉêÉíç=áå in which the fund invests; each specific state in which they offer or sell Üáë= êÉéçêíë= íç= íÜÉ= fåîÉëíçêK= = få= é~êíáÅìä~êI= íÜÉ ^ééÉ~äë=`çìêí=êÉÅçÖåáòÉÇ=íÜ~í=íÜÉ=íê~ÇÉ=ÅçåÑáêã~J (vi) the banking entity does not share the securities. Section 926 of the Dodd-Frank Act íáçåëI= Éã~áäë= ~åÇ= Ñ~ñÉë= íÜêçìÖÜ= ïÜáÅÜ= jêK= i~ó requires the SEC to adopt rules by July 21, same name or a variation of the same ÅçåÇìÅíÉÇ= íÜÉ= Ñê~ìÇ= ë~íáëÑáÉÇ= íÜÉ= ã~áäáåÖ= ~åÇ name with the fund; 2011, that will disqualify offerings from the pro- ïáêáåÖ= êÉèìáêÉãÉåí= ëáåÅÉ= íÜÉó= ïÉêÉ= ÇÉëáÖåÉÇ= íç (vii)no director or employee of the banking tections of Regulation D under the Securities ÅêÉ~íÉ=~=Ñ~äëÉ=ëÉåëÉ=çÑ=ëÉÅìêáíó=~åÇ=íç=ìäíáã~íÉäó entity takes or retains an equity or other Act if such offerings are made by certain "bad éçëíéçåÉ= íÜÉ= fåîÉëíçêDë= Åçãéä~áåíK= = ^äíÜçìÖÜ= áí ownership interest in the fund, except actors." The Dodd-Frank Act requires that Ü~Ç=åç=ÉÑÑÉÅí=çå=íÜÉ=çìíÅçãÉ=çÑ=íÜÉ=éêÉëÉåí=Å~ëÉI for any director or employee who is these new rules must be substantially similar to áí= ëÜçìäÇ= ÄÉ= åçíÉÇ= íÜ~í= çåÉ= àìÇÖÉ= ëáííáåÖ= çå= íÜÉ directly engaged in providing investment Rule 262 of the Securities Act. The Dodd- ^ééÉ~äë=`çìêí=é~åÉä=ÇáëëÉåíÉÇ=áå=é~êí=çå=íÜÉ=Ä~ëáë advisory or other services to the fund; Frank Act specifies that the new rules must dis- íÜ~í=íÜÉêÉ=ï~ë=åç=éêççÑ=áå=íÜÉ=êÉÅçêÇI=~é~êí=Ñêçã and qualify an offering or sale of securities as a íê~ÇÉ= ÅçåÑáêã~íáçå= ëäáéëI= ïÜáÅÜ= ïÉêÉ= çåäó= ã~áäÉÇ (viii) the banking entity discloses to prospec- Regulation D offering where the person offer- ÄÉíïÉÉå= Ä~åâë= íç= êÉÑäÉÅí= íê~ÇÉëI= íç= ëìééçêí= íÜÉ Åä~áã=íÜ~í=jêK=i~ó=Ü~Ç=ã~ÇÉ=~åó=çíÜÉê=áåíÉêëí~íÉ tive and actual investors that the fund's ing the securities: (i) is subject to a final order ã~áäáåÖ=Åçåí~áåáåÖ=~=ãáëêÉéêÉëÉåí~íáçåK losses are borne by the fund's investors by a state securities, banking or insurance (continued on page 14) and not by the banking entity; authority, a federal (continued on page 14)

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Newly Enacted Laws Affecting Private Funds (continued from page 13) Recent Litigation Affecting Private Funds (continued from page 13) banking agency or the National Credit Union providing or agreeing to provide, directly or Administration that (a) bars the person from (1) indirectly, payment to any third party (i.e., a association with any entity regulated by such placement agent) for solicitation of advisory DISCLOSURE OF LP LIST authority, (2) engaging in the business of secu- business from any government entity on _êçïå=fåîÉëíãÉåí=j~å~ÖÉãÉåíI=iKmK=îK P rities, insurance or banking, or (3) engaging in behalf of such adviser, unless the third party m~êâÅÉåíê~ä=däçÄ~äI=iKmK savings association or credit union activities, or is an SEC-registered investment adviser or lå=j~ó=OQI=OMNMI=íÜÉ=aÉä~ï~êÉ=`Ü~åÅÉêó=`çìêí (b) constitutes a final order based on a violation an SEC-registered broker-dealer, in each ÇÉåáÉÇ=~=ëí~ó=éÉåÇáåÖ=~ééÉ~ä=çÑ=íÜÉ=ÅçìêíDë=éêÉîáJ of any law or regulation that prohibits fraudu- case, subject to similar pay to play restric- çìë= êìäáåÖ= íÜ~í= íÜÉ= ÇÉÑÉåÇ~åí= ÑìåÇI= m~êâÅÉåíê~ä lent, manipulative or deceptive conduct within tions; and däçÄ~äI=iKmK=E?m~êâÅÉåíê~ä?F=ï~ë=êÉèìáêÉÇ=íç=éêçîáÇÉ éä~áåíáÑÑ= äáãáíÉÇ= é~êíåÉêI= _êçïå= fåîÉëíãÉåí the 10-year period ending on the date of the fil- coordinating or soliciting from others (a j~å~ÖÉãÉåíI=iKmK=E?_êçïå?FI=~=äáëí=çÑ=~ää=çíÜÉê=äáãáíJ ing of the Form D; or (ii) has been convicted of practice known as "bundling") campaign ÉÇ=é~êíåÉêë=çÑ=m~êâÅÉåíê~äK==få=íÜáë=Å~ëÉI=~=Öêçìé=çÑ any felony or misdemeanor in connection with contributions to certain elected officials who äáãáíÉÇ=é~êíåÉêëI=åçí=áåÅäìÇáåÖ=_êçïåI=Ü~Ç=áåáíá~íÉÇ the purchase or sale of any security or involving are in a position to influence the selection of ~= ëìáí= ~Ö~áåëí= m~êâÅÉåíê~ä= áå= qÉñ~ë= ÑÉÇÉê~ä= Åçìêí the making of any false filing with the SEC. the adviser or payments to certain political ~ÑíÉê= íÜÉ= ÜÉÇÖÉ= ÑìåÇ= ëìÑÑÉêÉÇ= ëáÖåáÑáÅ~åí= äçëëÉëI parties in the state or locality where the äÉ~ÇáåÖ=íç=íÜÉ=ÅäçëÉ=çÑ=áíë=ÄìëáåÉëëK==_êçïåI=ïÜáÅÜ Incentive-Based Compensation Ü~Ç=äçëí=áíë=Ñìää=ANS=ãáääáçå=áåîÉëíãÉåíI=êÉèìÉëíÉÇ adviser is seeking government business. íÜÉ=äáëí=çÑ=äáãáíÉÇ=é~êíåÉêë=Ñçê=íÜÉ=ëí~íÉÇ=éìêéçëÉë çÑ= ÅçããìåáÅ~íáåÖ= ïáíÜ= çíÜÉê= äáãáíÉÇ= é~êíåÉêë Section 956 of the Dodd-Frank Act directs fed- The Pay Rule becomes effective September 12, ?~Äçìí=íÜÉ=Ñ~áäìêÉ=çÑ=m~êâÅÉåíê~äI=éçíÉåíá~ä=ïêçåÖJ eral regulators, including the SEC, by April 2010; however, the restrictions on political con- ÇçáåÖ= ~í= m~êâÅÉåíê~äI= ~åÇ= íÜÉ= qÉñ~ë= äáíáÖ~íáçåK? 2011, to jointly prescribe regulations that would tributions will only apply to contributions made m~êâÅÉåíê~ä=êÉÑìëÉÇ=íç=éêçîáÇÉ=íÜÉ=äáãáíÉÇ=é~êíåÉê äáëíI=~êÖìáåÖI=~ãçåÖ=çíÜÉê=íÜáåÖëI=íÜ~í=íÜÉ=dê~ããJ require "covered financial institutions," includ- after March 12, 2011. Compliance with the ban ing investment advisers, to disclose to the iÉ~ÅÜJ_äáäÉó=^Åí=çÑ=NVVV=EíÜÉ=?dê~ããJiÉ~ÅÜJ_äáäÉó on the use of unregulated placement agents is ^Åí?F=éêÉÉãéíÉÇ=êáÖÜíë=ìåÇÉê=ëí~íÉ=ä~ï=íç=éêçîáÇÉ appropriate regulator the structures of their required by September 12, 2011. The SEC is áåÑçêã~íáçå= ~Äçìí= çíÜÉê= äáãáíÉÇ= é~êíåÉêëK= = qÜÉ incentive-based compensation arrangements. providing time for the Financial Industry aÉä~ï~êÉ=`Ü~åÅÉêó=`çìêí=áå=íÜáë=áåëí~åÅÉ=ÉñíÉåÇJ No reporting of the actual compensation of ÉÇ= íÜÉ= êìäáåÖ= áå= ^êÄçê= mä~ÅÉ= iKmK= îK= båÅçêÉ Regulatory Authority to propose a similar rule Q particular individuals would be required. lééçêíìåáíó= cìåÇI= iKiK`KI ÜçäÇáåÖ= íÜ~í= ~ë= ïáíÜ covering broker-dealers. Please see our July 9, Further, such regulators must jointly issue rules ^êÄçêI= ïÜÉêÉ= íÜÉ= Åçìêí= ÜÉäÇ= íÜ~í= íÜÉ= dê~ããJ 2010 client memorandum entitled "SEC Adopts iÉ~ÅÜJ_äáäÉó=^Åí=ÇáÇ=åçí=éêÉÉãéí=êáÖÜíë=ìåÇÉê=íÜÉ to prohibit any incentive-based payment Rule Regarding Political Contributions by Investment aÉä~ï~êÉ=iáãáíÉÇ=iá~Äáäáíó=`çãé~åó=^Åí=íç=éêçîáÇÉ arrangement that they determine will encourage Advisers" for further information on this topic. ~= äáëí= çÑ= áíë= ãÉãÄÉêë= íç= ~åçíÜÉê= ãÉãÄÉêI= íÜÉ inappropriate risks by the covered financial dê~ããJiÉ~ÅÜJ_äáäÉó=^Åí=ÇçÉë=åçí=éêÉÉãéí=êáÖÜíë institutions by providing their executive offi- ìåÇÉê= íÜÉ= aÉä~ï~êÉ= oÉîáëÉÇ= råáÑçêã= iáãáíÉÇ cers, employees, directors or principal share- SEC Adopts Amendments to m~êíåÉêëÜáé=^ÅíI=pÉÅíáçå=NTJPMRI=ïÜáÅÜ=éêçîáÇÉëI holders with excessive compensation, fees or Form ADV, Part 2 áå=é~êíI=íÜ~í=~=äáãáíÉÇ=é~êíåÉê=Ü~ë=?íÜÉ=êáÖÜíI=ëìÄàÉÅí íç=ëìÅÜ=êÉ~ëçå~ÄäÉ=ëí~åÇ~êÇë=K=K=K=K=íç=çÄí~áå=Ñêçã benefits or that could lead to material financial 1 íÜÉ=ÖÉåÉê~ä=é~êíåÉê=Ñêçã=íáãÉ=íç=íáãÉ=ìéçå=êÉ~ëçåJ loss to the institution. Covered financial institu- On July 28, 2010, the SEC published its release ~ÄäÉ=ÇÉã~åÇ=Ñçê=~åó=éìêéçëÉ=êÉ~ëçå~Ääó=êÉä~íÉÇ=íç tions with assets of less than $1 billion are discussing amendments recently adopted by the íÜÉ=äáãáíÉÇ=é~êíåÉêDë=áåíÉêÉëí=~ë=~=äáãáíÉÇ=é~êíåÉêK=K=K excluded from these provisions. SEC to Part 2 of Form ADV, and related rules ~=ÅìêêÉåí=äáëí=çÑ=íÜÉ=å~ãÉ=~åÇ=ä~ëí=âåçïå=ÄìëáåÉëëI under the Advisers Act, which require regis- êÉëáÇÉåÅÉ=çê=ã~áäáåÖ=~ÇÇêÉëë=çÑ=É~ÅÜ=é~êíåÉê=K=K=K=K? SEC Adopts Pay to Play Rule tered investment advisers to provide clients and få= ÇÉåóáåÖ= íÜÉ= ëí~óI= íÜÉ= Åçìêí= ÉãéÜ~ëáòÉÇ= íÜ~í m~êâÅÉåíê~ä=?Ü~Ç=åçí=ÇçåÉ=~åóíÜáåÖ=íç=~Ççéí=~=éçäJ prospective clients with a brochure and áÅó=êÉÖ~êÇáåÖ=íÜÉ=ÅçåÑáÇÉåíá~äáíó=çÑ=áíë=äáëí=çÑ=äáãáíÉÇ On June 30, 2010, the SEC adopted a new rule brochure supplements written in plain English, é~êíåÉêë=ÄÉóçåÇ=áëëìáåÖ=íÜÉ=éÉêáçÇ=éêáî~Åó=åçíáÅÉë under the Advisers Act to curb "pay to play" including clearly written, meaningful, current êÉèìáêÉÇ= Äó= íÜÉ= dê~ããJiÉ~ÅÜJ_äáäÉó= ^Åí?= ~åÇ practices by certain investment advisers. Pay to disclosure of the business practices, conflicts of ä~ÅâÉÇ=~=ÖççÇ=Ñ~áíÜ=Ä~ëáë=íç=ÄÉäáÉîÉ=íÜ~í=éêçîáÇáåÖ ëìÅÜ= ~= äáëí= ïçìäÇ= Ü~êã= m~êâÅÉåíê~äI= ÉëéÉÅá~ääó play refers to the practice of making campaign interest and background of the investment contributions to elected officials in an attempt ÖáîÉå= íÜÉ= Ñ~Åí= íÜ~í= m~êâÅÉåíê~ä= ï~ë= åç= äçåÖÉê= ~ adviser and its advisory personnel. The ÖçáåÖ=ÅçåÅÉêåK==qÜÉ=aÉä~ï~êÉ=`Ü~åÅÉêó=`çìêí=ÇáëJ to influence the awarding of contracts for the brochures must be filed electronically with the íáåÖìáëÜÉÇ= ~å= É~êäáÉê= Å~ëÉI= tóååÉÑáÉäÇ= m~êíåÉêë management of public pension plan assets and SEC and will be made available to the public pã~ää=`~é=s~äìÉI=iKmK=îK=ká~Ö~ê~=`çêéKIR áå=ïÜáÅÜ similar government investment accounts. through the SEC's website. áåëí~åÅÉ=~=ëí~ó=éÉåÇáåÖ=~ééÉ~ä=ï~ë=Öê~åíÉÇ=íç=íÜÉ Newly adopted Rule 206(4)-5 entitled "Political Åçêéçê~íáçå=áå=èìÉëíáçå=íÜ~í=ï~ë=áå=íÜÉ=ãáÇëí=çÑ=~ Contributions by Certain Investment Advisers" ÖçáåÖJéêáî~íÉ=íê~åë~ÅíáçåK==qÜÉ=aÉä~ï~êÉ=`Ü~åÅÉêó Currently, Part 2 requires investment advisers to (the "Pay Rule") prohibits an investment advis- `çìêí= íÜÉêÉÑçêÉ= äÉÑí= çéÉå= íÜÉ= éçëëáÄáäáíó= íÜ~í= íÜÉ respond to a series of multiple-choice and fill- ÇÉÅáëáçå= ã~ó= Ü~îÉ= ÇáÑÑÉêÉÇ= Ü~Ç= m~êâÅÉåíê~ä er from: in-the-blank questions organized in a "check- êÉã~áåÉÇ=~å=~ÅíáîÉ=ÑìåÇ=~åÇ=Ü~Ç=~ÇÇáíáçå~ä=Ñ~Åíë=íç providing advisory services for compensa- ÄçäëíÉê=áíë=~êÖìãÉåíë=~êçìåÇ=Ü~êã=íç=íÜÉ=é~êíåÉêJ tion to a government entity for two years the-box" format. Unfortunately, that format ëÜáé= çê= çíÜÉê= äáãáíÉÇ= é~êíåÉêëI= ëìÅÜ= ~ë= ~ÇÇáíáçå~ä after the adviser, or certain of its executives frequently does not correspond well to an éçäáÅáÉë= êÉÖ~êÇáåÖ= ÅçåÑáÇÉåíá~äáíó= çÑ= çíÜÉê= äáãáíÉÇ or employees, makes a contribution to cer- investment adviser's business. And, in some é~êíåÉêëD=áÇÉåíáíáÉë=~åÇ=~ÇÇêÉëëÉëK tain elected officials or candidates who are in cases, the required disclosure may not describe (continued on page 15) 3 a position to influence the selection of the the investment adviser's business or conflicts in 2010 Del. Ch. LEXIS 112 (May 24, 2010). a user-friendly manner. (continued on page 15) 4 adviser; 2002 Del. Ch. LEXIS 102 (Del. Ch. Jan. 29, 2002). 5 1 For a copy of the SEC's release, see http://www.sec.gov/rules/final/2010/ia-3060.pdf. 2006 Del. Ch. LEXIS 144 (Del. Ch. Aug. 9, 2006).

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Newly Enacted Laws Affecting Private Funds (continued from page 14) Recent Litigation Affecting Private Funds (continued from page 14) Under the new rules, investment advisers are Comptroller Liu also announced that the cur- required to prepare a narrative, plain English, rent ban on the use of placement agents will brochure, presented in a consistent, uniform remain in place. Effective July 1, 2010 (Fiscal EARLY WITHDRAWAL REQUEST manner that will make it easier for clients to Year 2011), there will be new policies relating to DENIED compare different investment advisers' disclo- disclosure in the due diligence investment táãÄäÉÇçå=cìåÇ=imJ^^ÄëçäìíÉ=oÉíìêå=cìåÇ sures. Investment advisers must deliver the process at TRS, NYCERS and BERS (collec- pÉêáÉë=îK=ps=péÉÅá~ä=páíì~íáçåë=cìåÇ=im=S brochure to a client before or at the time the tively, the "Systems"): lå= gìåÉ= NQI= OMNMI= áå= êÉëéçåëÉ= íç= ~= ëìãã~êó investment adviser enters into an advisory con- àìÇÖãÉåí= ãçíáçå= Äó= táãÄäÉÇçå= cìåÇ= imJ ^ÄëçäìíÉ= oÉíìêå= cìåÇ= pÉêáÉë= E?táãÄäÉÇçå?F= ~åÇ tract with the client. In addition, investment Investment managers must certify in writing ÅêçëëJãçíáçå= Äó= ps= péÉÅá~ä= páíì~íáçåë= cìåÇ= im advisers must provide each client an annual that they have not given any gifts to any E?ps= cìåÇ?FI= íÜÉ= aÉä~ï~êÉ= `Ü~åÅÉêó= `çìêí= ÜÉäÇ summary of material changes to the brochure employee in the Comptroller's Office, and íÜ~í=~=ÑìåÇJïáÇÉ=ïáíÜÇê~ï~ä=ëìëéÉåëáçå=~ééäáÉÇ=íç and either deliver a complete updated brochure have complied with NYC Conflict of Interest ~=äáãáíÉÇ=é~êíåÉê=íÜ~í=Ü~Ç=éêÉã~íìêÉäó=êÉèìÉëíÉÇ=~ or offer to provide the client with the updated Board gift restrictions for the Systems and ïáíÜÇê~ï~ä=éêáçê=íç=íÜÉ=~ååçìåÅÉãÉåí=çÑ=íÜÉ=ëìëJ éÉåëáçåI=åçíáåÖ=íÜ~í=áíë=êÉèìÉëí=ï~ë=ã~ÇÉ=éêáçê=íç brochure. The new brochure addresses those their respective Boards of Trustees; íÜÉ= ÉåÇ= çÑ= íÜÉ= ~ÖêÉÉÇJìéçå= äçÅâJìé= éÉêáçÇK= = få topics the SEC believes are most relevant to ÅçååÉÅíáçå=ïáíÜ=íÜÉ=áåîÉëíãÉåí=Äó=táãÄäÉÇçå=áå clients, including (i) advisory business; (ii) fees Investment managers must disclose all con- íÜÉ= ps= cìåÇ= çå= lÅíçÄÉê= NI= OMMTI= táãÄäÉÇçå and compensation; (iii) performance-based fees tacts with employees of the Comptroller's ÄçìåÇ=áíëÉäÑ=íç=íÜÉ=äáãáíÉÇ=é~êíåÉêëÜáé=~ÖêÉÉãÉåí=çÑ ps=cìåÇK==qÜÉ=aÉä~ï~êÉ=`Ü~åÅÉêó=`çìêí=ÜáÖÜäáÖÜíJ and side-by-side management; (iv) methods of Office regarding new investments as well as ÉÇ= Ñçìê= ã~áå= éêçîáëáçåë= áå= íÜÉ= ps= cìåÇDë= ~ÖêÉÉJ analysis, investment strategies and risk of loss; contacts with other individuals, such as mem- ãÉåí=íÜ~í=ÇÉíÉêãáåÉÇ=íÜÉ=ÜçäÇáåÖ=çÑ=íÜáë=Å~ëÉW=EáF (v) disciplinary information; (vi) code of ethics, bers of the Boards of Trustees, involved in äáãáíÉÇ=é~êíåÉêë=ÅçìäÇ=çåäó=ïáíÜÇê~ï=ÑìåÇë=ïáíÜçìí participation or interest in client transactions the investment decision-making process; íÜÉ=ÖÉåÉê~ä=é~êíåÉêDë=ÅçåëÉåí=~ë=çÑ=gìåÉ=PMíÜ=çê aÉÅÉãÄÉê=PMíÜ=çÑ=~åó=ÑáëÅ~ä=óÉ~êI=Äìí=áå=~åó=ÉîÉåí and personal trading; and (vii) brokerage prac- çåäó=~ÑíÉê=íÜÉ=çåÉJóÉ~ê=~ååáîÉêë~êó=çÑ=ëìÅÜ=äáãáíÉÇ tices. An investment adviser is also required to Investment managers must certify/agree to é~êíåÉêDë=áåáíá~ä=áåîÉëíãÉåíX=EááF=íÜÉ=ÖÉåÉê~ä=é~êíåÉê deliver brochure supplements to clients and the following: ÅçìäÇ=ëìëéÉåÇ=~ää=Å~éáí~ä=ïáíÜÇê~ï~äë=çÑ=é~êíåÉêë prospective clients providing them with infor- ìåÇÉê= ÅÉêí~áå= ÉåìãÉê~íÉÇ= ÅáêÅìãëí~åÅÉëX= EáááF= íÜÉ ÖÉåÉê~ä=é~êíåÉê=ÅçìäÇ=ï~áîÉ=çê=ãçÇáÑó=ïáíÜÇê~ï~ä mation about the specific individuals who will No placement agent was used in connec- íÉêãë= éìêëì~åí= íç= ~= ïêáííÉå= ~ÖêÉÉãÉåí= ïáíÜ= íÜÉ provide services to the clients. The supplement tion with securing the Systems' commit- äáãáíÉÇ=é~êíåÉêX=~åÇ=EáîF=ãçÇáÑáÅ~íáçåë=çê=ï~áîÉêë=çÑ will contain brief résumé-like disclosure about ment to any private equity investment íÜÉ=~ÖêÉÉãÉåí=áå=ÖÉåÉê~ä=êÉèìáêÉÇ=~=ëáÖåÉÇ=ïêáíáåÖK the educational background, business experi- transaction; få=cÉÄêì~êó=OMMUI=táãÄäÉÇçå=êÉèìÉëíÉÇ=íç=ïáíÜJ Çê~ï= áíë= áåîÉëíãÉåí= ~ë= çÑ= íÜÉ= åÉñí= êÉÇÉãéíáçå ence, other business activities and disciplinary Full disclosure of all fees and terms relat- Ç~íÉI= gìåÉ= PMI= OMMUK= = ps= cìåÇDë= Ñáêëí= ~åÇ= çåäó history of the individual, so that the client can ing to any firm retained to provide mar- êÉëéçåëÉ=ï~ë=~å=~ÅâåçïäÉÇÖãÉåí=áå=pÉéíÉãÄÉê assess the person's background and qualifica- keting or placement services for transac- OMMU=íÜ~í=áí=Ü~Ç=êÉÅÉáîÉÇ=táãÄäÉÇçåDë=êÉèìÉëí=íç tions. It will also include contact information tions that are not covered by the place- ïáíÜÇê~ï=ÑìåÇë=~ë=çÑ=gìåÉ=PMI=OMMUK==få=lÅíçÄÉê for the person's supervisor in case the client has ment agent ban; OMMUI=ps=cìåÇ=åçíáÑáÉÇ=~ää=çÑ=áíë=é~êíåÉêë=íÜ~í=áí=ï~ë ëìëéÉåÇáåÖ= ~ää= ÑìíìêÉ= ~åÇ= éÉåÇáåÖ= ïáíÜÇê~ï~ä a concern about the person. Marketing/placement fees, if any, shall êÉèìÉëíëK==qÜÉ=aÉä~ï~êÉ=`Ü~åÅÉêó=`çìêí=ÜÉäÇ=íÜ~íW be fully borne by the investment manag- EáF=ps=cìåÇDë=pÉéíÉãÄÉê=OMMU=~ÅâåçïäÉÇÖÉãÉåí Investment advisers that are currently regis- er; çÑ=íÜÉ=éêÉã~íìêÉ=ïáíÜÇê~ï~ä=êÉèìÉëí=ÇáÇ=åçí=ÅçåJ tered, with fiscal years ending on or after They have read and complied with ëíáíìíÉ=~å=ÉñéêÉëë=ÅçåëÉåí=íç=~å=É~êäó=ïáíÜÇê~ï~ä December 31, 2010, must file a brochure that Chapter 68 of the NYC Conflict of ~ë=çÑ=gìåÉ=PMI=OMMUX=EááF=íÜ~í=táãÄäÉÇçå=ï~ë=ëíáää=~ äáãáíÉÇ=é~êíåÉê=çÑ=íÜÉ=ps=cìåÇ=ïÜÉå=íÜÉ=ëìëéÉåJ complies with the new rules by March 31, 2011. Interest Board rules and have not caused ëáçå=åçíáÅÉ=ï~ë=áëëìÉÇ=ÄÉÅ~ìëÉ=ÉñéêÉëë=ÅçåëÉåí New investment advisers filing for registration any employee of the Comptroller's Ñçê=ïáíÜÇê~ï~ä=ï~ë=åçí=ÖáîÉåX=~åÇ=EáááF=íÜ~í=íÜÉêÉÑçêÉ after January 1, 2011 must file a brochure that Office or any member of the Boards of íÜÉ=ÑìåÇJïáÇÉ=ëìëéÉåëáçå=~ééäáÉÇ=íç=táãÄäÉÇçåDë complies with the new requirements with their Trustees or employee of NYCERS or ïáíÜÇê~ï~ä=êÉèìÉëí=êÉÖ~êÇäÉëë=çÑ=íÜÉ=Ñ~Åí=íÜ~í=íÜÉ êÉèìÉëí=ï~ë=ã~ÇÉ=éêáçê=íç=êÉÅÉáéí=çÑ=íÜÉ=ëìëéÉåJ application for registration. TRS to breach them in any way; and ëáçå= åçíáÅÉK= = få= ÅçãáåÖ= íç= íÜáë= ÜçäÇáåÖI= íÜÉ Agree that Systems may terminate an aÉä~ï~êÉ= `Ü~åÅÉêó= `çìêí= ÉãéÜ~ëáòÉÇ= íÜÉ= ÜáÖÜ New York City Adopts investment commitment or contract, and ÜìêÇäÉ=çÑ=ÇÉãçåëíê~íáåÖ=íÜ~í=~=é~êíó=Ü~Ç=ï~áîÉÇ=áíë Additional Pay to Play any obligations to pay future manage- Åçåíê~Åíì~ä=êáÖÜíëI=åçíáåÖ=íÜ~í=?ëáäÉåÅÉ=áë=åÉîÉê=ëìÑJ ÑáÅáÉåí=íç=Éëí~ÄäáëÜ=~=ï~áîÉê=ïÜÉêÉ=íÜÉ=é~êíó=Ü~ë=åç Policies ment or performance fees, for violation Çìíó= íç= ëéÉ~â?= ~åÇ= ÑìêíÜÉê= íÜ~í= ëìÅÜ= ~= ï~áîÉê of the Systems' placement agent policy åÉÉÇÉÇ= íç= ÄÉ= ~å= ?ìåÉèìáîçÅ~ä= áåÇáÅ~íáçå?= çÑ= ~ On June 22, 2010, New York City Comptroller and related disclosure requirements. ï~áîÉê= çÑ= êáÖÜíëK= = qÜÉ= aÉä~ï~êÉ= `Ü~åÅÉêó= `çìêí John Liu announced additional transparency ÑìêíÜÉê= åçíÉÇ= íÜ~í= íÜÉ= ps= cìåÇDë= ~ÖêÉÉãÉåí= ÇáÇ and disclosure initiatives implemented by his Comptroller Liu has voluntarily agreed not to åçí=êÉëíêáÅí=íÜÉ=ëìëéÉåëáçå=êáÖÜíë=íç=çåäó=éêçëéÉÅJ íáîÉ= ïáíÜÇê~ï~äë= ~åÇ= íÜ~í= íÜÉêÉÑçêÉ= Äó= áíë= éä~áå office relating to money managers seeking to do accept any campaign contributions from íÉêãëI= íÜÉ= ps= cìåÇDë= é~êíåÉêëÜáé= ~ÖêÉÉãÉåí= ÇáÇ business with the Teachers' Retirement System investment managers and their agents doing åçí=éêÉÅäìÇÉ=~å=~ééäáÅ~íáçå=çÑ=íÜÉ=ëìëéÉåëáçå=íç ("TRS"), the New York City Employees' business with, or seeking to do business with, éÉåÇáåÖ=ïáíÜÇê~ï~ä=êÉèìÉëíëK 6 Retirement System ("NYCERS") and the Board the New York City pension systems. C.A. No. 4780-VCS (Del. Ch. June 14, 2010). of Education Retirement System ("BERS").

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