Reading 2.2 Flashcards
2 theories of regulation
1) Public interest theory of regulation - people act via government for the benefit of society and seek to prevent and control problems associated with free markets (e.g., imperfect competition, environmental damage, and other market failures with potential dangers to the public).
2) Private interest theories of regulation
- regulation as primarily originating from self-interested motives of various parties (e.g., legislators and other government employees, business competitors, and industry groups).
3 principles of financial market regulation
1) Transparency
2) Market Integrity or fundamental fairness
3) Government protection of its economic and social systems through the rule of law
Qualified Opportunity Zones
areas in the U.S. designated for special income tax breaks for investors of private equity projects and real estate developments in those areas
They are also economically distressed communities
Investment management should involve analysis of ______ due to _____ changes.
risks and opportunities
regulatory and taxation
4 primary investment related regulators in US
1) Securities and Exchange Commission (SEC) - primary regulator of key securities markets
- Financial Industry Regulatory Authority (FINRA) - non-governmental, self-regulatory organization (SRO), overseen by the SEC, that supervises and regulates the broker-dealer industry
- U.S. Commodity Futures Trading Commission (CFTC) - oversees the derivatives market with the goal of protecting market users and their funds, consumers, and the public from fraud and manipulation related to derivatives.
- National Futures Association (NFA) - regulation of futures trading
The SEC’s responsibilities include
protecting investors;
maintaining fair, orderly, and efficient markets;
and facilitating capital formation.
The SEC disclosure regime includes
principles-based disclosure requirements, which provide investors with material information about companies and securities offerings so they can make informed investment decisions.
The 50 U.S. state securities commissions have blue sky laws, which are…
designed to protect state interests and prevent fraudulent activities within a state.
The SEC and state securities commissions share oversight authority and enforcement responsibilities
4 primary US FEDERAL legislation that govern securities and investments
1) Securities Act of 1933 (Securities Act) - registration with the SEC of securities, unless an offering qualifies for an exemption. It serves to ensure that investors receive financial and other significant information about securities
- Securities Exchange Act of 1934 (Exchange Act) - governs trading of securities on the secondary market
- Investment Advisers Act of 1940 (Advisers Act) - registration and regulation by the SEC of entities that advise on securities investments and defines the responsibilities of an investment adviser
- Investment Company Act of 1940 (‘40 Act) - regulates the organization of companies (including mutual funds) that engage primarily in securities investing and whose own securities are offered to the investing public.
Dodd Frank Act
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
most sweeping reform of asset management regulation in the U.S. since the 1940s.
- enacted after the global financial crisis.
- Intended to promote the stability of U.S. financial systems by improving accountability and transparency
- ending “too big to fail”
- protecting the U.S. taxpayer by ending bailouts
- protecting consumers from abusive financial services practices.
Commodity Exchange Act (CEA) relates to
derivatives investing
Employee Retirement Income Security Act of 1974 (ERISA) relates to
funds with certain types of retirement plan investors
FINRA may require registration as a broker for those engaged in the business of ______ for the accounts of others.
transacting securities
What determines with which agency does the adviser have to register?
Assets under management - AUM
If under 25m USD AUM what is the registration requirement? Who is the regulator?
Generally no and the regulator is n/a
When does a HF need to register with SEC?
1) Maintains a principal office and place of business in a state that does not require registration of investment advisers.
2) Maintains a principal office and place of business in a state where the investment adviser would not be subject to examination by the state securities commissioner.
3) Manages only HFs with AUM greater than $100 million and maintains managed accounts.
4) Manages HFs with AUM greater than $150 million and does not maintain managed accounts.
When doesnt a HF need to register with SEC?
When AUM is under 100m and operates in a place where there is a need to register for investment advisors
In addition to AUM requirements, who else needs to register with the SEC?
- Fund managers who manage a registered investment company or a business development company.
- Non-U.S.-based HFs with more than 15 U.S. clients and investors with AUM of more than $25 million.
2 exemptions from registration
1) Venture capital fund adviser exemption - An adviser solely to one or more venture capital funds is exempt from registration.
2) Private fund adviser exemption - An adviser solely to private funds with less than $150 million in AUM is exempt from registration.
SEC registration requirements for non-U.S. hedge funds are triggered for funds with ______ and investors with more than ____ AUM, unless exempt by the _____ exemption.
more than 15 U.S. clients
$25 million
private fund adviser
Advisers to whom exemptions apply are required to file with the SEC a subset of information requested by ___.
Form ADV
Registration with the SEC or the state imposes substantial _____ and _____ requirements on HF managers.
disclosure
regulatory
Investments in derivatives may require registration under the CEA as a ____
Commodity Trading Adviser (CTA)
anti-fraud prohibitions
assert the illegality of using any device, scheme, or deception to obtain money or property through the use of material misstatements or omissions;
or to engage in any transaction, practice, or course of business that operates as a fraud or deceit upon the purchaser.
12 matters regulated under the ADVISERS ACT
- Advertising
- Advisory agreement terms
- Client solicitation
- Compliance program
- Custody
- Gifts and entertainment
- Performance fees
- Personal securities reporting
- Political contributions
- Proxy voting
- Record-keeping
- Trading practices
Form ADV consists of 3 parts
1) Part 1 provides information about the hedge fund, its manager, and all associated persons; and is primarily used by regulators for administrative purposes.
2) Part 2 (composed of Part 2A and Part 2B) serves as a disclosure document for a business’s prospective and existing clients; and includes extensive information, including types of advisory services offered, fees, conflicts of interest, and disciplinary information.
3) Form CRS explains how a fund interacts with investors (e.g., fees, costs, conflicts of interest, and the firm’s legal or disciplinary history). The form must be provided to investors before they commit to a fund investment.
Form ADV is also used by advisers to
register with state securities authorities and to satisfy the legal requirement to provide certain written disclosures to clients.
When is the adviser legal required to deliver Form ADV Part 2 to its clients
initially,
annually,
and after certain disclosure items are updated.
For advisers who manage private fund clients (e.g., hedge funds), the client is the _____; thus, advisers must provide Form ADV Part 2 to the ______.
fund (not fund investors);
fund’s general partner or managing member
Who regulates alternative investments?
SEC
What assumptions are used in regulating the alternatives?
that the products are designed for wealthy individuals that are sophisticated investors or have sufficient resources to protect themselves
How to determine if alternative invest product needs to be registered?
perform analysis under SECURITIES ACT and the 1940 ACT
Accredited investor is…
natural person with:
1. A net worth (along with his or her spouse) exceeding $1 million (excluding the value of the person’s primary residence),
OR
- Income of at least $200,000 in each of the past two years or $300,000 jointly with a spouse, with a reasonable expectation of having the same income in the current year.
Non accredited investors need _____and _____ in financial and business matters to make them capable of evaluating an investment’s merits and risks
sufficient knowledge
experience
Private funds typically structure their offers and sales of interests as ______ based on _____ of the Securities Act, which is an exemption.
private placements
Rule 506
Rule 506 permits sales of fund interests to ______ of accredited investors or to _____ non-accredited investors
an unlimited number
at most 35
Private placement (i.e., unregistered interests) in funds may be offered via general solicitations or advertising if the following hold:
- All purchasers are accredited investors.
- The issuer takes reasonable steps to verify the purchasers’ accredited investor status.
- Some other conditions in Rule 506(c) of the Securities Act are met
most private funds use one of the two following exemptions.
1) Private investment fund exemption - Section 3(c)(1) of the 1940 Act
AND
2) Qualified purchaser fund exemption - Section 3(c)(7) of the 1940 Act
Funds must satisfy two tests for the private investment fund exemption under the Section 3(c)(7) of the 1940 Act.
i. At most 100 beneficial owners.
ii. No public offering (or proposal thereof)
To use Qualified purchaser fund exemption - Section 3(c)(7) of the 1940 Act, funds must be offered only to a qualified purchaser, which is one of the following:
i. A natural person with at least $5 million in investments.
ii. An institutional investor with at least $25 million in investments.
iii. An entity of which each beneficial owner is a qualified purchaser
What is the COO
Chief Compliance Officer
Under the Advisers Act, a registered adviser must do the following -
- Designate a CCO who is responsible for policies and procedures.
- Adopt and implement written policies and procedures that are reasonably designed to prevent, detect, and correct violations of the Advisers Act.
CCO is responsible for the following duties in administering the compliance program.
- testing the effectiveness of the policies and procedures.
- Reporting to senior management
Code of ethics does the following
sets forth standards of conduct and requires compliance with federal securities laws and is required to be established in writing, maintained, and enforced in the U.S. for any fund manager registered under the Advisers Act
access persons (e.g., the adviser’s directors, officers, partners, and supervised persons with access to nonpublic information regarding securities transactions) are required to do the following -
- Periodically report personal securities transactions and holdings.
- Obtain preapproval from the adviser before investing in reportable securities, including IPOs or limited offerings (e.g., interests in HFs).
