From ERA to RIA – An Overview of Compliance Requirements (Part 2)

Foreside
Contact

The number of exempt reporting advisors (“ERAs”) continues to rise as the popularity of hedge funds, private equity, venture capital and other private funds continue to attract capital from institutional and high net worth investors.  As addressed in the first installment of this article, ERAs face fewer compliance requirements than fully registered investment advisors (“RIAs”).  We already covered three substantive conditions ERAs must meet under current laws and regulations.  This article covers other important compliance requirements for ERAs.

What compliance obligations apply to ERAs?

As a reminder, we previously discussed ERAs’ (i) specific reporting requirements, (ii) anti-fraud rules, and (iii) Pay-to Play requirements.  In addition to these requirements, ERAs are also subject to the following:

  • Office of Foreign Asset Control – Both RIAs and ERAs are subject to the rules promulgated by the Office of Foreign Asset Control (“OFAC”) of the U.S. Treasury Department, which prohibits investment advisors from doing business with individuals and entities on certain lists maintained and published by OFAC.[i] As such, ERAs need to ensure that they do not accept individuals or entities included on OFAC’s lists as investors in their private funds and should notify OFAC of any suspect investor or transaction.

Although not required by law, ERAs may consider conducting employee OFAC training and implement robust customer identification and due diligence programs for prospective investors.

  • Privacy Rules – ERAs are subject to certain data privacy and security requirements under the Gramm-Leach-Bliley Act of 1999. The Federal Trade Commission (“FTC”) has implemented privacy rules that require ERAs to develop, implement, and maintain a comprehensive written information security program that identifies risks to the security, confidentiality, and integrity of customer information and contains safeguards for protecting such nonpublic personal information.  ERAs should also test and monitor such safeguards, adjust the program as needed, and appoint an individual to coordinate the program.  Finally, ERAs are required to send initial privacy notices to investors along with standard fund documents describing their privacy and procedures.  Subject to certain exceptions, ERAs should also send investors annual privacy disclosures and should send initial and annual privacy notices to investors describing the components of their privacy program.
  • Material Nonpublic Information (“MNPI”) – The Advisers Act requires RIAs to establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of the advisor’s business, to prevent the misuse of material, nonpublic information by the advisor or any person associated with the advisor in violation of the Advises Act, the Securities Exchange Act of 1934, or the rules or regulations promulgated The genesis for this requirement is the general prohibition of insider trading that has been a hallmark of federal securities laws since the mid-1980s.

The body of insider trading law applies to ERAs.  Therefore, ERAs should consider establishing appropriate written policies and procedures to help the firm (and its employees) prevent instances of insider trading and its potential economic and reputational harm.

  • Other Requirements – ERAs should also be aware of potential state law requirements. One such requirement is for ERAs to submit notice filings in the states where they have a place of business.  Another requirement for advisors to private funds that are trying to use the so-called “small advisor exemption” is to file Form ADV as an ERA in certain states that use the North America Securities Administrators Association (“NASAA”) Model Rule on state registration exemption for advisors to private funds.[ii]

Finally, ERAs face certain obligations with respect to the private funds they manage.  For example, Form D filings are required with respect to the private nature of securities offered by such funds. In addition, advisors to investment pools transacting in futures or options on futures, retail off-exchange forex contracts, or swaps, may be required to register with the National Futures Association (“NFA”) as a Commodity Pool Operator (“CPO”) and, therefore, become subject to additional compliance requirements.

Conclusion

As demonstrated by this article, ERAs face several regulatory pitfalls.  While ERAs may not be required to adopt a traditional RIA compliance manual, they should consider adopting compliance policies and procedures to address the requirements that apply to them.  In addition to preventing violation of laws and regulations, such policies and procedures may also help the ERA satisfy investor demands, assist with compliance with fund level covenants, and generally protect the firm.

[i] OFAC administers and enforces economic and trade sanctions based on US foreign policy and national security goals against targeted foreign countries and regimes, terrorists, international narcotics traffickers, those engaged in activities related to the proliferation of weapons of mass destruction, and other threats to the national security, foreign policy or economy of the United​ States.  OFAC publishes lists of individuals and companies owned or controlled by, or acting for or on behalf of , targeted countries. It also lists individuals, groups, and entities, such as terrorists and narcotics traffickers designated under programs that are not country-specific.

[ii] Private fund advisors taking advantage of the small adviser exemption in states that have not adopted the Model Rule are not required to file as an ERA.

Written by:

Foreside
Contact
more
less

Foreside on:

Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide
- hide

This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.