H.R. 5424, Investment Advisers Modernization Act of 2016

H.R. 5424

Investment Advisers Modernization Act of 2016

Date
September 9, 2016 (114th Congress, 2nd Session)

Staff Contact
John Huston

Floor Situation

On Friday, September 9, 2016, the House will begin consideration of H.R. 5424, Investment Advisers Modernization Act of 2016 under a structured rule. H.R. 5424 was introduced on June 9, 2016, by Rep. Robert Hurt (R-VA) and was referred to the Financial Services Committee, which ordered the bill reported by a vote of 47 to 12 on June 16, 2016.

Bill Summary

H.R. 5424 provides various reforms to the Investment Advisers Act of 1940 to modernize certain disclosure requirements for investors and their advisors and lessen the regulatory burden on private equity and other investment advisers. Specifically, the bill:

  • Allows advisers organized as partnerships to change the composition of the partnership without providing notice to the Securities and Exchange Commission (SEC) every time there is a change in the partnership;
  • Lifts certain securities advertising restrictions on advisors who advertise to qualified investors, exempts private equity fund sponsors from certain enhanced disclosures to the SEC (Form ADV, Part 2)[1];
  • Removes certain reporting requirements for large private equity funds to treat them like other equity funds (Form PF, Part 4)[2];
  • Provides an exemption from the Proxy Advisor Voting rule for investment advisers who exercise voting authority only with respect to non-public securities[3]
  • Expands the “privately offered securities” exemption under the Custody Rule[4] so that it applies to both certificated and uncertificated securities and providing an exemption for special purpose vehicles (SPV) managed by private fund sponsors and co-investment funds that hold only one investment.
  • Prevents the misapplication of SEC Rule 156 in the private funds space, thereby enabling both regulators and investors alike to understand that private funds and mutual funds are significantly different types of investment vehicles.

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[1] Form ADV is the uniform form used by investment advisers to register with both the Securities and Exchange Commission (SEC) and state securities authorities. Part 2 of the form requires investment advisers to prepare narrative brochures written in plain English that contain information such as the types of advisory services offered, the adviser’s fee schedule, disciplinary information, conflicts of interest, and the educational and business background of management and key advisory personnel of the adviser. See SEC Website: Fast Answers Form ADV
[2] Form PF is filed by SEC-registered investment advisers with at least $150 million in private funds assets under management to report information about the private funds that they manage.  The Financial Stability Oversight Council (FSOC) uses information in Form PF to monitoring risk to the U.S. financial system.  See SEC Website, “SEC Staff Publishes Private Funds Statistics Report,” October, 16, 2015.
[3] Proxy advisors provide services to shareholders and investment advisors to research and provide analysis regarding proposals being put up for a vote before all shareholders. According to the Wall Street Journal, “A 2003 SEC rule [relating to proxy advisors], combined with misguided advice from SEC staff, had all but required many investment fund managers to hand off voting decisions in corporate elections to outside proxy advisers.”
[4] The SEC Custody Rule implementing the Investment Advisers Act of 1940 requiring that advisers deemed to have custody of client funds or securities undergo an annual surprise examination, hold client assets in a certain manner, among other requirements.

Background

Hedge funds, private equity funds, and venture capital funds are pooled investment vehicles that channel investment capital from investors and deploy these funds to both emerging and mature corporations through outright acquisition or through the acquisition of partial stakes in the businesses. From the standpoint of the federal securities laws and regulations, historically these funds, which are known as private funds or private investment funds, have largely been defined by what they are not. From a regulatory perspective, they are different from another kind of pooled investment vehicle known as an investment company, of which mutual funds are perhaps the best known example. Investment companies are subject to extensive regulation under the federal securities laws because they are generally open to anyone throughout the investing public.[1] The rationale for most federal securities regulation is to protect ordinary investors.

By contrast, private funds only advise sophisticated investors (e.g. pension funds, endowments, high net-worth individuals) and, accordingly, should not have to incur the regulatory burden and costs required of entities whose securities are publicly available without restrictions.[2]

The Investment Advisers Act of 1940 (IAA) generally requires any person or entity that, for compensation, is engaged in the act of providing advice, making recommendations, issuing reports or furnishing analyses on securities, either directly or through publications, to register as an investment adviser with the SEC. Among other things, registration requires advisers to disclose information about their business, the persons who own or control the adviser, whether the adviser or certain of its personnel have been sanctioned for violating securities laws or other laws, and the adviser’s business practices, fees, and conflicts of interest that the adviser may have with its clients.[3]

Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. 111-203) requires the advisers to private funds, who are usually the general partners (who organize and oversee operations) of the fund(s) to register with the SEC as advisers under the IAA, except for advisers to venture capital which were provided an further exemption from registration. Prior to its repeal by the Dodd-Frank Act, private fund advisers availed themselves of the less-than-15 client exemption,  Various private-sector entities and Members of Congress have criticized the mandatory private equity fund adviser registration provision in the Dodd-Frank Act as the IAA does not consider the size of the adviser or the assets under management and in doing so the Act imposes burdensome costs on certain private equity funds, harms the viability, and undermines the ability of advisers to provide capital to companies, especially smaller-sized firms.[4]

According to the bill sponsor, “Small businesses are the backbone of our economy, and the ability for these entities to access private capital is imperative for their success and the success of our local and national economies. In order for our economy to grow and for our small business owners to be able to create the jobs that we need, we must remove unnecessary regulations that tie up private capital and create economic uncertainty and put in place policies that encourage investment, innovation, and the entrepreneurial spirit that makes America the beacon of economic opportunity.

“This bipartisan effort to rid the IAA of outdated, cumbersome regulatory schemes would not curtail the Securities and Exchange Commission’s ability to carry out its role, but rather, this measure is a much-needed legislative update to an antiquated law that does not reflect the current model of our nation’s small businesses and investors. Through updating and reducing the costly regulations being placed on those who are making critical investments in our economy, our small business owners will have the ability to gain access to capital more easily so that more jobs can be created and more jobs can be preserved.”

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[1] See CRS Report, “Legislation to Repeal the Private Equity Fund Adviser Registration Requirement in the Dodd-Frank Act: In Brief,” December 3, 2013.
[2] Id.
[3] Id.
[4] Id.

Cost

The Congressional Budget Office (CBO) estimates that enacting H.R. 5424 would not increase net direct spending or on-budget deficits in any of the four consecutive 10-year periods beginning in 2027.

Amendments

  1. Rep. Bill Foster (D-IL)—The amendment removes provisions related to brochure delivery and the requirement for annual audits at select private funds.

Additional Information

For questions or further information please contact John Huston with the House Republican Policy Committee by email or at 6-5539.