Summary

H.R. 5424, the “Investment Advisers Modernization Act of 2016”

The Investment Advisers Modernization Act of 2016 (H.R. 5424), introduced by U.S. Reps. Robert Hurt (R-Va.), with co-sponsors Juan Vargas (D-Ca.), Steve Stivers (R-Ohio), and Bill Foster (D-Ill) was approved by the U.S. House of Representatives on September 9 by a vote of 261-145. The bill would modernize certain provisions of the Investment Advisers Act of 1940 (Advisers Act). It was introduced on June 9 and favorably reported out of the House Financial Services Committee by a 47-12 vote on June 16.

In particular, the bill would direct the SEC to amend certain rules related to advertising, custody, and assignment of advisory contacts. It would also limit the SEC’s authority to apply rules related to sales literature for registered investment companies to offerings of private funds under the Securities Act of 1933 (Securities Act). The provisions of the bill would not apply to advisory services to registered investment companies.

The bill is supported by the American Investment Council, the Association for Corporate Growth, the Small Business Investment Alliance, and the Investment Adviser Association.

Provisions Applicable to All Advisers

Assignment of Advisory Contracts (Sections 202(a)(1) and 205(a)(2) of the Advisers Act) (Bill Section 2(a))

The bill would amend the Advisers Act to change two aspects of the assignment provisions related to advisory contracts. First, the bill would amend the definition of “assignment” to state that no assignment of an investment advisory contract will be deemed to result from: (1) the death or withdrawal, or the sale or transfer of the interests, of a minority of the members, partners, shareholders, or other equity owners of the adviser having only a minority interest in the business of the investment adviser; or (2) the admission to the investment adviser of one or more of the members, partners, shareholders, or other equity owners who, after such admission, will be only a minority of the members, partners, shareholders, or other equity owners and shall have only a minority interest in the business. This provision would exclude from the definition of “assignment” transfers of minority interests in the adviser regardless of the adviser’s corporate structure.

Second, the bill would amend the pre-assignment consent requirement for clients that are “qualified clients.” Instead, consent for the assignment from a qualified client could be obtained at the time the parties enter into, extend, or renew the advisory contract.

Custody (Rule 206(4)-2 of the Advisers Act) (Bill Section 3(b))

The bill would require the SEC to broaden a custody rule exception relating to privately offered securities. It would eliminate the condition that privately offered securities must be “uncertificated” and recorded only on the books of the issuer/transfer agent in the name of the client in order to be excluded from the rule’s requirement that securities be held by a qualified custodian (e.g., bank or broker-dealer). Therefore, certificated privately offered securities would also be eligible for the exclusion from the qualified custodian requirement.

Proxy Voting (Rule 206(4)-6 of the Advisers Act) (Bill Section 3(c))

The bill would require the SEC to amend the proxy voting rule so that it does not apply to any voting authority with respect to client securities that are not public securities (i.e., not securities of issuers that submit reports under the Securities Exchange Act of 1934 (Exchange Act) or have a security listed or traded on an exchange).

Provisions Applicable Only to Advisers with Certain Sophisticated or High Net Worth Clients

Advertising (Rule 206(4)-1 of the Advisers Act) (Bill Section 2(b))

The bill would require the SEC to amend the advertising rule to provide an exemption from the prohibition against testimonials and past specific recommendations for advertisements that are published, circulated, or distributed solely to a(n):

  • Qualified client (defined in Advisers Act Rule 205-3),
  • Knowledgeable employee (defined in Investment Company Act of 1940 (Investment Company Act) Rule 3c-5) of any private fund advised by the investment adviser,
  • Qualified purchaser (defined in Section 2(a) of the Investment Company Act), or
  • Accredited investor (defined in Securities Act Rule 501).

The provisions would be limited solely to advertisements that are targeted to the specified persons, determined as of the time of the advertisement, and such advertisements would remain subject to the broad anti-fraud provisions of the Advisers Act.

Provisions Applicable to All Private Fund Advisers

Custody (Rule 206(4)-2 of the Advisers Act) (Bill Section 3(b))

The bill would require the SEC to broaden another custody rule exception relating to privately offered securities that are held by a private fund. The provision would eliminate the requirement that privately offered securities in an unaudited pooled vehicle must be held by a qualified custodian. Currently, only privately offered securities in an audited fund have an exception from the requirement that a qualified custodian physically hold the privately offered securities in the fund. This provision of the bill would not affect the current requirement that privately offered securities remain transferrable only with prior consent of the issuer or holders of the outstanding securities of the issuer.

Sales Literature (Rule 156 of the Securities Act) (Bill Section 4)

The bill would prohibit the SEC from extending Rule 156 of the Securities Act to offerings of private funds. Currently, Rule 156 interprets the anti-fraud provisions of the federal securities laws in connection with sales literature used by registered investment companies. Private fund advisers would remain subject to anti-fraud provisions of the Advisers Act, and the funds and promoters would remain subject to Securities Act and Exchange Act anti-fraud provisions.

Provisions Applicable Only to Private Equity Fund Advisers

Form PF (Rule 204(b)-1 of the Advisers Act) (Bill Section 3(a))

The bill would require the SEC to amend Rule 204(b)-1 to eliminate the requirement that private equity fund advisers report detailed information that is currently required under Section 4 on Form PF relating to every private equity fund advised and each fund’s portfolio companies. Private equity fund advisers required to file Form PF would continue to file Sections 1a and 1b.