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April 23, 2018 |
FinCEN Issues FAQs on Customer Due Diligence Regulation

Click for PDF On April 3, 2018, FinCEN issued its long-awaited Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions, FIN-2018-G001. https://www.fincen.gov/resources/statutes-regulations/guidance/frequently-asked-questions-regarding-customer-due-0.[1]  The timing of this guidance is very controversial, issued five weeks before the new Customer Due Diligence (“CDD”) regulation goes into effect on May 11, 2018.[2]  Most covered financial institutions (banks, broker-dealers, mutual funds, and futures commission merchants and introducing brokers in commodities) already have drafted policies, procedures, and internal controls and made IT systems changes to comply with the new regulation.  Covered financial institutions will need to review these FAQs carefully to ensure that their proposed CDD rule compliance measures are consistent with FinCEN’s guidance. The guidance is set forth in 37 questions.  As discussed below, some of the information is helpful, allaying financial institutions’ most significant concerns.  Other FAQs confirm what FinCEN has said in recent months informally to industry groups and at conferences.  A few FAQs raise additional questions, and others, particularly the FAQ on rollovers of certifications of deposit and loan renewals, are not responsive to industry concerns and may raise significant compliance burdens for covered financial institutions.  The guidance reflects FinCEN’s regulatory interpretations based on discussions within the government and with financial institutions and their trade associations.  The need for such extensive guidance on so many issues in the regulation illustrates the complexity of compliance and suggests that FinCEN should consider whether clarifications and technical corrections to the regulation should be made.  We provide below discussion of highlights from the FAQs, including areas of continued ambiguity and uncertainty in the regulation and FAQs. Highlights from the FAQs FAQ 1 and 2 discuss the threshold for obtaining and verifying beneficial ownership.  FinCEN states that financial institutions can “choose” to collect beneficial ownership information at a lower threshold than required under the regulation (25%), but does not acknowledge that financial institution regulators may expect a lower threshold for certain business lines or customer types or that there may be regulatory concerns if financial institutions adjust thresholds upward to meet the BSA regulatory threshold.  A covered financial institution may be in compliance with the regulatory threshold, but fall short of regulatory expectations. FAQ 7 states that a financial institution need not re-verify the identity of a beneficial owner of a legal entity customer if that beneficial owner is an existing customer of the financial institution on whom CIP has been conducted previously provided that the existing information is “up-to-date, accurate, and the legal entity’s customer’s representative certifies or confirms (verbally or in writing) the accuracy of the pre-existing CIP information.”  The example given suggests that no steps are expected to verify that the information is up-to-date and accurate beyond the representative’s confirmation or certification.  The beneficial ownership records must cross reference the individual’s CIP record. FAQs 9-12 address one of the most controversial aspects of the regulation, about which there has been much confusion: the requirement that, when an existing customer opens a new account, a financial institution must identify and verify beneficial ownership information.  FinCEN provides further clarity on what must be updated and how:Under FAQ 10, if a legal entity customer, for which the required beneficial ownership information has been obtained for an existing account, opens a new account, the financial institution can rely on the information obtained and verified previously “provided the customer certifies or confirms (verbally or in writing) that such information is up-to-date and accurate at the time each subsequent new account is opened,” and the financial institution has no knowledge that would “reasonably call into question” the reliability of the information.  The financial institution also would need to maintain a record of the certification or confirmation by the customer.There is no grace period.  If an account is opened on Tuesday, and a new account is opened on Thursday, the certification or confirmation is still required.  In advance planning for compliance, many financial institutions had included a grace period in their procedures. FAQ 11 provides that, when the financial institution opens a new account or subaccount for an existing legal entity customer whose beneficial ownership has been verified for the institution’s own recordkeeping and operational purposes and not at the customer’s request, there is no requirement to update the beneficial ownership information for the new account.  This is because the account would be considered opened by the financial institution and the requirement to update only applies to each new account opened by a customer.  This is consistent with what FinCEN representatives have said at recent conferences.The FAQ specifies that this would not apply to (1) accounts or subaccounts set up to accommodate a trading strategy of a different legal entity, e.g., a subsidiary of the customer, or (2) accounts of a customer of the existing legal entity customer, “i.e., accounts (or subaccounts) through which a customer of a financial institution’s existing legal entity carries out trading activity through the financial institution without intermediation from the existing legal entity customer.”  We believe the FAQ may fall far short of addressing all the concerns expressed to FinCEN on this issue by the securities industry. FAQ 12 addresses an issue which has been a major concern to the banking industry:  whether beneficial ownership information must be updated when a certificate of deposit (“CD”) is rolled over or a loan is renewed.  These actions are generally not considered opening of new accounts by banks.FinCEN continues to maintain that CD rollovers or loan renewals are openings of new accounts for purposes of the CDD regulation.  Therefore, the first time a CD or loan renewal for a legal entity customer occurs after May 11, 2018, the effective date of the CDD regulation, beneficial ownership information must be obtained and verified, and at each subsequent rollover or renewal, there must be confirmation that the information is current and accurate (consistent with FAQ 10) as for any other new account for an existing customer.  There is an exception or alternative approach authorized in FAQ 12 “because the risk of money laundering is very low”:  If, at the time of the rollover or renewal, the customer certifies its beneficial ownership information, and also agrees to notify the financial institution of any change in information in the future, no action will be required at subsequent renewals or rollovers.The response in FAQ 12 is not responsive to the concerns that have been expressed by the banking industry and will be burdensome for banks to administer.  Obtaining a certification in time, without disrupting the rollover or renewal, will be challenging, and it appears that if it the certification or promise to update is not obtained in time, the account may have to be closed. FAQs 13 through 17 address another aspect of the regulation that has generated extensive discussion: When (1) must beneficial ownership be obtained for an account opened before the effective date of the regulation, or (2) beneficial ownership information updated on existing accounts whose beneficial ownership has been obtained and verified.Following closely what was said in the preamble to the final rule, FAQ 13 states that the obligation is triggered when a financial institution “becomes aware of information about the customer during the course of normal monitoring relevant to assessing or reassessing the risk posed by the customer, and such information indicates a possible change in beneficial ownership.”FAQ 14 clarifies somewhat what is considered normal monitoring but is not perfectly clear what triggers obtaining and verifying beneficial ownership.  It is clear that there is no obligation to obtain or update beneficial ownership information in routine periodic CDD reviews (CDD refresh reviews) “absent specific risk-based concerns.” We would assume that means, following FAQ 13, concerns about the ownership of the customer.  Beyond that FAQ 14  is less clear.  It states that the obligation is triggered “when, in the course of normal monitoring a financial institution becomes aware of information about a customer or an account, including a possible change of beneficial ownership information, relevant to assessing or reassessing the customer’s overall risk profile.  Absent such a risk-related trigger or event, collecting or updating of beneficial ownership information is at the discretion of the covered financial institution.”The trigger or event may mean in the course of SAR monitoring or when conducting event-driven CDD reviews, e.g., when a subpoena is received or material negative news is identified – something that may change a risk profile.  Does the obligation then arise only if the risk profile change includes a concern about whether the financial institution has accurate ownership information?  That may be the intent, but is not clearly stated.  If the account is being considered for closure because of the change in risk profile, would the financial institution be released from the obligation to obtain beneficial ownership?   That would make sense, but is not stated.  This FAQ is in need of clarification and examples would be helpful.On another note, the language in FAQ 14 also is of interest because it may suggest, in FinCEN’s view, that periodic CDD reviews should be conducted on a risk basis, and CDD refresh reviews may not be expected for lower risk customers, as is the practice for some banks. FAQ 18 seems to address at least partially a technical issue with the regulation that arises because SEC-registered investment advisers are excluded from the definition of legal entity customer in the regulation, but U.S. pooled investment vehicles advised by them are not excluded.[3]  FAQ 18 states that, if the operator or adviser of a pooled investment vehicle is not excluded from the definition of legal entity customer, under the regulation, e.g., like a foreign bank, no beneficial ownership information is required to be obtained on the pooled investment vehicle under the ownership prong, but there must be compliance with beneficial ownership control party prong, i.e., verification of identity of a control party.  A control party could be a “portfolio manager” in these situations.FinCEN describes why no ownership information is required as follows:  “Because of the way the ownership of a pooled investment vehicle fluctuates, it would be impractical for covered financial institutions to collect and verify ownership identity for this type of entity.”  Thus, in the case where the operator or adviser of the pooled investment vehicle is excluded from the definition of legal entity, like an SEC-registered investment adviser, it would seem not to be an expectation to obtain beneficial ownership information under the ownership prong.  Nevertheless, the question of whether you need to obtain and verify the identity of a control party for a pooled investment vehicle advised by a SEC registered investment adviser is not squarely answered in the FAQ.  A technical correction to the regulation is still needed, but it is unlikely there would be regulatory or audit criticism for following the FAQ guidance at least with respect to the ownership prong. FAQ 19 clarifies that, when a beneficial owner is a trust (where the legal entity customer is owned more than 25% by a trust), the financial institution is only required to verify the identity of one trustee if there are multiple trustees. FAQ 20 deals with what to do if a trust holds more than a 25% beneficial interest in a legal entity customers and the trustee is not an individual, but a legal entity, like a bank or law firm.  Under the regulation, if a trust holds more than 25% beneficial ownership of a legal entity customer, the financial institution must verify the identity of the trustee to satisfy the ownership prong of the beneficial ownership requirement.  The ownership prong references identification of “individuals.”  Consequently, the language of the regulation does not seem to contemplate the situation where the trustee was a legal entity.FAQ 20 seems to suggest that, despite this issue with the regulation, CIP should be conducted on the legal entity trustee, but apparently, on a risk basis, not in every case:  “In circumstances where a natural person does not exist for purposes of the ownership/equity prong, a natural person would not be identified.  However, a covered financial institution should collect identification information on the legal entity trustee as part of its CIP, consistent with the covered institution’s risk assessment and customer risk profile.”  (Emphasis added.)More clarification is needed on this issue, and perhaps an amendment to the regulation to address this specific situation.  Pending additional guidance, the safest course appears to be to verify the identity of legal entity trustee consistent with CIP requirements, which may pose practical difficulties, e.g., will a law firm trustee easily provide its TIN?  Presumably, CIP would not be required on any legal entity trustee that is excepted from the definition of legal entity under 31 C.F.R. § 1010.230(e)(2). FAQ 21 addresses the question of how does a financial institution verify that a legal entity comes within one of the regulatory exceptions to the definition of legal entity customer in 31 C.F.R. § 1010.230(e)(2).  The answer is that the financial institution generally can rely on information provided by the customer if it has no knowledge of facts that would reasonably call into question the reliability of the information.  Nevertheless, that is not the end of the story.  The FAQ provides that the financial institution also must have risk-based policies and procedures that specify the type of information they will obtain and reasonably rely on to determine eligibility for exclusions. FAQ 24 may resolve another technical issue in the regulation.  The exceptions to the definition of legal entity in the regulation refer back to the BSA CIP exemption provisions, which in turn, cross reference the Currency Transaction Reporting (CTR) exemption for banks when granting so-called Tier One exemptions.  One category for the CTR exemption is “listed” entities, which includes NASDAQ listed entities, but excludes NASDAQ Capital Markets Companies, i.e., this category of NASDAQ listed entity is not subject to CIP or CTR Tier One exemptions.  31 C.F.R. § 1020.315(b)(4).  This carve out was not discussed in the preamble to the CDD final regulation or in FAQ 24.The FAQ simply states:  “[A]ny company (other than a bank) whose common stock or analogous equity interests are listed on the New York Stock Exchange, the American Stock Exchange (currently known as the NYSE American), or NASDAQ stock exchange” is excepted from the definition of legal entity.  In any event, as with the FAQ 18 issue, it would appear that a technical correction is needed on this point, but, given the FAQ, it is unlikely that a financial institution would be criticized if it treated NASDAQ Capital Markets Companies as excepted legal entities. FAQs 32 and 33 end the speculation that the CDD regulation impacts CTR compliance.  Consistent with FinCEN CTR guidance, under FAQ 32, the rule remains that, for purposes of CTR aggregation, the fact that two businesses share a common owner does not mean that a financial institution must aggregate the currency transactions of the two businesses for CTR reporting, except in the narrow situation where there is a reason to believe businesses are not being operated separately. Conclusion Financial institutions and their industry groups will likely continue to seek further guidance on the most problematic issues in the CDD regulation.  It is our understanding that FinCEN and the bank regulators also will address compliance with the CDD regulation in the upcoming update to the FFIEC Bank Secrecy Act/Anti-Money Laundering Examination Manual. Covered financial institutions already have spent, and will continue to spend, significant time and resources to meet the complex regulatory requirements and anticipated regulatory expectations.  In this flurry of activity to address regulatory risk, it is essential for financial institutions to continue to consider any money laundering risk of legal entity clients and that CDD not become simply mechanical.  It is not only a matter of documenting and updating all of the right information about beneficial ownership and control, but financial institutions should continue to assess whether the ownership structure makes sense for the business or whether it is overly complex for the business type and purposely opaque.  Also, it is important to consider whether it makes sense for a particular legal entity to be seeking a relationship with your financial institution and whether the legal entity is changing financial institutions voluntarily.  CDD measures to address regulatory risk and money laundering risk overlap but are not equivalent.    [1]   FinCEN also issued FAQs on the regulation on July 19, 2016. https://www.fincen.gov/sites/default/files/2016-09/FAQs_for_CDD_Final_Rule_%287_15_16%29.pdf.   FINRA issued guidance on the CDD regulation in FINRA Notice to Members 17-40 (Nov. 21, 2017). http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-40.pdf.    [2]   The Notice of Final Rulemaking was published on May 11, 2016 and provided a two-year implementation period.  81 Fed. Reg. 29,398 (May 11, 2016). https://www.gpo.gov/fdsys/pkg/FR-2016-05-11/pdf/2016-10567.pdf.  FinCEN made some slight amendments to the rule on September 29, 2017.  https://www.fincen.gov/sites/default/files/federal_register_notices/2017-09-29/CDD_Technical_Amendement_17-20777.pdf The new regulations are set forth in the BSA regulations at 31 C.F.R. § 1010.230 (beneficial ownership requirements); 31 C.F.R. § 1020.210(a)(5) (banks); 31 C.F.R. § 1023.210(b)(5) (broker-dealers); 31 C.F.R. § 1024.210(b)(4) (mutual funds); and 31 C.F.R. § 1026.210(b)(5) (future commission merchants and introducing brokers in commodities).    [3]   The regulation does not clearly address the beneficial ownership requirements for a U.S. pooled investment vehicle operated or controlled by a registered SEC investment adviser.  Pooled investment vehicles operated or advised by a “financial institution” regulated by a Federal functional regulator are not considered legal entities under the regulation.  31 C.F.R. § 1010.230(e)(2)(xi).  An SEC registered investment adviser, however, is not yet a financial institution under the BSA.  Under 31 C.F.R. § 1010.230(e)(3), a pooled investment vehicle that is operated or advised by a “financial institution” not excluded from the definition of legal entity is subject to the beneficial ownership control party prong. Gibson Dunn’s lawyers  are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the authors: Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Linda Noonan – Washington, D.C. (+1 202-887-3595, lnoonan@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

April 5, 2018 |
M&A Report – AOL and Aruba Networks Continue Trend of Delaware Courts Deferring to Deal Price in Appraisal Actions

Click for PDF Two recent decisions confirm that, in the wake of the Delaware Supreme Court’s landmark decisions in Dell and DFC, Delaware courts are taking an increasingly skeptical view of claims in appraisal actions that the “fair value” of a company’s shares exceeds the deal price.[1] However, as demonstrated by each of these recent Delaware Court of Chancery decisions—In re Appraisal of AOL Inc. and Verition Partners Master Fund Limited v. Aruba Networks, Inc.—several key issues are continuing to evolve in the Delaware courts.[2] In particular, Delaware courts are refining the criteria in appraisal actions for determining whether a transaction was “Dell-compliant.” If so, then the court will likely look to market-based indicators of fair value, though which such indicator (unaffected share price or deal price) is the best evidence of fair value remains unresolved. If not, the court will likely conduct a valuation based on discounted cash flow (DCF) analysis or an alternative method to determine fair value. The development of these issues will help determine whether M&A appraisal litigation will continue to decline in frequency and will be critical for deal practitioners.[3] DFC and “Dell-Compliant” Transactions In DFC, the Delaware Supreme Court endorsed deal price as the “best evidence of fair value” in an arm’s-length merger resulting from a robust sale process. The Court held that, in determining fair value in such transactions, the lower court must “explain” any departure from deal price based on “economic facts,” and must justify its selection of alternative valuation methodologies and its weighting of those methodologies, setting forth whether such methodologies are grounded in market-based indicators (such as unaffected share price or deal price) or in other forms of analysis (such as DCF, comparable companies analysis or comparable transactions analysis). In Dell, the Court again focused on the factual contexts in which market-based indicators of fair value should be accorded greater weight. In particular, the Court found that if the target has certain attributes—for example, “many stockholders; no controlling stockholder; highly active trading; and if information is widely available and easily disseminated to the market”—and if the target was sold in an arm’s-length transaction, then the “deal price has heavy, if not overriding, probative value.” Aruba Networks and AOL: Marking the Boundaries for “Dell-Compliant” Transactions In Aruba Networks, the Delaware Court of Chancery concluded that an efficient market existed for the target’s stock, in light of the presence of a large number of stockholders, the absence of a controlling stockholder, the deep trading volume for the target’s stock and the broad dissemination of information about the target to the market. In addition, the court found that the target’s sale process had been robust, noting that the transaction was an arm’s-length merger that did not involve a controller squeeze-out or management buyout, the target’s board was disinterested and independent, and the deal protection provisions in the merger agreement were not impermissibly restrictive. On this basis, the Court determined that the transaction was “Dell-compliant” and, as a result, market-based indicators would provide the best evidence of fair value. The Court found that both the deal price and the unaffected stock price provided probative evidence of fair value, but in light of the significant quantum of synergies that the parties expected the transaction to generate, the Court elected to rely upon the unaffected stock price, which reflected “the collective judgment of the many based on all the publicly available information . . . and the value of its shares.” The Court observed that using the deal price and subtracting synergies, which may not be counted towards fair value under the appraisal statute,[4] would necessarily involve judgment and introduce a likelihood of error in the Court’s computation. By contrast, AOL involved facts much closer to falling under the rubric of a “Dell-compliant” transaction, but the Court nonetheless determined that the transaction was not “Dell-compliant.” At the time of the transaction, the target was well-known to be “likely in play” and had communicated with many potential bidders, no major conflicts of interest were present and the merger agreement did not include a prohibitively large breakup fee. Nonetheless, the Court focused on several facts that pointed to structural defects in the sale process, including that the merger agreement contained a no-shop period with unlimited three-day matching rights for the buyer and that the target failed to conduct a robust auction once the winning bidder emerged. In addition, and importantly, the Court took issue with certain public comments of the target’s chief executive officer indicating a high degree of commitment to the deal after it had been announced, which the Court took to signal “to potential market participants that the deal was done, and that they need not bother making an offer.” On this basis, the Court declined to ascribe any weight to the deal price and instead conducted a DCF analysis, from which it arrived at a fair value below the deal price. It attributed this gap to the inclusion of synergies in the deal price that are properly excluded from fair value. Parenthetically, the Court did take note of the fact that its computation of fair value was close to the deal price, which offered a “check on fair value analysis,” even if it did not factor into the Court’s computation. Key Takeaways Aruba Networks and AOL provide useful guidelines to M&A practitioners seeking to manage appraisal risk, while also leaving several open questions with which the Delaware courts will continue to grapple: Whether market-based indicators of fair value will receive deference from the Delaware courts (and, correspondingly, diminish the incentives for would-be appraisal arbitrageurs) depends upon whether the sale process could be considered “Dell-compliant.” This includes an assessment of both the robustness of the sale process, on which M&A practitioners seeking to manage appraisal risk would be well-advised to focus early, and the efficiency of the trading market for the target’s stock, to which litigators in appraisal actions should pay close attention. For those transactions found to be “Dell-compliant,” the best evidence of fair value will be a market-based indicator of the target’s stock. Whether such evidence will be the deal price, the unaffected stock price or a different measure remains an open question dependent upon the facts of the particular case. However, for those transactions in which synergies are anticipated by the parties to be a material driver of value, Aruba Networks suggests that the unaffected share price may be viewed as a measure of fair value that is less susceptible to errors or biases in judgment. For those transactions found not to be “Dell-compliant,” DCF analyses or other similar calculated valuation methodologies are more likely to be employed by courts to determine fair value. As AOL and other recent opinions indicate, however, there is no guarantee for stockholders that the result will yield a fair value in excess of the deal price—particularly given the statutory mandate to exclude expected synergies from the computation. [1] Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017); DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017). See our earlier discussion of Dell and DFC here. [2] In re Appraisal of AOL Inc., C.A. No. 11204-VCG, 2018 WL 1037450 (Del. Ch. Feb. 23, 2018); Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL, 2018 WL 922139 (Del. Ch. Feb. 15, 2018). [3] It is worth noting that, after DFC and Dell, the Delaware Supreme Court summarily affirmed the decision of the Court of Chancery in Merlin Partners, LP v. SWS Grp., Inc., No. 295, 2017, 2018 WL 1037477 (Table) (Del. Feb. 23, 2018), aff’g, In re Appraisal of SWS Grp., Inc., C.A. No. 10554-VCG, 2017 WL 2334852 (Del. Ch. May 30, 2017). The Court of Chancery decided SWS Group prior to the Delaware Supreme Court’s decisions in DFC and Dell. Nonetheless, it is clear that the court would have found the transaction at issue in SWS Group not to be “Dell-compliant,” as the transaction involved the sale of the target to a buyer that was also a lender to the target and so could exercise veto rights over any transaction. Indeed, no party to the SWS Group litigation argued that the deal price provided probative evidence of fair value. See our earlier discussion of the SWS Group decision by the Delaware Court of Chancery here. [4] See 8 Del. C. § 262(h) (“[T]he Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation . . . .”); see also Global GT LP v. Golden Telecom, Inc., 993 A.2d 497, 507 (Del. Ch.) (“The entity must be valued as a going concern based on its business plan at the time of the merger, and any synergies or other value expected from the merger giving rise to the appraisal proceeding itself must be disregarded.” (internal citations omitted)), aff’d, 11 A.3d 214 (Del. 2010). The following Gibson Dunn lawyers assisted in preparing this client update:  Barbara Becker, Jeffrey Chapman, Stephen Glover, Eduardo Gallardo, Jonathan Layne, Joshua Lipshutz, Brian Lutz, Adam Offenhartz, Aric Wu, Meryl Young, Daniel Alterbaum, Colin Davis, and Mark Mixon. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group: Mergers and Acquisitions Group / Corporate Transactions: Barbara L. Becker – Co-Chair, New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Co-Chair, Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Co-Chair, Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Dennis J. Friedman – New York (+1 212-351-3900, dfriedman@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310-552-8641, jlayne@gibsondunn.com) Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com) Jonathan Corsico – Washington, D.C. (+1 202-887-3652), jcorsico@gibsondunn.com Mergers and Acquisitions Group / Litigation: Meryl L. Young – Orange County (+1 949-451-4229, myoung@gibsondunn.com) Brian M. Lutz – San Francisco (+1 415-393-8379, blutz@gibsondunn.com) Aric H. Wu – New York (+1 212-351-3820, awu@gibsondunn.com) Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Michael M. Farhang – Los Angeles (+1 213-229-7005, mfarhang@gibsondunn.com) Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com) Adam H. Offenhartz – New York (+1 212-351-3808, aoffenhartz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

February 14, 2018 |
Compliance Reminders for Private Fund Advisers – 2018

Click for PDF Private fund advisers are subject to a number of regulatory reporting requirements and other compliance obligations, many of which need to be completed on an annual basis.  This Client Alert provides a brief overview. 1.         Regulatory Filing Obligations under the Advisers Act A private fund adviser that is either a registered investment adviser (“RIA“) or an exempt reporting adviser (“ERA“) under the U.S. Investment Advisers Act of 1940, as amended (the “Advisers Act“), must comply with a number of regulatory reporting obligations.  Chief among these is the obligation to update the adviser’s Form ADV and Form PF filings with the SEC on an annual basis.  The following is a brief summary of those filing obligations and the applicable deadlines (assuming a fiscal year end of December 31, 2017): Form ADV Annual Update (3/31/2018 deadline).  Each RIA and ERA has an ongoing obligation to update the information provided in its Form ADV no less frequently than annually.  This annual update must be filed within 90 days of the end of the adviser’s fiscal year.  An RIA must update the information provided in both the “check the box” portion of its Form ADV (Part 1A) and in its “disclosure brochure” (Part 2A).  An ERA is only required to update the information reported in its abbreviated Part 1A filing.  This year, most private fund advisers will be filing for the first time on the amended Part 1A that went into effect on October 1, 2017.[1]  We strongly recommend that each private fund adviser build extra time into its annual Form ADV updating process for this year in order to assess and address any changes to its reporting obligations.All such updates must be filed with the SEC electronically through IARD.  To avoid last minute delays, we recommend that each RIA and ERA check its IARD account early to ensure that its security access codes are up-to-date and that it has sufficient funds in its IARD account to cover all Federal and state filing fees. Each RIA is also required to update the information provided in its “supplemental brochures” (Part 2B) no less frequently than annually.[2]  Although an RIA is not required to publicly file its supplemental brochures with the SEC, up-to-date supplemental brochures must be kept on file at the RIA’s offices. Disclosure Brochure Delivery (4/30/2018 deadline).  An RIA is also required to deliver an updated version of its Part 2A disclosure brochure to all clients within 120 days of the end of its fiscal year.[3]  An RIA may comply with this requirement either by mailing a complete copy of its updated brochure to its clients or by sending a letter providing a summary of any material changes that have been made to the brochure since its last annual update and offering to provide a complete copy of the updated brochure upon request free of charge.[4] Forms PF and CPO-PQR (4/30/2018 deadline).  An RIA with regulatory assets under management attributable to private funds exceeding $150 million is required to provide a report on Form PF to the SEC regarding its private funds’ investment activities.  For most private fund advisers, the Form PF is required to be filed once a year within 120 days of the end of the RIA’s fiscal year.  However, a private fund adviser with assets under management exceeding certain thresholds may be required to file more frequently and/or on shorter deadlines.[5]  In addition, the information that such a large private fund adviser must provide to the SEC is significantly more extensive.An RIA that is also registered under the Commodity Exchange Act (“CEA“) as a Commodity Pool Operator (“CPO“) or Commodity Trading Adviser (“CTA“) should consider its reporting obligations under Form CPO-PQR, a Commodity Futures Trading Commission (“CFTC“) form that serves the same purpose as, and requires the reporting of similar types of information to, Form PF.  In theory, a dual registrant may comply with its reporting obligations under both the Advisers Act and the CEA by filing a single Form PF.  However, the CFTC still requires certain information to be provided in a Form CPO-PQR filing in order to take advantage of this feature. 2.         Annual Compliance Program Review Rule 206(4)-7 under the Advisers Act (the “Compliance Program Rule“) requires an RIA (but not an ERA) to review no less frequently than annually the adequacy of its compliance policies and procedures and the effectiveness of their implementation.  Although the Compliance Program Rule does not require that these reviews be in writing, the SEC’s examination staff has a clear expectation that an RIA will document its review.  SEC examiners routinely request copies of an RIA’s annual compliance program review reports as part of the examination process. Producing an annual compliance program review report need not be overly burdensome.  Although an RIA may consider engaging a third party to conduct a comprehensive audit of the firm’s compliance program from time to time, under normal circumstances an RIA can take a more risk-based approach to the process.  For example, an RIA might build a review around the following three themes where potential compliance risks may be most acute: Compliance policies and procedures that may be affected by changes in the RIA’s business or business practices since the last review was conducted; Any areas where SEC examiners have identified deficiencies or where the firm has experienced compliance challenges; and Any changes in applicable law, regulation, interpretive guidance or regulatory priorities. In addition, a CCO should document in the annual review report any incremental improvements that have been made to the firm’s compliance program throughout the year, not just as part of a formal annual review process. 3.         Notable Regulatory Developments  The following is a brief summary of the more notable regulatory developments for 2017 that a private fund adviser may want to consider when conducting its annual compliance program review: Fees and Expenses.  The SEC continues to focus on industry practices concerning the collection of non-investment advisory fees from portfolio companies and on the allocation of certain of the adviser’s expenses to funds.  This past year, in continuation of a line of enforcement actions against private fund advisers dating back to 2015, the SEC’s Enforcement Division settled several enforcement actions against private equity firms in which violations of fiduciary duties were found with respect to the collection of non-advisory fees and/or the allocation of expenses.[6]  Examples of the types of practices that could trigger SEC scrutiny (particularly if not the subject of clear prior disclosure and/or a contractual basis in the applicable fund governing documents) include: re-characterizing non-investment advisory fee revenue in a manner intended to avoid triggering management fee offsets; charging accelerated monitoring or similar fees to portfolio companies; allocating expenses related to the adviser’s overhead and/or back-office services to its funds; allocating broken deal expenses to funds without allocating a portion of those expenses to other potential co-investors (especially affiliated co-investors); and negotiating discounts on service provider fees for work performed on behalf of the adviser without also making the benefit of those discounts available to the adviser’s funds. We continue to encourage private fund advisers to review their financial controls with respect to fee collection, management fee offsets and expense allocation to ensure that their practices are consistent with their funds’ governing documents (including any disclosure documents) and in line with SEC expectations.  We also encourage private fund advisers to periodically review their policies regarding fee collection and expense allocation practices to make sure that they are up-to-date and comprehensive. Cybersecurity.  The SEC continues to make cybersecurity a high priority for the entire financial services industry.  In the past three years, OCIE has published five “Risk Alerts” relating to cybersecurity and identified cybersecurity as one of its examination priorities in 2015, 2016, 2017 and 2018.[7]  In addition, the SEC’s Division of Enforcement has formed a “CyberUnit” to focus on combatting cyber-related threats.  In light of this regulatory focus, we recommend that each private fund adviser review its information security policies and practices thoroughly and implement enhancements to address any identified gaps promptly. Custody Rule.  One two occasions in February 2017, the staff of the SEC’s Division of Investment Management issued interpretive guidance on Rule 206(4)-2 under the Advisers Act (the “Custody Rule“). In a no-action letter, the staff was asked to affirm that an adviser did not have custody under the Custody Rule in circumstances where an investment adviser was authorized to instruct a custodian to transfer client funds to a designated third party account pursuant a standing letter of instruction from the client to both the adviser and the custodian.  The staff refused, stating that “an investment adviser with power to dispose of client funds or securities for any purpose other than authorized trading” has access to the client’s assets and is therefore subject to the Custody Rule.  However, the staff did grant relief from the surprise audit requirements under the Custody Rule in circumstances where a standing letter of instruction meeting certain conditions is in place.[8] In a separate “IM Guidance Update,” the staff also cautioned investment advisers that, even in circumstances where the adviser’s investment management agreement with a client prohibits the adviser from gaining access to the client’s assets, the adviser may still “inadvertently” be subject to the requirements of the Custody Rule in circumstances where the client’s custodian agreement purports to grant the adviser broader access to the client’s assets.[9] Together, both interpretations demonstrate that the SEC continues to take a broad view of what constitutes “custody” under the Custody Rule.  Advisers may wish to review their custody arrangements in view of this interpretive guidance to ensure that they are in strict compliance with the Custody Rule. OCIE “Frequent Findings” Reports.  OCIE issued two Risk Alerts in 2017 in which it summarized the most frequent findings from its compliance examinations of investment advisers.  The first report focused on OCIE’s exam findings generally and identified the following topics as the five most frequently cited deficiencies:   failure to adopt or implement adequate compliance policies and procedures in accordance with Compliance Program Rule or to perform adequate annual reviews of such compliance policies and procedures; failure to submit accurate or timely regulatory filings; failure to comply with the Custody Rule; failure to comply with Rule 204-1 under the Advisers Act (the “Code of Ethics Rule“); and failure to maintain proper books and records in compliance with Rule 204-2 under the Advisers Act (the “Books and Records Rule“).[10] The second report focused more specifically on OCIE’s findings with respect to investment adviser advertising practices, and identified a number of topics as frequently cited deficiencies, including the use of misleading performance results, misleading one-on-one representations, misleading claims of compliance with voluntary performance standards, cherry-picked profitable stock selections, misleading selection of recommendations, and inadequate compliance policies and procedures.  The staff also identified several common deficiencies as a result of its “touting initiative” focusing on the use of “accolades” in advertising materials, including the misleading use of third-party rankings or awards, and the misleading use of professional designations and testimonials.[11] Other Conflicts.  Finally, private fund advisers should remain vigilant for any other practices or circumstances that could present actual or potential conflicts of interest.  Several recent enforcement actions serve to emphasize the SEC’s view that the failure to properly address and disclose potential conflicts of interest is a breach of an investment adviser’s fiduciary duties under the Advisers Act, even in the absence of clear harm to investors.[12]   4.         Compliance Program Maintenance Each private fund adviser should (and in some cases must) perform certain annual maintenance tasks with respect to its compliance program.  The following is a list of mandatory and recommended tasks that should be completed: Code of Ethics Acknowledgements.  Each RIA is required under the Code of Ethics Rule to obtain a written acknowledgement from each of its “access persons” that such person has received a copy of the firm’s Code of Ethics and any amendments thereto.  As a matter of best practice, many RIAs request such acknowledgements on an annual basis.  In addition, each access person must provide an annual “securities holdings report” at least once every 12 months and quarterly “securities transactions reports” within 30 days of the end of each calendar quarter.  We recommend that each RIA review its records to ensure that each of its access persons has complied with these acknowledgement and personal securities reporting requirements, as the failure to maintain such documentation is a frequent deficiency identified by the SEC’s examiners.[13] Custody Rule Audits.  Compliance with the Custody Rule generally requires a private fund adviser to prepare annual audited financial statements in accordance with US GAAP for each of its private funds and to deliver such financial statements to each fund’s investors within 120 days of the fund’s fiscal year end (180 days in the case of a fund-of-funds). Disclosure Documents/ Side Letter Certifications.  In addition to the updates to an RIA’s disclosure and supplemental brochures on Form ADV Parts 2A and 2B discussed above, private fund advisers whose funds are continuously raising new capital (e.g., hedge funds) should review the offering documents for their funds to ensure that the disclosure in these documents is up-to-date.  A private fund adviser should also check to see that it has complied with all reporting, certification or other obligations it may have under its side letters with investors. Privacy Notice.  An investment adviser whose business is subject to the requirements of Regulation S-P (e.g., because it maintains records containing “nonpublic personal information” with respect to “consumers”) is required to send privacy notices to its “customers” on an annual basis.  As a matter of best practice, most private fund advisers simply send privacy notices to all of their clients and investors, often at the same time they distribute the annual updates to their disclosure brochures on Form ADV (see above).  We recommend that each adviser review its privacy notice for any updates to reflect changes in its business practices and for compliance with the applicable safe harbor provided in Regulation S-P. Political Contributions.  For a firm whose current or potential investor base includes state or local government entities (e.g., state or municipal employee retirement plans or public universities), we recommend that the political contributions of any of the firm’s “covered associates” be reviewed for any potential compliance issues under Advisers Act Rule 206(4)-5 (the “Pay-to-Play” rule). 5.         Other Potential Compliance Obligations Depending on the scope and nature of a private fund adviser’s business, numerous other regulatory reporting requirements and other compliance obligations may apply.  For example: Rule 506(d) Bad Actor Questionnaires.  For a private fund adviser whose funds are either continuously raising capital (e.g., hedge funds), or where the firm anticipates raising capital in the next twelve months, we recommend that the firm ensure that it has up-to-date “Bad Actor Questionnaires” under Regulation D Rule 506(d) on file for each of its directors, executive officers and any other personnel that are or may be involved in such capital raising efforts.  Firms that are or are contemplating engaging in general solicitations under Rule 506(c) of Regulation D should also review their subscription procedures to ensure that they are in compliance with the enhanced accredited investor verification standards required under that Rule. ERISA.  Funds that are not intended to constitute ERISA “plan assets” (e.g., because the fund is a “venture capital operating company” or because “benefit plan investors” own less than 25% of each class of equity of the fund) are typically required to certify non-plan asset status to their ERISA investors annually.  Thus, a private fund adviser should confirm that its funds have continued to qualify for a plan asset exception and prepare the required certifications.  In addition, investment advisers to funds that are ERISA plan assets sometimes agree to prepare an annual Form 5500 for the fund as a “direct filing entity.”  This approach allows underlying ERISA plan investors to rely on this Form 5500 with respect to the investment and have more limited auditing procedures for their own Forms 5500.  If this approach is used, Form 5500 is due 9-1/2 months after year-end (i.e., October 15 for calendar year filers).  Alternatively, if the fund does not itself file a Form 5500, it will need to provide ERISA investors the information they need to complete their own Forms 5500. CFTC Considerations.  A private fund adviser that is registered as either a CPO or a CTA, or which relies on certain exemptions from registration as a CPO or CTA, is subject to certain annual updating and/or reaffirmation filing requirements under the CEA and the rules adopted by the CFTC thereunder. Exempt Advisers.  Many advisers and general partners of private funds that trade in a de minimis amount of commodity interests (i.e., futures, options on futures, options on commodities, retail forex transaction, swaps) are not required to register under the CEA as a CPO, but need to qualify for, and rely on, an exemption from CPO registration.  CFTC Regulation 4.13(a)(3) provides an exemption for advisers and general partners of private funds that engage in a de minimis amount of commodity interests (the “De Minimis Exemption“) pursuant to a test found in that regulation.  Other exemptions from registration as a CPO or a CTA may be available to advisers or general partners of private funds.  An adviser or general partner must claim an exemption from CPO registration with respect to each fund that invests in commodity interests by filing an initial exemption through the National Futures Association (“NFA“) website and must reaffirm its exemption filing within 60 days after the end of each calendar year or else the exemption will be deemed to be withdrawn. Registered CPOs and CTAs.  If a private fund does not qualify for the De Minimis Exemption or another exemption, the adviser or general partner of that private fund may be required to register with the CFTC as a CPO or a CTA, resulting in annual fees, disclosure, recordkeeping and reporting requirements.  Notably, a registered CPO must file an annual report with respect to each relevant commodity pool that it operates and update disclosures to investors (unless a limited exemption under CFTC Regulation 4.7 applies).  A registered CPO should also consider reporting obligations under Form CPO-PQR, which would need to be filed with the NFA within 60 days of the end of each calendar quarter (depending on AUM).  Similarly, registered CTAs must consider reporting obligations under Form CTA-PR, which must be filed with the NFA within 45 days after the end of each calendar quarter.  If a manager or general partner is dually-registered as both a CPO and a CTA, it must complete Form CTA-PR and Form CPO-PR with respect to the relevant private funds. Other Considerations – Clearing, Trading and Uncleared Margin.  Regardless of whether an adviser or general partner claims an exemption from CPO registration with respect to a private fund, the simple fact that the private fund invests in commodity interests makes the private fund a “commodity pool” and the adviser and general partner CPOs (even if they are exempt from registration).  The designation as a commodity pool has some practical implications for private funds as commodity pools are considered “financial entities” under Section 2(h)(7)(C)(i) of the CEA and are therefore subject to mandatory clearing, trade execution and margin requirements with respect to their swaps activities.  Notably, rules requiring commodity pools to exchange variation margin for uncleared swaps came into force on March 1, 2017. Exchange Act Reporting Obligations.  A private fund adviser that invests in “NMS securities” (i.e., exchange-listed securities and standardized options) is reminded that such holdings may trigger various reporting obligations under the Securities Exchange Act of 1934 (the “Exchange Act“). For example: Schedules 13D & 13G.  An investment adviser that exercises investment or voting power over more than 5% of any class of a public company’s outstanding equity securities must file a holdings report on Schedule 13G if it qualifies as a passive institutional investor.[14]  Schedule 13G filings must be made within 45 days of the end of the calendar year and within 10 days after the end of any calendar month in which the adviser’s holdings in the applicable equity security exceeds 10%.  A Schedule 13G filer is also required to file an amended report on Schedule 13G within 10 days after the end of any calendar month in which its holdings in an NMS security exceeded 10% and within 10 days after the end of any calendar month after that in which such holdings changes by more than 5%.  An investment adviser that does not qualify as a passive institutional investor must file a report on Schedule 13D within 10 days of acquiring more than 5% of any class of an issuer’s outstanding equity securities and “promptly” (typically within 24 hours) after any material change in the information provided in the Schedule 13D (including any change in such adviser’s holdings of more than 1% or a change in the adviser’s investment intent with respect to such holdings). Form 13F.  An institutional investment adviser who exercises investment discretion over accounts holding publicly-traded equity securities[15] having an aggregate fair market value in excess of $100 million on the last trading day of any month in a calendar year must report such holdings to the SEC on Form 13F within 45 days after the end of such calendar year and within 45 days after the end of each of the first three calendar quarters of the subsequent calendar year. Form 13H.  A private fund adviser whose trading activity in NMS securities exceeds certain “large trader” thresholds[16] is required to file a report on Form 13H “promptly” (within 10 days) after exceeding the threshold.  In addition, such filings must be amended within 45 days after the end of each calendar year and promptly after the end of each calendar quarter if any of the information in the Form 13H becomes inaccurate. Section 16.  A private fund adviser that holds a greater than 10% voting position in a public company or whose personnel sit on the board of directors of a public company may also have reporting obligations under Section 16 of the Exchange Act and be subject to that Section’s restrictions on “short swing profits.” Regulation D and Blue Sky Renewal Filings.  A private fund that engages in a private offering lasting more than one year may be subject to annual renewal filing requirements under Regulation D and/or State blue sky laws. State Pay-to-Play and Lobbyist Registration Laws.  A private fund adviser that is soliciting state or local government entities for business may be subject to registration and reporting obligations under applicable lobbyist registration or similar state or municipal statutes in the jurisdictions where the adviser is engaged in such activities. Cross-Border Transaction Reporting Requirements.   A private fund adviser that engages in cross-border transactions or which has non-US investors in its funds may be subject to various reporting requirements under the Department of Treasury’s International Capital System (“TIC“) or the Bureau of Economic Analysis’ (“BEA“) direct investment survey program.  In general, investments that take the form of investments in portfolio securities are subject to TIC reporting requirements, while investments that take the form of direct investments in operating companies are subject to the BEA’s reporting requirements. A direct investment is generally defined by the BEA as an investment that involves a greater than 10% voting interest in an operating company.  For purposes of applying this definition, general partners are the only entities considered to have a voting interest in a limited partnership.  Limited partner interests are not considered voting securities.  The BEA’s reporting requirements apply to any direct investment that exceeds $3 million in size (whether by a US investor overseas or by a non-US investor in the US), even if the BEA has not provided notice to the applicable investor that a reporting obligation applies.  Which BEA Form applies, and the extent of the reporting person’s reporting requirements, depends on the size and nature of the direct investment.  This year, the BEA will conduct a 5-year “benchmarking survey” of all foreign direct investment into the United States.  As of the date of this Client Alert, the BEA had not yet published the version of Form BE-12 that it will use to conduct the survey, but a private fund adviser that is either domiciled outside the U.S. or that makes direct investments into the U.S. through offshore funds should keep track of developments in this area. In general, any cross-border investment (whether by an investor in a fund or by a fund in a portfolio security) that does not meet the BEA’s definition of a direct investment is reportable under TIC.  Again, the form to be used and the frequency and scope of the reporting obligation depends on the size and nature of the investment.  In general, however, unless an investor receives written notice from the Federal Reserve Bank of New York to the contrary, an investor is only required to participate in the TIC’s “benchmark surveys”, which are conducted once every five years.[17]  In addition, the reporting requirement generally falls on the first (or last) US financial institution in the chain of ownership at the US border, which means that in many cases for private fund advisers, the actual reporting obligations applies to the fund’s custodian bank or prime broker, and not to the private fund adviser itself. European Regulatory Reporting Requirements.  Private fund advisers that are either registered as alternative investment fund managers (“AIFMs“) or authorized to manage or market alternative investment funds (“AIFs“) in the European Economic Area (“EEA“) are required to regularly report information (referred to as transparency information) to the relevant regulator in each EEA jurisdiction in which they are so registered or authorized (“Annex IV Reports“).  The process of registering to market an AIF is not consistent across jurisdictions.  Registration of some type (which can range from mere notice to a formal filing-review-approval process lasting many months) is generally necessary before any marketing of the AIF may take place. Once registered, the AIFM must begin making Annex IV Reports in each relevant jurisdiction.  The transparency information required by the Annex IV Reports concerns the AIFM and the AIFs it is managing or marketing in the EEA.  The AIFM must provide extensive details about the principal markets and instruments in which it trades on behalf of the AIFs it manages or markets in the EEA, as well as a thoughtful discussion of various risk profiles.  Preparing Annex IV Reports, therefore, can be a challenging exercise.  Further, while Annex IV Reports are conceptually analogous across jurisdictions, the precise reporting requirements imposed by each regulator differ. The reporting frequency will depend on the type and amount of assets under management of the AIFM, as well as the extent of leverage involved, but will be yearly, half-yearly, or quarterly. The reports must be filed within one month of the end of the annual (December 31st), half yearly (June 30th and December 31st) or quarterly (March 31st, June 30th, September 30th and December 31st) reporting periods, as applicable.  Furthermore, AIFMD requires the AIF to prepare annual reports for its European investors, covering a range of specified information. We generally recommend that firms assess reporting requirements on an on-going basis in accordance with any changes to assets under management, and in consultation with reliable local counsel. As well as requiring the submission of Annex IV reports, AIFMD also imposes other requirements on AIFMs for information to be given to investors and regulators on an on-going basis (including in relation to the acquisition of control of EU companies by the AIF).  Consequently, we have seen an increase in the number of firms choosing to adopt a “rent-an-AIFM” approach, effectively outsourcing the compliance function to a local service vendor.  This removes the need to continually monitor shifts in local regulations, but not the need to do the internal collection and analysis of investment data required to complete the filings. EU General Data Protection Regulation.  The European Union General Data Protection Regulation (“GDPR”) is a replacement for the current Data Protection Directive in the EU.  Notably, the scope of the GDPR has been broadened and now extends to data controllers and processors outside the EU whose processing activities relate to the offering of goods or services (even if for free) to, or monitoring the behavior of, data subjects within the EU.  Non-EU funds that are subject to the GDPR may be required to appoint an EU-based representative in connection with their GDPR obligations. The GDPR makes existing data protection obligations more onerous, and introduces a raft of new obligations. For example, the GDPR expands the information that must be provided to data subjects about how their data is processed, and introduces more stringent consent requirements.  In addition, the GDPR places onerous accountability obligations on data controllers and data processors to demonstrate compliance with the GDPR.  This includes requiring them to appoint data protection officers in certain instances and: (i) maintain and develop records of processing activities, (ii) conduct a data protection impact assessment (this applies only to data controllers), prior to data processing that is inherently “high risk” (e.g. a systematic monitoring of a publicly accessible area on a large scale), and (iii) implement data protection, including by not repurposing data (subject to limited exceptions, including consent) and through data minimization (which refers to the principle that personal data must be adequate, relevant and limited to what is necessary in relation to the purposes for which it is processed). Breaching the GDPR carries serious reputational and financial risk. A range of sanctions may be imposed for non-compliance, including fines of up to the greater of EUR 20,000,000 or 4% of total worldwide annual revenue for the preceding financial year, whichever is higher.[18] The Markets in Financial Instruments Directive II (“MiFID II”).  MiFID II came into force on January 3, 2018.  The impact of MiFID II on a firm will depend upon the relevant firm’s regulatory classification.  The MiFID II framework will continue to apply directly to EU discretionary portfolio managers conducting MiFID activities (“MiFID AIFMs“), but has now been extended to apply directly to management companies of undertakings for the collective investment in transferable securities (“UCITS“) and EU AIFMs which manage separate discretionary accounts.  MiFID II also harmonizes the EU’s regulatory approach to non-EU investment firms by introducing a passport regime for the provision of services to eligible counterparties and professional clients in the EU.  In order for a country to be eligible for a third country passport, the EU Commission will have to assess whether the relevant firm is subject to equivalent supervision in its home jurisdiction.  A MiFID third country passport may offer UK firms currently passporting their services to other EU countries under MiFID access to EU markets post-Brexit. MiFID AIFMs have needed to update their systems, controls, policies and procedures to address the following regulatory changes introduced by MiFID II: Best execution:  MiFID II has raised the best execution standard from an obligation to take “all reasonable steps” to an obligation to take “all sufficient steps consistently”, to achieve the best possible result for the customer. In addition, firms are now subject to more onerous disclosure obligations regarding best execution (including a requirement to publish annually information relating to the firm’s top five execution venues (including brokers, regulated markets, multi-lateral trading facilities and organized trading facilities) by volume, and on the execution quality provided by each (by reference to each different class of instrument). Client Categorization:  As a result of mis-selling concerns connected to the sale of complex products to local government authorities, under MiFID II firms are no longer permitted to treat such investors as eligible counterparties or as per se professional clients.  Under MiFID II, local authorities are now automatically deemed to be retail clients, with the ability to request an “opt-up” process in order to become elective professional clients.  If local authorities are unable to satisfy the opt-up criteria, firms will need to assess whether their existing permissions allow them to continue providing services to such entities or if additional retail permissions are necessary. Inducements and Investment Research:  MiFID II imposes additional restrictions affecting how discretionary investment managers may pay for research. Under MiFID II, firms carrying out MiFID business comprising portfolio management are restricted from how they may accept fees, commissions, or any monetary or non-monetary benefits paid or provided by a third party (e.g. research from an investment bank) in relation to the provision of services to clients.  Such firms may, nonetheless, continue to receive third party research without contravening the inducements rules, provided that they pay for research either directly from their own resources or from a separate research payment account controlled by the firm but charged to its clients (the latter will need to satisfy a number of requirements, including as to transparency). Product Governance:  A new regime has been introduced which imposes requirements on firms that manufacture and distribute financial instruments to act in the clients’ best interests during the lifecycle of the relevant products (for PE firms, the product is the fund itself).  The granular rules include requirements to ensure the clear identification of a target market, the review of existing products and their suitability for the target market, and review the risks for new products. Scope of Transaction Reporting Rules:  Prior to MiFID II, MiFID’s reporting rules applied to financial instruments admitted to trading on EU regulated markets and assets that derive their value from such investments (e.g. OTC derivatives). MiFID II extends the scope of the transaction reporting requirements to all financial instruments traded, or admitted to trading, on EU trading venues (this will expand the reporting regime to cover instruments traded on, inter alia, multi-lateral trading facilities and organized trading facilities). This is aimed at providing greater  transparency and ensuring that the MiFID II reporting requirements mirror the scope of the Market Abuse Directive. Telephone Recording:  Prior to MiFID II, the majority of private equity firms were exempt from the requirements to record calls and other electronic communications, under an exemption for discretionary managers. However, this exemption has now been removed and recording requirements under MiFID II apply to all communications that relate to activities such as arranging deals in investments, dealing in investments as agents, managing investments and in certain circumstances, managing AIFs.  The requirements cover communications that were intended to result in a transaction, even if the communication does not, in fact, result in a transaction.  Telephone recording is required to be carried out on a best endeavors basis and the recordings must be retained for 5 years.  UK Exemptions for Non-MiFID AIFMs.  In the UK the Financial Conduct Authority (“FCA”) has granted a number of exemptions from the above requirements to AIFMs that are not MiFID AIFMs.  For example: the scope of the Telephone Recording obligations is limited to activities which involve financial instruments being traded on a trading venue or for which a request for admission has been made; the Inducements and Investment Research obligations do not apply to an AIF or collective investment scheme, which generally invests in issuers or non-listed companies in order to acquire control over such companies; and the Best Execution obligations do not apply, but AIFMs that are not MiFID AIFMs will nonetheless still need to comply with the best execution rules under the AIFMD Level 2 Regulations. However, it is also worth noting that these exemptions will not be available if and when an AIFM is carrying on MiFID business. In practice, our experience has been that firms managing collective funds and segregated accounts have chosen to apply common standards across their MiFID and non-MiFID business activities. Tax.  Depending on the structure and nature of a private fund adviser’s investment activities and/or client base, certain tax filings or tax compliance procedures may need to be undertaken.  Examples include: Investments by U.S. persons in non-U.S. entities may need to be disclosed on IRS Form 5471 (ownership in non-U.S. corporation), IRS Form 8865 (ownership in non-U.S. partnership) and IRS Form 8858 (ownership in non-U.S. disregarded entity), which forms are required to be filed together with such U.S. persons’ annual U.S. federal income tax returns. Investments by non-U.S. persons in U.S. entities may need to be disclosed on IRS Form 5472 (25% ownership in a U.S. corporation).  For tax years beginning on or after January 1, 2017, a U.S. disregarded entity that is wholly owned by a non-U.S. person is treated as a U.S. corporation for purposes of determining any reporting obligations on IRS Form 5472. Transfer of property by a U.S. person to a foreign corporation may require the U.S. person to file an IRS Form 926. Ownership of interests in or signature authority over non-U.S. bank accounts and similar investments, may need to be disclosed under foreign bank and financial accounts reporting regime (FBAR) on Form FinCEN 114, the due date of which has been moved to April 15th for initial filings, with an automatic extension available to October 15th. Managers may need to report the existence of certain accounts to the U.S. IRS or their local jurisdiction under FATCA or the OECD Standard for Automatic Exchange of Financial Account Information – Common Reporting Standard. Managers should be aware that IRS Forms W-8 provided by non-U.S. investors generally expire after three years from the execution date of the form and they may need to collect updated IRS Forms W-8 from their non-U.S. investors. Clients are urged to speak to their Gibson Dunn contacts if they have any questions or concerns regarding these or any other regulatory requirements.   [1]   See Significant Amendments to Form ADV go into Effect on October 1, 2017, Gibson Dunn Client Alert (Sept. 25, 2017) https://www.gibsondunn.com/significant-amendments-to-form-adv-go-into-effect-on-october-1-2017/.  The most significant changes to Form ADV include the formalization of the SEC’s practice of permitting so-called umbrella registration of multiple private fund advisers operating as a single firm and the expansion of reporting requirements for advisers of separately managed accounts.   [2]   An RIA is required to prepare a supplemental brochure for each supervised person that (i) formulates investment advice for and has direct contact with a client, or (ii) has discretionary investment power over client assets (even if such person does not have direct client contact).  As a practical matter, most private fund advisers prepare supplemental brochures for each member of their investment committees and/or each of their portfolio managers.   [3]   As a technical matter, investors in a private fund are not considered “clients” of the fund’s investment adviser.  As a matter of best practice, however, most private fund advisers make updated copies of their disclosure brochures available to the investors in their funds.   [4]   Such letters must also provide a website address (if available), e-mail address (if available) and telephone number by which a client may obtain a copy of the RIA’s current disclosure brochure, as well as the website address through which a client may obtain information about the adviser through the SEC’s Investment Adviser Public Disclosure (IAPD) system.   [5]   In particular, a hedge fund adviser with more than $1.5 billion in regulatory assets under management attributable to its hedge funds is required to report on Form PF on a quarterly basis within 60 days of the end of each calendar quarter and to complete an additional section of the Form (Section 2).  A private liquidity fund adviser with more than $1.0 billion in combined regulatory assets under management attributable to both registered money market funds and private liquidity funds is required to report on Form PF on a quarterly basis within 15 days of the end of each calendar quarter and to complete an additional section of the Form (Section 3).  A private equity fund adviser with more than $2.0 billion in regulatory assets under management attributable to its private equity funds is only required to file on an annual basis within 120 days of the end of its fiscal year, but is required to complete an additional section of the Form (Section 4).   [6]   See TPG Capital Advisers, Advisers Act Release No. 4830 (Dec. 21, 2017); and Platinum Equity Advisers, Advisers Act Release No. 4772 (Sept. 17, 2017).  See also Apollo Management V, L.P., et. al.¸ Advisers Act Release No. 4493 (Aug. 23, 2016); Blackstreet Capital Management, LLC, et. al., Exchange Act Release No. 77957, Advisers Act Release No. 4411 (Jun. 1, 2016); Equinox Fund Management, LLC, Securities Act Release No. 10004, Exchange Act Release No. 76927, Advisers Act Release No. 4315 (Jan. 19, 2016); Cherokee Investment Partners, LLC, et. al., Advisers Act Release No. 4258 (Nov. 5, 2015); Fenway Partners, LLC, et. al., Advisers Act Release No. 4253 (Nov. 3, 2015); Blackstone Management Partners L.L.C., et. al., Advisers Act Release No. 4219 (Oct. 7, 2015); Kohlberg, Kravis Roberts & Co., Advisers Act Release No. 4131 (Jun. 29, 2015); and Alpha Titans, LLC, et al., Exchange Act Release No 74828, Advisers Act Release No. 4073, Investment Company Act Release No. 31586 (Apr. 29, 2015).   [7]   See OCIE Cybersecurity Initiative, National Exam Program Risk Alert, Vol. IV, Issue 2 (Apr. 15, 2014); Cybersecurity Examination Sweep Summary, National Exam Program Risk Alert, Vol. IV, Issue 4 (Feb. 3, 2015); OCIE’s 2015 Cybersecurity Examination Initiative, National Examination Program Risk Alert, Vol. IV, Issue 8 (Sept. 15, 2015); Cybersecurity: Ransomware Alert, National Exam Program Risk Alert, Vol. VI, Issue 4 (May 17, 2017); and Observations from Cybersecurity Examinations, National Exam Program Risk Alert, Vol. VI, Issue 5 (Aug. 7, 2017).  See also, Examination Priorities for 2015, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 13, 2015); Examination Priorities for 2016, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 11, 2016); Examination Priorities for 2017, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 12, 2017); and 2018 National Exam Program Examination Priorities, National Exam Program, Office of Compliance Inspections and Examinations (Feb. 7, 2018).   [8]   Investment Adviser Association, SEC No-Action Letter (pub. avail. Feb. 21, 2017).   [9]   Inadvertent Custody: Advisory Contract Versus Custodial Contract Authority, IM Guidance Update No. 2017-01 (February 2017). [10]   The Five Most Frequent Compliance Topics Identified in OCIE Examinations of Investment Advisers, National Exam Program Risk Alert, Vol. VI Issue 3 (Feb. 7, 2017). [11]   The Most Frequent Advertising Rule Compliance Issues Identified in OCIE Examinations of Investment Advisers, National Exam Program Risk Alert, Vol. VI Issue 6 (Sept. 14, 2017). [12]   See, e.g., Centre Partners Management, LLC, Advisers Act Release No. 4604 (Jan. 10, 2017) and New Silk Road Advisors, Advisers Act Release No. 4587 (Dec. 14, 2016). [13]   See Footnote 10 above and accompanying text. [14]   To qualify as a passive institutional investor, an investment adviser must be an RIA that purchased the securities in question “in the ordinary course of business and not with the purpose or effect of changing or influencing the control of the issuer nor in connection with or as a participant in any transaction having such purpose or effect.” [15]   The SEC maintains a definitive list of securities subject to Form 13F reporting at http://www.sec.gov/divisions/investment/13flists.htm. [16]   A “Large Trader” is defined as any person that exercised investment discretion over transactions in Regulation NMS securities that equal or exceed (i) two million shares or $20 million during any single trading day, or (ii) 20 million shares or $200 million during any calendar month. [17]   The next 5-year benchmark survey will cover foreign investment in U.S. securities and is scheduled to be conducted in 2019. [18]   For a further discussion of the requirements of the GDPR, see The General Data Protection Regulation: A Primer for U.S.-Based Organizations that Handle EU Personal Data, Gibson Dunn Client Alert (Dec. 4, 2017) https://www.gibsondunn.com/the-general-data-protection-regulation-a-primer-for-u-s-based-organizations-that-handle-eu-personal-data/. Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, or any of the following leaders and members of the firm’s Investment Funds practice group: Chézard F. Ameer – Dubai (+971 (0)4 318 4614, cameer@gibsondunn.com) Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, jbellah@gibsondunn.com) Edward D. Sopher – New York (+1 212-351-3918, esopher@gibsondunn.com) Y. Shukie Grossman – New York (+1 212-351-2369, sgrossman@gibsondunn.com) Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com) Edward D. Nelson – New York (+1 212-351-2666, enelson@gibsondunn.com) Marc J. Fagel – San Francisco (+1 415-393-8332, mfagel@gibsondunn.com) C. William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com) Gregory Merz – Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 1, 2018 |
Public Company Virtual-Only Annual Meetings

Palo Alto partner Lisa Fontenot is the author of “Public Company Virtual-Only Annual Meetings,” [PDF] published in The American Bar Association’s The Business Lawyer Vol.73, Winter 2017-2018.

September 25, 2017 |
Significant Amendments to Form ADV Go into Effect on October 1, 2017

Investment advisers that file Form ADV with the Securities and Exchange Commission ("SEC") either as registered investment advisers ("RIAs") or as exempt reporting advisers ("ERAs")[1] are reminded that significant amendments to Part 1A of Form ADV ("Part 1A") go into effect on October 1, 2017.  For most investment advisers having a fiscal year end of December 31st, the amendments will first impact their annual updating filings that will be due on April 2, 2018. The following Client Alert provides a brief summary of the changes that have been made to Part 1A.  Investment advisers would be well-advised to begin considering how these changes will impact their Form ADV filing requirements for 2018 and how they will capture the additional data they will need to complete amended Part 1A.[2] 1.   Enhanced Reporting Regarding Separately Managed Accounts. One of the most significant changes to Part 1A is the addition of new reporting requirements for RIAs[3] with respect to their separately managed accounts ("SMAs").[4]  Specifically, new Item 5.K has been added to Part 1A that will require an RIA to identify (i) whether it has any regulatory assets under management ("RAUM") attributable to SMAs ("SMA Assets"), (ii) whether it engages in borrowing transactions on behalf of SMAs, (iii) whether it engages in derivatives transactions on behalf of SMAs, and (iv) whether any single custodian holds more than 10% of the RIA’s SMA Assets.  A "yes" answer to any of these questions will trigger a requirement to complete the applicable parts of new Section 5.K of Schedule D to Form ADV. New Section 5.K of Schedule D requires an RIA to report certain data on an aggregated basis with respect to its SMA Assets.[5]  In particular: Section 5.K(1) will require an RIA to report the percentage of SMA Assets it manages in each of twelve separate asset categories.[6]  An RIA with $10 billion or more in SMA Assets must report this data as of the end of its second fiscal quarter and as of the end of its fiscal year.  An RIA will less than $10 billion in SMA Assets is only required to report this data as of the end of its fiscal year. Section 5.K(2) will require an RIA with $10 billion or more in SMA Assets that engages in borrowing or derivatives transactions on behalf of its SMAs to report the amount of SMA Assets it manages in three ranges of "gross notional exposure:" (i) less than 10%, (ii) between 10% and 149%, and (iii) 150% or more.  For each range, the RIA is further required to report the aggregate dollar amount of all borrowings on behalf of the SMAs in such range, and the gross notional value of all derivatives held in such accounts, broken down into six categories of derivative instruments.[7]  This information must be presented on a semi-annual basis as of the end of the RIA’s second fiscal quarter and as of the end of its fiscal year.  For purposes of calculating this data, an RIA may (but is not required to) exclude SMAs with less than $10 million in RAUM.  An RIA with between $500 million and $10 billion in SMA Assets will be required to report the amount of SMA Assets it manages in each of the three ranges of gross notional exposure as of the end of its fiscal year only. Such RIAs will also be required to report the aggregate dollar amount of borrowings on behalf of its SMAs within each range of gross notional exposure, but will not be required to provide a breakdown of the derivative instruments held in such accounts.  An RIA with less than $500 million in SMA Assets will not be subject to this reporting requirement. Finally, Section 5.K(3) will require an RIA to identify each custodian that holds more than 10% of the RIA’s SMA Assets. 2.   Enhanced Reporting of Certain Information Regarding the Investment Adviser and its Business. A number of amendments have been made to Part 1A that will increase the level of detail an investment adviser is required to provide relating to itself and the nature of its business.  In particular: Item 1 of Part 1A has been amended to require an investment adviser to identify any publicly available social media sites whose content is controlled by the adviser.  In addition, the adviser will be required to report the total number of branch offices it has and identify each of its 25 largest branch offices by number of employees, including (i) the number of employees in such branch office engaged in performing investment advisory functions, (ii) any other business activities conducted by the investment adviser at the branch office, and (iii) a brief description of the investment-related activities conducted from the branch office.[8]  Further, an adviser who outsources its chief compliance officer ("CCO") function to a third party will be required to provide the name and IRS employer identification number of the CCO’s employer.  Finally, a large investment adviser with $1 billion or more in assets on its own balance sheet will be required to identify whether such assets fall within one of three ranges.[9] Item 5 of Part 1A has been amended to significantly change the manner in which RIAs report information relating to their client base.[10]  Specifically, an RIA will be required to complete a new table identifying the number of clients it has in each of thirteen enumerated classes of clients[11] and the amount of the RIA’s RAUM attributable to each class of clients.  RIA’s will also be required to identify approximately how many clients it has that do not have RAUM attributable to them (i.e., client accounts for which the RIA does not provide "continuous and regular supervisory or management services"),[12] the approximate percentage of its clients that are non-U.S. persons and the amount of its RAUM that is attributable to such non-U.S. person clients.  An RIA that manages registered investment companies or who participates in wrap fee programs will also be subject to additional reporting requirements with respect to those activities. Finally, Section 7.B(1) of Schedule D to Part 1A, under which an investment adviser is required to provide detailed information with respect to the private funds it manages, has been revised to require an investment adviser to provide the PCAOB number, if any, of the auditor of each of its private funds, and to report whether the investors in any 3(c)(1) funds it manages are required to be "qualified clients." 3.   Relying Advisers. The amendments to Part 1A also codify certain no-action relief granted by the SEC in 2012[13] permitting certain registered private fund advisers ("Filing Advisers") to register multiple entities ("Relying Advisers") under the Advisers Act using a single Form ADV filing ("Umbrella Registration").  For the most part, these amendments to Part 1A follow the already existing no-action letter precedent and do not impose significant additional reporting or other compliance burdens on a Filing Adviser that is already using Umbrella Registration.  However, as discussed below, in adopting the amendments the SEC has clarified certain interpretations of its requirements pertaining to Umbrella Registration that may result in some unexpected results for private fund advisers.  The conditions for qualifying to register Relying Advisers pursuant to an Umbrella Registration under amended Part 1A have not changed in substance.  A Filing Adviser and its Relying Advisers must operate as a single private fund investment advisory business where: (i) the firm’s only clients are private funds or SMAs for qualified clients that invest in parallel with such private funds, (ii) the principal place of business for the firm is located in the U.S., (iii) all personnel are subject to the Filing Adviser’s supervision and control, (iv) the investment activities of each Relying Adviser are subject to the Advisers Act and SEC examination, and (v) the Filing Adviser and all Relying Advisers are subject to a single compliance program and code of ethics administered by a single CCO. A Filing Adviser relying on Umbrella Registration will now be required to complete a new Schedule R to Form ADV for each Relying Adviser covered by the Umbrella Registration.  For the most part, the information that is required to be reported in Schedule R is as one would expect.  It should be noted, however, that new Schedule R will require a Filing Adviser to separately identify the basis upon which each Relying Adviser independently qualifies to register under the Advisers Act.[14]  In addition, a Filing Adviser will be required to separately report the complete ownership structure for each Relying Adviser in such Relying Adviser’s Schedule R to the same degree of detail as is required for the Filing Adviser in Schedules A and B of Form ADV.  Despite numerous requests in comment letters to do so, the SEC declined to expand the availability of Umbrella Registration beyond U.S. based RIAs whose business is limited exclusively to managing private funds.  In particular, Umbrella Registration is still not available to non-U.S. based advisers or to ERAs.  The SEC did state in the Adopting Release, however, that certain no-action relief permitting ERAs to rely on a somewhat different form of Umbrella Registration will still be available.[15] 4.   Other Changes. In addition to the changes summarized above, the SEC adopted two amendments to Rule 204-2 under the Advisers Act (the "Books and Records Rule") that expand an RIA’s record-keeping obligations with respect to written communications containing performance data.[16]  In particular: First, the SEC amended Rule 204-2(a)(16) such that RIAs will be required to maintain records to support performance claims in communications sent to any person.  Under the current rule, RIAs are only required to maintain such records for performance claims in communications sent to ten or more persons. In addition, the SEC added a new requirement to Rule 204-2(a)(7) that will require RIAs to maintain records of all written communications sent or received by the RIA relating to the performance or rate of return of any or all managed accounts or securities recommendations. Both of these amendments go into effect on October 1, 2017. Clients are urged to speak to their Gibson Dunn contacts if they have any questions or concerns regarding these or any other regulatory requirements.   [1]   RIAs and ERAs are referred to collectively herein as investment advisers.   [2]   Complete copies of the revised instructions to Form ADV and amended Part 1A can be found on the SEC’s website using the following links: General Instructions:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-a.pdf Instructions for Part 1A:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-b.pdf Glossary of Terms:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-c.pdf Part 1A:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-d.pdf In addition, a copy of amended Part 1A, marked to show changes against the current version, can also be found on the SEC’s website at https://www.sec.gov/rules/final/2016/ia-4509-form-adv-summary-of-changes.pdf.   [3]   ERAs will not be subject to these new reporting requirements.   [4]   An SMA is defined for this purpose as any client account other than a registered investment company, business development company or other pooled investment vehicle (including private funds).    [5]   The reporting requirements are somewhat akin to reporting obligations under Form PF that apply to an RIA with respect to any private funds it manages.  Unlike the data provided under Form PF, however, the data provided in response to Schedule D, Section 5.K, will be publicly available on the SEC’s website.   [6]   The asset categories are (i) exchange-traded equity securities, (ii) non exchange-traded equity securities, (iii) U.S. government/agency bonds, (iv) U.S. state and local government bonds, (v) sovereign bonds, (vi) investment grade corporate bonds, (vii) non-investment grade corporate bonds, (viii) derivatives, (ix) securities issued by registered investment companies or business development companies, (x) securities issued by other pooled investment vehicles, (xi) cash and cash equivalents, and (xii) other.   [7]   The six categories of derivative instruments are (i) interest rate derivatives, (ii) foreign derivatives, (iii) credit derivatives, (iv) equity derivatives, (v) commodities derivatives and (vi) other derivatives.   [8]   Unlike most of the information provided in Item 1 (which must be promptly updated on an other-than-annual basis if the information provided becomes inaccurate in any respect), the information with respect to an investment adviser’s branch offices will only need to be updated once a year as part of the investment adviser’s annual updating amendment to its Form ADV.   [9]   The ranges are (i) from $1 billion to $10 billion, (ii) from $10 billion to $50 billion, and (iii) more than $50 billion. [10]   ERAs, which are not required to complete Item 5 of Part 1A, will not be subject to these requirements. [11]   The enumerated classes of clients are (i) individuals (other than high net worth individuals), (ii) high net worth individuals, (iii) banking or thrift institutions, (iv) business development companies, (v) registered investment companies, (vi) other pooled investment vehicles, (vii) pension and profit sharing plans (other than government pension plans), (viii) state and municipal government entities (including government pension plans), (ix) other investment advisers, (x) insurance companies, (xi) sovereign wealth funds and foreign government institutions, (xii) corporations and other businesses, and (xiii) other clients.  [12]   In the Adopting Release, the SEC cites nondiscretionary accounts or one-time financial plans as examples of situations where, depending on the facts and circumstances, an adviser may provide investment advice but does not have RAUM.  See SEC Adopting Release, Form ADV and Investment Advisers Act Rule, Release No. IA-4509, File No. S7-09-15 (Aug. 25. 2016), https://www.sec.gov/rules/final/2016/ia-4509.pdf, at footnote 144.  [13]   See SEC No-Action Letter, Investment Advisers Act of 1940 – Sections 203(a) and 208(d) American Bar Association, Business Law Section (Pub. avail. Jan. 18, 2012), https://www.sec.gov/divisions/investment/noaction/2012/aba011812.htm. [14]   This will not be a problem for any Relying Adviser that has the same principal place of business with the Filing Adviser.  However, Relying Advisers whose principal place of business is not the same as the Filing Adviser will need to identify a separate grounds for claiming SEC jurisdiction under the Advisers Act, such as by having $100 million or more in RAUM or by having its principal place of business located outside of the U.S. [15]   See SEC Staff Interpretive Guidance, Frequently Asked Questions on Form ADV and IARD (June 12, 2017), https://www.sec.gov/divisions/investment/iard/iardfaq.shtml at "Reporting to the SEC as anExempt Reporting Adviser." [16]   ERAs are not subject to these record-keeping requirements. Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, or any of the following leaders and members of the firm’s Investment Funds practice group: Chézard F. Ameer – Dubai (+971 (0)4 318 4614, cameer@gibsondunn.com)Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, jbellah@gibsondunn.com)Edward D. Sopher – New York (+1 212-351-3918, esopher@gibsondunn.com)Y. Shukie Grossman – New York (+1 212-351-2369, sgrossman@gibsondunn.com)Mark K. Schonfeld (+1 212-351-2433, mschonfeld@gibsondunn.com)Edward D. Nelson – New York (+1 212-351-2666, enelson@gibsondunn.com)Marc J. Fagel (+1 415-393-8332, mfagel@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com)Gregory Merz – Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 8, 2017 |
UK Private Fund Limited Partnerships

On 6 April 2017, the Legislative Reform (Private Fund Limited partnerships) Order 2017 ("LRO") came into force. The LRO amends the Limited Partnerships Act 1907 ("LPA") and introduces a new form of limited partnership, the ‘private fund limited partnership’ ("PFLP") for use as a fund vehicle. UK limited partnerships are often used as investment vehicles across a range of asset classes, including private equity and real estate, due to their organisational flexibility, tax transparency and limited liability for investors. UK limited partnerships have not been as popular in recent years as certain, more flexible, forms of limited partnerships are available in other jurisdictions. The intention of the LRO is to enhance the competitiveness of UK limited partnerships compared to limited partnerships in other jurisdictions by reducing the administrative burdens and complexities of limited partnerships and codifying activities that may be taken by limited partners without jeopardising their limited liability status. Establishing a PFLP Designation as a PFLP is voluntary and open to existing and new limited partnerships. A limited partnership can elect to become a PFLP by making a filing with Companies House subject to the following conditions: (i) the PFLP is constituted by an agreement in writing; and (ii) the PFLP is a ‘collective investment scheme’ as defined in section 235 of the Financial Services and Markets Act 2000 (ignoring the exemptions from such classification for these purposes). While we would expect that most limited partnerships would be able to meet these two conditions, certain limited partnerships may fall outside of the definition of ‘collective investment scheme’ if the limited partners have significant involvement in the day-to-day operations. As was the case under the LPA prior to amendment, a PFLP must include ‘limited partnership’ or ‘LP’ after its name, but its status as a PFLP need not be disclosed in its name. It will not therefore be immediately obvious whether a partnership is a PFLP unless the Companies House filings are inspected. Once designated as a PFLP, the limited partnership will not be able to reverse the election. Both an existing limited partnership and a new limited partnership can be designated as a PFLP. It may be necessary for an existing limited partnership to amend its limited partnership agreements in order to become designated as a PFLP. To be designated as a PFLP, the general partner of a limited partnership must file either form LP7 with Companies House at the time of the initial registration of the limited partnership or form LP8 if designation as a PFLP is sought after the initial registration of the limited partnership. Key changes White list:  Limited partnerships have traditionally been a popular investment structure as they offer flexibility, tax transparency and, provided limited partners do not take part in management, limited liability to the limited partners. One problematic area under the previous law was uncertainty as to the scope of activities a limited partner could be involved in without being considered to have taken part in management of the limited partnership, with the consequent loss of limited liability status. While the fundamental position remains the same (if a limited partner engages in management it loses its limited liability), the LRO introduces a ‘white list’ of permitted activities that limited partners can undertake without the risk of being found to have taken part in management (the inclusion of this white list brings the LPA into line with equivalent limited partnership regimes in other jurisdictions, such as Jersey, Guernsey and Luxembourg). The full ‘white list’ can be found here and includes: taking part in a decision about the variation of the limited partnership agreement, the nature of the limited partnership or a disposal or dissolution of the limited partnership; consulting or advising the general partner or manager about the limited partnership’s affairs or accounts; providing surety or acting as guarantor for the limited partnership; taking part in decisions authorising the general partner to incur, extend, vary or discharge debt of the limited partnership; approving the accounts of the limited partnership or valuations of its assets; taking part in decisions regarding changes to persons in charge of the day-to-day management of the limited partnership; taking part in a decision regarding the disposal of the limited partnership, or the acquisition of another business by the limited partnership; acting, or authorising a person to act, as a director, member, employee, officer or agent of, or a shareholder or partner in, a general partner of, or a manager or adviser to, the limited partnership (provided that this does not extend to taking part in management of the partnership’s business); and appointing or nominating a representative to a committee, for example to an advisory committee. The ‘white list’ is a non-exhaustive list of activities and, therefore, it remains the case that if a limited partner undertakes an activity which is not on the list, a determination of whether a limited partner has taken part in the management of the company (and thus liable for all debts and obligations of the limited partnership as if it were a general partner) will continue to be subject to case law. Capital contributions:  Limited partners are generally required to make capital contributions to a limited partnership upon admission and, if such capital contributions are returned during the term of the limited partnership they are then liable for the debts and obligations of the limited partnership up to the amount returned. In the fund context, this restriction was typically addressed by allocating limited partners’ commitments into loan and capital contribution elements, allowing for earlier repayment of loan commitments without any adverse consequences to the limited partners. Limited partners in PFLPs are not required to contribute capital on admission to the limited partnership and may withdraw any capital contributions made to a PFLP without incurring liability for the amount withdrawn. However, the ability to withdraw capital contributions without liability does not apply (i) to capital contributions made before 6 April 2017, or (ii) where a capital contribution was made before the limited partnership became a PFLP. Winding up:  The LRO removes the requirement for the limited partners of a PFLP to obtain a court order to wind up the limited partnership in circumstances where the general partner has been removed. In such circumstances, the limited partners can instead appoint a third party to wind up the limited partnership. The LRO provides limited partners with further comfort in the ‘white list’ of activities that the appointment of a third party to wind up the limited partnership will not constitute ‘taking part in the management’ of the limited partnership. Gazette notices:  The LRO removes certain administrative burdens on PFLPs, including the requirement for a Gazette notice to be published upon the assignment by a limited partner of its interest in a PLFP to give the assignment legal effect, for the purposes of the LPA. Fewer Companies House filings:  A PFLP will not be required to notify Companies House of changes to (i) the nature of the limited partnership’s business, (ii) the character of the limited partnership or (iii) the amount of capital contributions made to the limited partnership. *          *          * These changes should make UK limited partnerships more attractive as investment vehicles by streamlining administration and bringing the law surrounding unlimited liability of limited partners into line with equivalent limited partnership regimes in, for example, Jersey, Guernsey, the Cayman Islands and Luxembourg, which have in recent years introduced reforms to make structuring and operating private funds more efficient. We expect that a significant number of fund sponsors that use UK limited partnerships will choose to register new limited partnerships as PFLPs and fund sponsors that have looked elsewhere for the formation of limited partnerships may now consider UK limited partnerships as a viable alternative. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work or the authors: Wayne McArdle – Partner, London (+44 (0)20 7071 4237, WMcArdle@gibsondunn.com) Chézard F. Ameer – Partner, Dubai (+971 (0)4 318 4614, CAmeer@gibsondunn.com) Josh Tod – Of Counsel, London (+44 (0)20 7071 4157, JTod@gibsondunn.com) Edward A. Tran – Of Counsel, London (+44 (0)20 7071 4228, ETran@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 1, 2017 |
India – Legal and Regulatory Update (May 2017)

The Indian Market The Indian market continues to attract foreign investment as the Government of India (‘Government‘) accelerates the implementation of second generation market reforms. The Indian Parliament recently enacted the legislative framework to implement a uniform goods and services tax (‘GST‘) throughout the country. Once implemented, GST will substantially improve the trade of goods and services within India. This update provides a brief overview of certain key legal and regulatory developments in India between January 1, 2017 and April 28, 2017. Key Legal And Regulatory Developments Mergers & Acquisitions  Merger Control Exemptions Expanded: In 2011, the Government had introduced a de minimis target based exemption (i.e., based on the valuation of assets or turnover of the target company) (‘Exemption‘) which excluded certain transactions from the notification and approval requirements applicable to combinations under the [Indian] Competition Act, 2002 (‘Competition Act‘). Transactions that fell below the threshold did not have to be notified to the Competition Commission of India (‘CCI‘). The Exemption was applicable for a period of five years. According to the annual report published by CCI for 2015-2016, 113 notifications of combinations that were not eligible for the Exemption were filed with the CCI. The majority of such notifications were approved within a period of thirty days.[1] On March 4, 2016, the Government by a notification (‘2016 Notification‘) extended the period of Exemption for a further period of five years and increased the value of the assets/turnover thresholds (for details please refer to our client alert dated March 15, 2016). By a further notification dated March 27, 2017 (‘2017 Notification‘)[2], the Government introduced the following changes to the Exemption- (a) Extension of Exemption to All Combinations: Earlier, the CCI had interpreted the Exemption to include only acquisitions. The 2017 Notification extends the Exemption to mergers and amalgamations. (b) Acquisition of a Part of a Business: The 2017 Notification stipulates that when a part of a business is being acquired (for example an asset, slump, or business sale), only the value of the assets or turnover of that part of the business that is being acquired will be considered for the purposes of determining the de minimis thresholds. The value of assets or turnover in relation to the entire enterprise is no longer included for the purposes of determining the de minimis threshold exemption. The 2017 Notification will be applicable prospectively to transactions that are entered into from March 27, 2017. The 2016 Notification will continue to apply to transactions that were entered into prior to March 27, 2017.  Besides obviating the distinction between acquisitions and mergers/amalgamations for the purpose of the Exemption, the 2017 Notification significantly extends the scope of the Exemption. The Exemption, being a definitive test, provides transaction parties with greater certainty.   Cross-Border Mergers Permitted: Previously, under the [Indian] Companies Act, 1956, only inbound mergers were permitted and any capital gains arising from such transactions was exempt from tax. Now, the Government has notified Section 234 of the [Indian] Companies Act, 2013 (‘Companies Act‘) and Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016, (bringing them into effect from April 13, 2017), which enable inbound and outbound mergers between an Indian company and a foreign company. Cross-border mergers will require prior permission of the Reserve Bank of India (‘RBI‘) before an application can be made to the National Company Law Tribunal, in accordance with the procedure for court-approved mergers under the Companies Act. Additionally, transactions in certain sectors such as insurance or pension funds may require prior permission from the appropriate industry regulators. Outbound mergers will be permitted only with foreign companies incorporated in certain permitted jurisdictions, which includes most major jurisdictions.[3] However, amendments to certain other laws will be required to fully operationalise the outbound cross-border merger framework. These include amendments to current Indian exchange control and taxation laws.[4] The use of this structure, in the absence of alignment with laws of other major jurisdictions for transferring liabilities (including tax liabilities and external commercial borrowings subject to RBI regulations), is likely to be limited. Foreign Investment Promotion Board (‘FIPB‘) to be Abolished: The Government, in its annual budgetary statement to Parliament, announced its intention to abolish the FIPB. Under Indian exchange control regulations, there are two routes for foreign strategic investors to invest in an Indian company: (a) Government Route: Where prior approval of the Government is required for foreign investment in certain specific industry sectors or beyond certain prescribed investment thresholds; and (b) Automatic Route: Where foreign investment is freely permitted without the prior approval of the Government. In the case of Government Route sectors, the FIPB was the governmental authority that granted permission for investments up to INR 50 billion or approximately USD 775 million. However, in many Government Route sectors, additional permission from the industry regulator was also required. With this announcement, it appears that only one set of Government approvals (that of the relevant industry regulator) will be required for investment in Government Route sectors. While this change is aimed at further simplifying the approval process for foreign investment, much will depend on the language of the revised foreign direct investment policy, which will be announced later this year. Labour & Employment Laws Maternity Benefit Act Amendment: The Indian Parliament enacted the Maternity Benefit (Amendment) Act, 2017 (‘2017 Amendment‘) that incorporates the following significant changes in the [Indian] Maternity Benefits Act, 1961 (‘Maternity Benefits Act‘): (a) Increase in Maternity Leave: Maternity leave under the Maternity Benefits Act has been increased from twelve to twenty-six weeks. However, a woman with two or more surviving children will only be entitled to twelve weeks of maternity leave. (b) Adopting and Commissioning Mothers: The 2017 Amendment has introduced twelve weeks of maternity leave for a woman who adopts a child below the age of three months and for women who become mothers through surrogacy. This period of maternity leave is calculated from the date when the child is handed over to the mother. (c) Child Care Facilities:  Private employers with fifty or more employees are required to provide access to crèche facilities as prescribed by the Government, each female employee using the facilities has the right to visit it four times in a day. (d) Written Information of Benefits: Employers are mandated to inform their female employees, in writing and electronically, of all the benefits available to them under the Maternity Benefits Act. Consolidation of Statutory Registers: In an attempt to improve compliance with labour and employment laws, the Government has notified the [Indian] Ease of Compliance to Maintain Registers under various Labour Law Rules, 2016. Employers are obliged to maintain various statutory registers for employee matters under nine central (i.e., federal enactments).[5] With the implementation of these Rules the number of statutory registers have reduced from fifty-six to five, which are as follows: (a) Employee Register; (b) Wage Register; (c) Register of Loan and Recoveries; (d) Attendance Register, and (e) Register of Rest/Leave/Leave Wages.    [1]   Annual Report for 2015–-2016 published by the Competition Commission of India (available at http://www.cci.gov.in/sites/default/files/annual%20reports/annual%20report%202015-16.pdf); Notably, the Competition Act stipulates a statutory limit of two hundred and ten days for the disposal of notifications received for combinations.    [2]   Notification S.O. 988(E) dated March 27, 2017 (available at http://www.mca.gov.in/Ministry/pdf/Notification_30032017.pdf)    [3]      Permitted jurisdictions are those: (a) who are signatories to Appendix A of the Multilateral Memorandum of Understanding of the International Organization of Securities Commissions; (b) whose securities market regulator has executed a bilateral Memorandum of Understanding with the Securities and Exchange Board of India; or (c) whose central bank is a member of the Bank of International Settlement.       [4]   On April 26, 2017, the RBI released the draft  Foreign Exchange Management (Cross border Merger) Regulations, 2017 that will govern the exchange control aspects of cross-border mergers.(available at: https://rbidocs.rbi.org.in/rdocs/Content/PDFs/CBMD08484A86A9AE4780A2D825C5D85184B3.PDF)    [5]   Building and Other Construction Workers (Regulation of Employment and Conditions of Service) Act, 1996, Contract Labour (Regulation and Abolition) Act, 1970; Equal Remuneration Act, 1976; Inter-State Migrant Workmen (Regulation of Employment and Conditions of Service) Act, 1979; Mines Act, 1952;, Minimum Wages Act, 1948; Payment of Wages Act, 1936; Sales Promotion Employees (Conditions of Service) Act, 1976; Working Journalists and Other Newspaper Employees (Conditions of Service) and Miscellaneous Provisions Act, 1955. Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details, please contact the Gibson Dunn lawyer with whom you usually work or the following authors in the firm’s Singapore office: India Team:Jai S. Pathak (+65 6507 3683, jpathak@gibsondunn.com)Karthik Ashwin Thiagarajan (+65 6507 3636, kthiagarajan@gibsondunn.com)Sidhant Kumar (+65 6507 3661, skumar@gibsondunn.com)  © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

February 17, 2017 |
Reporting Requirements for Private Fund Advisers Under the Department of Treasury’s Benchmark Survey on Form SHC Due March 3, 2017

A US resident private fund adviser that invests overseas or which sponsors offshore funds may be subject to reporting requirements under the Department of Treasury’s Form SHC.  The deadline for submitting Form SHC is March 3, 2017.  Form SHC is part of the Treasury International Capital (TIC) System, which collects data that the US Federal Government uses to determine the US balance of payment accounts and the US international investment position, and in the formulation of international economic and financial policies.  Information reported on TIC is confidential.  The Federal Reserve Bank of New York ("FRBNY") administers TIC on behalf of the Department of Treasury.  Form SHC is used to conduct a "benchmark survey" of holdings in foreign (i.e. non-US) portfolio securities by US investors once every five years.  Certain financial institutions may be required to report their holdings in foreign portfolio securities more frequently, but only if they receive notice to that effect from the FRBNY.  The following is a high-level summary of the applicable reporting requirements under Form SHC: Form SHC applies to all US resident "custodians" and "end investors" (together "Reporting Persons") that hold investments in foreign portfolio securities.  Based on the instructions in the Form, it appears that most private fund advisers would be considered "end investors" for this purpose. In general, whether a security is a "foreign security" is determined by reference to the jurisdiction in which the issuer has been organized.  Thus, any security issued by any non-US legal entity is considered a foreign security, even if the security is denominated in US dollars and trades in US markets.  A "portfolio" security is any security that is not a "direct investment."  A direct investment is generally defined as an equity investment in which the holder has a 10% or greater voting interest in the issuer.  Direct investments are subject to a separate reporting regime administered by the Bureau of Economic Analysis (BEA) and need not be reported on Form SHC.[1]  Investments taking the form of limited partnership interests are considered to be portfolio securities (regardless of the percentage ownership interest represented by the limited partnership interest), because limited partnership interests are not considered voting securities for this purpose.  Conversely, a general partner interest in an offshore limited partnership is considered a direct investment. Form SHC is comprised of three parts (or "Schedules"): Schedule I is required to be completed by all Reporting Persons who have either received notice from the FRBNY that they are subject to Form SHC reporting requirements or who are otherwise required to report data on either Schedule II or Schedule III (see below).  Schedule I requires a Reporting Person to provide basic information identifying itself and summaries of the information provided in the Schedule II and Schedule III reports submitted by the Reporting Person. Schedule II applies to any holdings in foreign portfolio securities that a Reporting Person (i) holds directly, (ii) holds through a US-resident or foreign central securities depository, or (iii) holds through a foreign-resident custodian, provided that the total aggregate amount of such holdings exceeds $200 million.  If a Reporting Person’s aggregate holdings in such securities is below the $200 million threshold, the Reporting Person is exempt from Schedule II reporting requirements.  If aggregate holdings in such securities exceeds the $200 million threshold, the Reporting Person must complete a separate Schedule II for each foreign security it holds that falls into one of the above three categories, including detailed information as to the type of security, amount held, and the fair market value of such holding. Schedule III applies to any holdings in foreign portfolio securities that a Reporting Person maintains though a US-resident custodian, provided that the total aggregate amount of such holdings exceeds $200 million.  If a Reporting Person’s aggregate holdings in such securities is below the $200 million threshold, the Reporting Person is exempt from Schedule III reporting requirements.  If aggregate holdings in such securities exceeds the $200 million threshold, the Reporting Person must complete a separate Schedule III for each US-resident custodian that it uses, reporting the identity of the custodian and the total value of the foreign portfolio securities held through that custodian.  Form SHC filings may be submitted electronically using the Federal Reserve Reporting Central System.  Use of the System is mandatory if the end investor is submitting more than one hundred Schedule II reports. Copies of the Schedules to Form SHC, and the instructions for completing them, can be found at http://ticdata.treasury.gov/Publish/shc2016in.pdf. Clients are urged to speak to their Gibson Dunn contacts if they have any questions or concerns regarding these or any other regulatory requirements.   [1]   The BEA’s reporting requirements apply to any direct investment that exceeds $3 million in size (whether by a US investor overseas or by a non-US investor in the US), even if the BEA has not provided notice to the applicable investor that a reporting obligation applies.  Which BEA Form applies, and the extent of the reporting person’s reporting requirements, depends on the size and nature of the direct investment. Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, or any of the following leaders and members of the firm’s Investment Funds practice group: Chézard F. Ameer – Dubai (+971 (0)4 318 4614, cameer@gibsondunn.com)Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, jbellah@gibsondunn.com)Edward D. Sopher – New York (+1 212-351-3918, esopher@gibsondunn.com)Y. Shukie Grossman – New York (+1 212-351-2369, sgrossman@gibsondunn.com)Mark K. Schonfeld (+1 212-351-2433, mschonfeld@gibsondunn.com)Edward D. Nelson – New York (+1 212-351-2666, enelson@gibsondunn.com)Marc J. Fagel (+1 415-393-8332, mfagel@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com)Gregory Merz – Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com)   © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

February 3, 2017 |
Compliance Reminders for Private Fund Investors

Private fund advisers are subject to a number of regulatory reporting requirements and other compliance obligations, many of which need to be completed on an annual basis.  This memorandum provides a brief overview. 1.      Regulatory Filing Obligations under the Advisers Act Private fund advisers that are either registered investment advisers ("RIAs") or exempt reporting advisers ("ERAs") under the U.S. Investment Advisers Act of 1940, as amended (the "Advisers Act"), must comply with a number of regulatory reporting obligations under the Advisers Act.  Chief among these are the obligations to update their Form ADV and Form PF filings with the SEC on an annual basis.  The following is a brief summary of those filing obligations and the applicable deadlines (assuming a fiscal year end of December 31, 2016): (a)        Form ADV Annual Update (3/31/2017 deadline).  Each RIA and ERA has an ongoing obligation to update the information provided in its Form ADV no less frequently than annually.  This annual update must be filed within 90 days of the end of the adviser’s fiscal year end.  An RIA must update the information provided in both the "check the box" portion of its Form ADV (Part 1A) and in its "disclosure brochure" (Part 2A).  An ERA is only required to update the information reported in its abbreviated Part 1A filing.  All such updates must be filed with the SEC electronically through IARD.  In order to avoid last minute delays, we strongly recommend that each private fund adviser check its IARD account early to ensure that its security access codes are up-to-date and working.  We also recommend that each firm check the balance in its IARD account and wire sufficient funds to cover all Federal and state filing fees well in advance of the filing deadline.  Each RIA is also required to update the information provided in its "supplemental brochures" (Part 2B) no less frequently than annually.[1]  Although an RIA is not required to publicly file its supplemental brochures with the SEC, updated supplemental brochures must be kept on file at the RIA’s offices.  (b)        Disclosure Brochure Delivery (5/01/2017 deadline).  An RIA is also required to deliver an updated version of its Part 2A disclosure brochure to all clients within 120 days of the end of its fiscal year.[2]  An RIA may comply with this requirement either by mailing a complete copy of its updated brochure to its clients or by sending a letter providing a summary of any material changes that have been made to the brochure since its last annual update and offering to provide a complete copy of the updated brochure upon request free of charge.[3] (c)        Forms PF and CPO-PQR (5/01/2017 deadline).  An RIA (but not an ERA) whose assets under management attributable to private funds exceeds $150 million is required to provide a report on Form PF to the SEC regarding its private funds’ investment activities.  For most registered private fund advisers, the Form PF is required to be filed once a year within 120 days of the end of the adviser’s fiscal year.  However, a private fund adviser whose assets under management exceed certain thresholds may be required to file more frequently and/or on shorter deadlines.[4]  In addition, the information that such a large private fund adviser must provide to the SEC is significantly more extensive.  An RIA that is also registered under the Commodity Exchange Act ("CEA") as a Commodity Pool Operator ("CPO") or Commodity Trading Adviser ("CTA") should also consider its reporting obligations under Form CPO-PQR, a Commodity Futures Trading Commission ("CFTC") form that serves the same purpose as, and requires the reporting of similar types of information to, Form PF.  In theory, a dual registrant may comply with its reporting obligations under both the Advisers Act and the CEA by filing a single Form PF.  However, the CFTC still requires certain information to be provided in a Form CPO-PQR filing in order to take advantage of this feature. 2.      Annual Compliance Program Review Rule 206(4)-7 under the Advisers Act (the "Compliance Program Rule") requires an RIA (but not an ERA) to review no less frequently than annually the adequacy of its compliance policies and procedures and the effectiveness of their implementation.  Although the Compliance Program Rule does not require that these reviews be in writing, the SEC’s Staff has a clear expectation that an RIA will document its review.  SEC examiners routinely request copies of an RIA’s annual compliance program review reports as part of the examination process. Producing an annual compliance program review report need not be overly burdensome.  Although an RIA may consider engaging a third party to conduct a comprehensive audit of the firm’s compliance program from time to time, under normal circumstances an RIA can take a more risk-based approach to the process.  For example, an RIA might build a review around the following three themes where potential compliance risks may be most acute: Compliance policies and procedures that may be affected by changes in the RIA’s business or business practices since the last review was conducted; Any areas where SEC examiners have identified deficiencies or where the firm has experienced compliance challenges; and Any changes in applicable law, regulation, interpretive guidance or regulatory priorities. In addition, a CCO should include in the report any incremental improvements that have been made to the firm’s compliance program throughout the year, not just as part of a formal annual review process. 3.      Notable Regulatory Developments The following is a brief summary of the more notable regulatory developments for 2016 that private fund advisers may want to take into consideration when conducting their annual compliance program reviews. (a)        Fees and Expenses.  The SEC continues to send clear signals that it places a high priority on industry practices concerning the collection of non-investment advisory fees from portfolio companies and on the allocation of the adviser’s expenses to funds.  This past year, the SEC’s Enforcement Division settled several well-publicized enforcement actions against private equity firms in which violations of fiduciary duties were found with respect to the collection of non-advisory fees and/or the allocation of expenses.[5]  Examples of the types of practices that could trigger SEC scrutiny, (particularly if not the subject of clear prior disclosure and/or a contractual basis in the applicable fund governing documents) include: re-characterizations of non-investment advisory fee revenue that appear to be intended to avoid triggering management fee offsets; charging accelerated monitoring or similar fees to portfolio companies; allocating expenses related to the adviser’s overhead and/or back-office services to its funds; allocating broken deal expenses to funds without allocating a portion of those expenses to other potential co-investors (especially affiliated co-investors); and negotiating discounts on service provider fees for work performed on behalf of the adviser without also making the benefit of those discounts available to the adviser’s funds.  We continue to encourage private fund advisers to review their financial controls with respect to fee collection, management fee offsets and expense allocations to ensure that their practices are consistent with their funds’ governing documents and in line with SEC expectations.  We also encourage firms to review their disclosure regarding fee collection and expense allocation practices to make sure that it is up-to-date and comprehensive. (b)        Unregistered Broker Activities.  This past year, the SEC settled a significant enforcement action against a private fund adviser for, among other things, engaging in unregistered securities broker activities in violation of the Securities Exchange Act of 1934 (the "Exchange Act").[6]  This enforcement action is notable in several respects.  First, although the SEC found that the private fund adviser had engaged in multiple serious violations of the Advisers Act, the SEC chose to emphasize only its finding that the adviser had acted as an unregistered broker in its press release announcing the enforcement action.[7]  More importantly, neither the press release nor the administrative order itself provide any meaningful detail as to precisely what activities the adviser had engaged in that required registration as a broker under the Exchange Act.  The administrative order acknowledges that the governing documents for the adviser’s funds expressly permitted the adviser to charge transaction or brokerage fees and that this practice had been fully disclosed to the investors in the funds.  Beyond that, however, the administrative order states only that the adviser received roughly $1.9 million in "transaction-based compensation" in connection with "soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing and executing the transactions."  The SEC appears to have focused on the manner in which the adviser was being compensated and concluded that the receipt of "transaction based fees" for these services without being registered as a broker violated the Exchange Act.  In light of the uncertainty, we recommend that private fund advisers reexamine their practices with respect to the receipt of any compensation that might be characterized as transaction fees.  (c)        Supervisory Practices.  In September of 2016, the SEC’s Office of Compliance Investigations and Examinations ("OCIE") issued a Risk Alert announcing a new initiative focusing on the supervisory practices of RIAs.  In addition, the SEC also settled several enforcement actions against private fund advisers in 2016 in which a failure to properly supervise was among the violations found by the SEC.[8]  Although OCIE’s Risk Alert focuses primarily on the need to adopt enhanced supervisory and oversight procedures for employees with a history of disciplinary events, private fund advisers may want to consider whether any enhancements to their supervisory structure and practices are advisable in light of this initiative. (d)        Cybersecurity.  The SEC continues to make cybersecurity a high priority for the entire financial services industry.  In the past two years, OCIE has published three "Risk Alerts" relating to cybersecurity and identified cybersecurity as one of its examination priorities in 2015, 2016 and 2017.[9]  In light of this regulatory focus, we recommend that each private fund adviser review its information security policies and practices thoroughly and implement enhancements to address any identified gaps promptly. (e)        Other Conflicts.  Finally, private fund advisers should remain vigilant for any other practices or circumstances that could present actual or potential conflicts of interest.  In announcing its 2017 examination priorities, OCIE states that its examinations of private fund advisers would continue to focus on "conflicts of interest and disclosure of conflicts of interest as well as actions that appear to benefit the adviser at the expense of investors."[10]  Several recent enforcement actions also serve to emphasize the SEC’s view that the failure to properly address and disclose potential conflicts of interest is a breach of an investment adviser’s fiduciary duties under the Advisers Act, even in the absence of clear harm to investors.[11] The SEC adopted a new rule for RIAs in 2016 that amends Form ADV in a number of significant ways.  These include formalization of the SEC’s practice of permitting so-called umbrella registration of multiple private fund advisers operating as a single firm and enhancement of reporting requirements for advisers of separately managed accounts.  In addition, the SEC enhanced its record-keeping requirements with respect to performance advertising.  The compliance date for these new rules is not until October 1, 2017.  Nevertheless, each RIA should consider reviewing its record-keeping procedures now in order to make sure it will be able to capture the additional data that it will need to comply with these new reporting and recordkeeping requirements when they go into effect. The SEC also proposed a new rule in 2016 that would require RIAs to adopt written business continuity/disaster recovery plans ("BC/DR Plans") and written succession plans.  This rule has not yet been adopted, and its fate is uncertain in light of the many changes in personnel that are currently taking place at the SEC.  Nevertheless, OCIE already expects investment advisers to maintain written BC/DR Plans in accordance with its interpretation of an adviser’s fiduciary obligations under the Advisers Act, and it would not be surprising if SEC examiners were to begin asking advisers to produce copies of their written succession plans even if the proposed rule is not adopted. 4.      Compliance Program Maintenance Each private fund adviser should (and in many cases is required to) perform certain annual maintenance tasks with respect to its compliance program.  The following is a list of mandatory and recommended tasks that should be completed: (a)        Code of Ethics Acknowledgements.  Each RIA is required by Rule 204A-1 under the Advisers Act (the "Code of Ethics Rule") to obtain a written acknowledgement from each of its "access persons" that such person has received a copy of the firm’s Code of Ethics and any amendments thereto.  As a matter of best practice, many RIAs request such acknowledgements on an annual basis.  In addition, each access person must provide an annual "securities holdings report" at least once every 12 months and quarterly "securities transactions reports" within 30 days of the end of each calendar quarter.  We recommend that each RIA review its records to ensure that each of its access persons has complied with these acknowledgement and personal securities reporting requirements, as the failure to maintain such documentation is a frequent deficiency identified by the SEC’s examiners. In addition, the SEC’s Division of Investment Management issued a Guidance Update in June of 2015 in which the Staff cautioned RIAs against interpreting the exemption for managed accounts from the pre-clearance and reporting requirements of the Code of Ethics Rule too broadly.[12]  According to the Staff, the delegation of investment discretion to a third party trustee or investment adviser, by itself, may not be sufficient to demonstrate that an access person is not exercising "direct or indirect influence or control" over the investment account.  Among other things, the Staff suggested that RIAs adopt enhanced annual certification requirements for managed accounts designed to ensure that an access person is not in fact exercising direct or indirect influence or control over any investment portfolios for which an access person is claiming the managed account exemption.  RIAs may wish to review their practices with respect to managed account exemption in light of this interpretive guidance. (b)        Custody Rule Audits.  Compliance with Rule 206(4)-2 under the Advisers Act (the "Custody Rule") generally requires a private fund adviser to prepare annual audited financial statements in accordance with US GAAP for each of its private funds and to deliver such financial statements to the fund’s investors within 120 days of the fund’s fiscal year end (180 days in the case of a fund-of-funds).  The SEC’s Staff issued interpretive guidance in 2014 providing its views on the circumstances in which the annual audit requirement under the Custody Rule applies to special purpose vehicles and escrow arrangements.[13]  We encourage each private fund adviser to review its fund structures to ensure that every fund and special purpose vehicle that is subject to an annual audit requirement under the Custody Rule is being audited and that such audits are on schedule to be delivered to investors on a timely basis.  An RIA that is relying on the alternative "surprise audit" requirements to comply with the Custody Rule for any of its funds or separately managed accounts should engage its auditing firm early in the calendar year to conduct the required surprise audits. (c)        Disclosure Documents/ Side Letter Certifications.  In addition to the updates to an RIA’s disclosure and supplemental brochures on Form ADV Part 2A and 2B discussed above, private fund advisers whose funds are continuously raising new capital (e.g., hedge funds) should review the offering documents for their funds to ensure that the disclosure in these documents is up-to-date.  A private fund adviser should also check to see that it has complied with all reporting, certification or other obligations it may have under its side letters with investors.  (d)        Privacy Notice.  An investment adviser whose business is subject to the requirements of Regulation S-P, because it maintains records containing "nonpublic personal information" with respect to "consumers," is required to send privacy notices to its "customers" on an annual basis.  As a matter of best practice, most private fund advisers simply send privacy notices to all of their clients and investors, often at the same time they distribute the annual updates to their disclosure brochures on Form ADV (see above).  We recommend that each adviser review its privacy notice for any updates to reflect changes in its business practices and for compliance with the requirements of the safe harbor available under Regulation S-P.  (f)         Political Contributions.  For a firm whose current or potential investor base includes state or local government entities (e.g., state or municipal employee retirement plans or public university endowments), we recommend that the political contributions of any of the firm’s "covered associates" be reviewed for any potential compliance issues under Advisers Act Rule 206(4)-5 (the "pay-to-play" rule). 5.      Other Potential Compliance Obligations Depending on the nature and scope of a private fund adviser’s business, numerous other regulatory reporting requirements and other compliance obligations may apply.  For example: (a)        Rule 506(d) Bad Actor Questionnaires.  For a private fund adviser whose funds are either continuously raising capital (e.g., hedge funds), or where the firm anticipates raising capital in the next twelve months, we recommend that the firm ensure that it has up-to-date "Bad Actor Questionnaires" under Regulation D Rule 506(d) on file for each of its directors, executive officers and any other personnel that are or may be involved in such capital raising efforts.  Firms that are or are contemplating engaging in general solicitations under Rule 506(c) of Regulation D should also review their subscription procedures to ensure that they are in compliance with the enhanced accredited investor verification standards required under that Rule. (b)        ERISA.  Funds that are not intended to constitute ERISA "plan assets" (e.g., because the fund is a "venture capital operating company" or because "benefit plan investors" own less than 25% of each class of equity of the fund) are typically required to certify non-plan asset status to their ERISA investors annually.  Thus, a private fund adviser should confirm that its funds have continued to qualify for a plan asset exception and prepare the required certifications.  In addition, investment advisers to funds that are ERISA plan assets sometimes agree to prepare an annual Form 5500 for the fund as a "direct filing entity."  This approach allows an underlying ERISA plan investor to rely on this Form 5500 with respect to its investment in the fund and have more limited auditing procedures for its own Form 5500.  If this approach is used, Form 5500 is due 9-1/2 months after year-end (i.e., October 15 for calendar year filers).  Alternatively, if the fund does not itself file a Form 5500, it will need to provide ERISA investors the information they need to complete their own Form 5500s. (c)        CFTC Considerations.  A private fund adviser that is registered as either a CPO or a CTA, or which relies on certain exemptions from registration as a CPO or CTA, is subject to certain annual updating and/or reaffirmation filing requirements under the CEA and the rules adopted by the CFTC thereunder. Exempt Advisers.  Many advisers and general partners of private funds that trade in a de-minimis amount of commodity interests (i.e., futures, options on futures, options on commodities, retail forex transaction, swaps) are not required to register under the CEA as a CPO, but need to qualify for, and rely on, an exemption from CPO registration.  CFTC Regulation 4.13(a)(3) provides an exemption for advisers and general partners of private funds that engage in a "de minimis" amount of commodity interests (the "De Minimis Exemption") pursuant to a test found in that regulation.  Other exemptions from registration as a CPO or a CTA may be available to advisers or general partners of private funds.  An adviser or general partner must claim an exemption from CPO registration with respect to each fund that invests in commodity interests by filing an initial exemption through the National Futures Association ("NFA") website and must affirm its exemption filing within 60 days after the end of each calendar year or else the exemption will be deemed to be withdrawn.  Registered CPOs and CTAs.  If a private fund does not qualify for the De Minimis Exemption or another exemption, the adviser or general partner of that private fund may be required to register with the CFTC as a CPO or a CTA, resulting in annual fees, disclosure, recordkeeping and reporting requirements.  Notably, a registered CPO must file an annual report with respect to each relevant commodity pool that it operates and update disclosures to investors (unless a limited exemption under CFTC Regulation 4.7 applies).  A registered CPO should also consider reporting obligations under Form CPO-PQR, which would need to be filed with the NFA within 60 days of the end of each calendar quarter (depending on AUM).  Similarly, registered CTAs must consider reporting obligations under Form CTA-PR, which must be filed with the NFA within 45 days after the end of each calendar quarter.  If a manager or general partner is dually-registered as both a CPO and a CTA, it must complete Form CTA-PR and Form CPO-PR with respect to the relevant private funds. Other Considerations – Clearing, Trading and Uncleared Margin.  Regardless of whether an adviser or general partner claims an exemption from CPO registration with respect to a private fund, the simple fact that the private fund engages in commodity interests makes the private fund a "commodity pool" and the adviser and general partner CPOs (even if they are exempt from registration).  The designation as a commodity pool has some practical impacts on private funds as commodity pools are considered "financial entities" under Section 2(h)(7)(C)(i) of the CEA and are therefore subject to mandatory clearing, trade execution and margin requirements with respect to their swaps activities.  Notably, rules with respect to variation margin requirements for uncleared swaps come into force beginning on March 1, 2017, after which date all such uncleared swaps of commodity pools will be subject to variation margin requirements. (d)        Exchange Act Reporting Obligations.  Private fund advisers that invest in "NMS securities" (i.e., exchange-listed securities and standardized options) are reminded that such holdings may trigger various reporting obligations under the Exchange Act. For example: Schedules 13D & 13G.  Investment advisers that exercise investment or voting power over more than 5% of any class of a public company’s outstanding equity securities must file a holdings report on Schedule 13G if they qualify as passive institutional investors.[14]  Schedule 13G filings must be made within 45 days of the end of the calendar year and within 10 days after the end of any calendar month in which the adviser’s holdings in the applicable equity security exceeds 10%.  Schedule 13G filers are also required to file amended reports on Schedule 13G within 10 days after the end of any calendar month in which their holdings exceeded 10% and within 10 days after the end of any calendar month after that in which their holdings changes by more than 5%.  Investment advisers that do not qualify as passive institutional investors must file a report on Schedule 13D within 10 days of acquiring more than 5% of any class of an issuer’s outstanding equity securities and "promptly" (typically within 24 hours) after any material change in the information provided in the Schedule 13D (including any change in such adviser’s holdings of more than 1% or a change in the adviser’s investment intent with respect to such holdings). Form 13F.  Institutional investment advisers who exercise investment discretion over accounts holding publicly-traded equity securities[15] having an aggregate fair market value in excess of $100 million on the last trading day of any month in a calendar year must report such holdings to the SEC on Form 13F within 45 days after the end of such calendar year and within 45 days after the end of each of the first three calendar quarters of the subsequent calendar year. Form 13H.  Private fund advisers whose trading activity in NMS securities exceed certain "large trader" thresholds[16] are required to file a report on Form 13H "promptly" (within 10 days) after exceeding the threshold.  In addition, such filings must be amended within 45 days after the end of each calendar year and promptly after the end of each calendar quarter if any of the information in the Form 13H becomes inaccurate. Section 16.  Private fund advisers who hold a greater than 10% voting position in a public company or whose personnel sit on the board of directors of a public company may also have reporting obligations under Section 16 of the Exchange Act and be subject to that Section’s restrictions on "short swing profits." (e)        Regulation D and Blue Sky Renewal Filings.  A private fund that engages in a private offering lasting more than one year may be subject to annual renewal filing requirements under Regulation D and/or State blue sky laws. (f)         State Pay-to-Play and Lobbyist Registration Laws.  A private fund adviser that either has or is soliciting state or local government entities for business may be subject to registration and reporting obligations under applicable lobbyist registration or similar state or municipal statutes in the jurisdictions where the adviser is engaged in such activities. (g)        Cross-Border Transaction Reporting Requirements.  A private fund adviser that engages in cross-border transactions or which has non-US investors in its funds may be subject to various reporting requirements under the Department of Treasury’s International Capital ("TIC") System or the Bureau of Economic Analysis’ ("BEA") direct investment survey program.  In general, investments that take the form of investments in portfolio securities are subject to TIC reporting requirements, while investments that take the form of direct investments in operating companies are subject to the BEA’s reporting requirements.  BEA.  A direct investment is generally defined by the BEA as an investment that involves a greater than 10% voting interest in an operating company.  For purposes of applying this definition, general partners are the only entities considered by have a voting interest in a limited partnership.  Limited partner interests are not considered voting securities.  The BEA’s reporting requirements apply to any direct investment that exceeds $3 million in size (whether by a US investor overseas or by a non-US investor in the US), even if the BEA has not provided notice to the applicable investor that a reporting obligation applies.  Which BEA Form applies, and the extent of the reporting person’s reporting requirements, depends on the size and nature of the direct investment. TIC.  In general, any cross-border investment (whether by an investor in a fund or by a fund in a portfolio security) that does not meet the BEA’s definition of a direct investment is reportable under TIC.  Again, the form to be used and the frequency and scope of the reporting obligation depends on the size and nature of the investment.  In general, however, unless an investor receives written notice from the Federal Reserve Bank of New York to the contrary, an investor is only required to participate in the TIC’s "benchmark surveys", which are conducted once every five years.  In addition, the reporting requirement generally falls on the first (or last) US financial institution in the chain of ownership at the US border, which means that in many cases for private fund advisers, the actual reporting obligations applies to the fund’s custodian bank or prime broker, and not on the private fund adviser itself. (h)        European Regulatory Reporting Requirements.  Private fund advisers that are either registered as alternative investment fund managers ("AIFMs") or authorized to manage or market alternative investment funds ("AIFs") in the European Economic Area ("EEA") are required to regularly report information (referred to as transparency information) to the relevant regulator in each EEA jurisdiction in which they are so registered or authorized ("Annex IV Reports").  The process of registering to market an AIF is not consistent across jurisdictions.  Registration of some type (which can range from mere notice to a formal filing-review-approval process lasting many months) is generally necessary before any marketing of the AIF may take place. Once registered, the AIFM must begin making Annex IV Reports in each relevant jurisdiction.  The transparency information required by the Annex IV Reports concerns the AIFM and the AIFs it is managing or marketing in the EEA.  The AIFM must provide extensive details about the principal markets and instruments in which it trades on behalf of the AIFs it manages or markets in the EEA, as well as a thoughtful discussion of various risk profiles.  Preparing Annex IV Reports, therefore, can be a challenging exercise.  Further, while Annex IV Reports are conceptually analogous across jurisdictions, the precise reporting requirements imposed by each regulator differ. The reporting frequency will depend on the type and amount of assets under management of the AIFM, as well as the extent of leverage involved, but will be yearly, half-yearly, or quarterly. The reports must be filed within one month of the end of the annual (December 31st), half yearly (June 30th and December 31st) or quarterly (March 31st , June 30th, September 30th and December 31st) reporting periods, as applicable.  Furthermore, AIFMD requires the AIF to prepare annual reports for its European investors, covering a range of specified information. We generally recommend that firms assess reporting requirements on an on-going basis in accordance with any changes to assets under management, and in consultation with reliable local counsel.  As well as requiring the submission of Annex IV reports, AIFMD also imposes other requirements on AIFMs for information to be given to investors and regulators on an on-going basis (including in relation to the acquisition of control of EU companies by the AIF).  Consequently, we have seen an increase in the number of firms choosing to adopt a "rent-an-AIFM" approach, effectively outsourcing the compliance function.  This removes the need to continually monitor shifts in local regulations, but not the need to do the internal collection and analysis of investment data required to populate the filings. (i)         Tax.  Depending on the structure and nature of a private fund adviser’s investment activities and/or client base, certain tax filings or tax compliance procedures may need to be undertaken.  Examples include:  Investments by U.S. persons in non-U.S. entities may need to be disclosed on IRS Form 5471 (ownership in non-U.S. corporation), IRS Form 8865 (ownership in non-U.S. partnership) and IRS Form 8858 (ownership in non-U.S. disregarded entity), which forms are required to be filed together with such U.S. persons’ annual U.S. federal income tax returns. Investments by non-U.S. persons in U.S. entities may need to be disclosed on IRS Form 5472 (25% ownership in a U.S. corporation). Transfer of property by a U.S. person to a foreign corporation may require the U.S. person to file an IRS Form 926.  Ownership of interests in or signature authority over non-U.S. bank accounts and similar investments, may need to be disclosed under foreign bank and financial accounts reporting regime (FBAR) on Form FinCEN 114, the due date of which has been moved to April 15th for initial filings, with an automatic extension available to October 15th. Advisers may need to report the existence of certain accounts to the U.S. IRS or their local jurisdiction under FATCA or the OECD Standard for Automatic Exchange of Financial Account Information – Common Reporting Standard. Advisers should be aware that IRS Forms W-8 provided by non-U.S. investors generally expire after three years from the execution date of the form and they may need to collect updated IRS Forms W-8 from their non-U.S. investors. Clients are urged to speak to their Gibson Dunn contacts if they have any questions or concerns regarding these or any other regulatory requirements.                 [1]              An RIA is required to prepare a supplemental brochure for each supervised person that (i) formulates investment advice for and has direct contact with a client, or (ii) has discretionary investment power over client assets (even if such person does not have direct client contact).  As a practical matter, most private fund advisers prepare supplemental brochures for each member of their investment committees and/or each of their portfolio managers.                 [2]              As a technical matter, investors in a private fund are not considered "clients" of the fund’s investment adviser.  As a matter of best practice, however, most private fund advisers make updated copies of their disclosure brochures available to the investors in their funds.                 [3]              Such letters must also provide a website address (if available), e-mail address (if available) and telephone number by which a client may obtain a copy of the RIA’s current disclosure brochure, as well as the website address through which a client may obtain information about the adviser through the SEC’s Investment Adviser Public Disclosure (IAPD) system.                 [4]              In particular, a hedge fund adviser with more than $1.5 billion in regulatory assets under management attributable to its hedge funds is required to report on Form PF on a quarterly basis within 60 days of the end of each calendar quarter and to complete an additional section of the Form (Section 2).  A private liquidity fund adviser with more than $1.0 billion in combined regulatory assets under management attributable to both registered money market funds and private liquidity funds is required to report on Form PF on a quarterly basis within 15 days of the end of each calendar quarter and to complete an additional section of the Form (Section 3).  A private equity fund adviser with more than $2.0 billion in regulatory assets under management attributable to its private equity funds is only required to file on an annual basis within 120 days of the end of its fiscal year, but is required to complete an additional section of the Form (Section 4).                 [5]              See Apollo Management V, L.P., et. al.¸ Advisers Act Release No. 4493 (Aug. 23, 2016); Blackstreet Capital Management, LLC, et. al., Exchange Act Release No. 77957, Advisers Act Release No. 4411 (Jun. 1, 2016); and Equinox Fund Management, LLC, Securities Act Release No. 10004, Exchange Act Release No. 76927, Advisers Act Release No. 4315 (Jan. 19, 2016).  See also Cherokee Investment Partners, LLC, et. al., Advisers Act Release No. 4258 (Nov. 5, 2015); Fenway Partners, LLC, et. al., Advisers Act Release No. 4253 (Nov. 3, 2015); Blackstone Management Partners L.L.C., et. al., Advisers Act Release No. 4219 (Oct. 7, 2015); Kohlberg, Kravis Roberts & Co., Advisers Act Release No. 4131 (Jun. 29, 2015); and Alpha Titans, LLC, et al., Exchange Act Release No 74828, Advisers Act Release No. 4073, Investment Company Act Release No. 31586 (Apr. 29, 2015).                 [6]              Blackstreet Capital Management, LLC, et. al., Exchange Act Release No. 77957, Advisers Act Release No. 4411 (Jun 1, 2016).                 [7]              These violations included (i) diversion of fund assets to pay for political contributions, charitable donations, and business entertainment on behalf of the adviser, (ii) engaging in undisclosed affiliated transactions with the adviser’s funds, and (iii) multiple violations of the terms of the funds’ limited partnership agreements.                 [8]              See Artis Capital Management, L.P., et. al., Advisers Act Release No. 4550 (Oct. 13, 2016); Apollo Management V, L.P., et. al.¸ Advisers Act Release No. 4493 (Aug. 23, 2016),                 [9]              See OCIE Cybersecurity Initiative, National Exam Program Risk Alert, Vol. IV, Issuer 2 (Apr. 15, 2014); Cybersecurity Examination Sweep Summary, National Exam Program Risk Alert, Vol. IV, Issue 4 (Feb. 3, 2015), and OCIE’s 2015 Cybersecurity Examination Initiative, National Examination Program Risk Alert, Vol. IV, Issue 8 (Sept. 15, 2015).  See also, Examination Priorities for 2015, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 13, 2015); Examination Priorities for 2016, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 11, 2016); and Examination Priorities for 2017, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 12, 2017).                 [10]           See Examination Priorities for 2017, National Exam Program, Office of Compliance Inspections and Examinations (Jan. 12, 2017) at page 5.                 [11]           See, e.g., Centre Partners Management, LLC, Advisers Act Release No. 4604 (Jan. 10, 2017) and New Silk Road Advisors, Advisers Act Release No. 4587 (Dec. 14, 2016).                 [12]           See Personal Securities Transactions Reports by Registered Investment Advisers: Securities Held In Accounts Over Which Reporting Persons Had No Influence or Control, IM Guidance Update No. 2015-03 (June 2015).                 [13]           See Private Funds and the Application of the Custody Rule to Special Purpose Vehicles and Escrows, IM Guidance Update No. 2014-07 (Jun. 2014).                 [14]           To qualify as a passive institutional investor, an investment adviser must be an RIA that purchased the securities in question "in the ordinary course of business and not with the purpose or effect of changing or influencing the control of the issuer nor in connection with or as a participant in any transaction having such purpose or effect."                 [15]           The SEC maintains a definitive list of securities subject to Form 13F reporting at http://www.sec.gov/divisions/investment/13flists.htm.                 [16]           A "Large Trader" is defined as any person that exercised investment discretion over transactions in Regulation NMS securities that equal or exceed (i) two million shares or $20 million during any single trading day, or (ii) 20 million shares or $200 million during any calendar month. Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, or any of the following leaders and members of the firm’s Investment Funds practice group: Chézard F. Ameer – Dubai (+971 (0)4 318 4614, cameer@gibsondunn.com)Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, jbellah@gibsondunn.com)Edward D. Sopher – New York (+1 212-351-3918, esopher@gibsondunn.com)Y. Shukie Grossman – New York (+1 212-351-2369, sgrossman@gibsondunn.com)Mark K. Schonfeld (+1 212-351-2433, mschonfeld@gibsondunn.com)Edward D. Nelson – New York (+1 212-351-2666, enelson@gibsondunn.com)Marc J. Fagel (+1 415-393-8332, mfagel@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com)Gregory Merz – Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com)   © 2017 Gibson, Dunn & Crutcher LLP, Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 19, 2017 |
India – Legal and Regulatory Update (January 2017)

The Indian Market The Indian economy continues to be an attractive investment destination due to its sustained stable growth and implementation of further liberalisation policies by the Government of India ("Government"). In November 2016, the Government announced that Indian Rupees 500 and 1000 would cease to be legal tender. These high-value currency notes comprised the majority of the currency in circulation in the market. While this move has created some uncertainty in the market, the Government expects that this will lead to an increase in tax collections and bank deposits, creating room for reductions in interest and tax rates in the first half of 2017. Following on from our previous update dated October 3, 2016 (which sets out an overview of key legal and regulatory developments in India from May 1, 2016 to August 31, 2016), this update will provide a brief overview of the key legal and regulatory developments in India between September 1, 2016 and December 31, 2016. Key Legal and Regulatory Developments Foreign Investment 100% Foreign Investment in Certain Financial Services: The Reserve Bank of India ("RBI") has permitted 100% foreign investment, without prior Government approval, in non-banking finance companies ("NBFCs") providing financial services regulated by financial services regulators such as the RBI, Securities and Exchange Board of India ("SEBI"), Insurance Regulation and Development Authority etc.[1] However, such investment will be subject to applicable conditions imposed by relevant financial services regulators or other applicable laws, including minimum capitalisation requirements. Further, 100% foreign investment in unregulated financial services has also been permitted under the Government approval route. Previously, foreign investment up to 100% was permitted under the automatic approval route only in NBFCs engaged in 18 specified financial services. India-Singapore Double Taxation Avoidance Agreement Amendment: India and Singapore have signed a protocol (the "Protocol") amending the agreement between India and Singapore for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income ("India-Singapore DTAA").[2] This radically changes the tax liability on capital gains earned by a Singapore tax resident from sale of shares of an Indian company. Under the erstwhile regime, such gains were taxable in the country of residence i.e. Singapore, where there is no tax on capital gains. Now, the Protocol imposes taxes on such gains at the source i.e. in India (where the company is registered) at the applicable domestic tax rate. This amendment effectively takes away the capital gains benefits that were available to investments by Singapore tax resident entities. The Protocol has been made effective on investments made on or after April 1, 2017. Therefore, investments made prior to March 31, 2017 and related exits/share transfers will remain unaffected by this change. This follows similar amendments to the convention for the avoidance of double taxation and the prevention of fiscal evasion between India and Mauritius ("India-Mauritius DTAA") (discussed in our previous update dated October 3, 2016). India-Cyprus Revised Double Taxation Avoidance Agreement: India and Cyprus have also revised their agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital ("India-Cyprus DTAA"), to incorporate source-based taxation in place of the residence-based taxation under the existing agreement.[3] This change will be effective from April 1, 2017. This is in line with recent amendments to the India-Mauritius DTAA and the India-Singapore DTAA (as discussed above). Previously, the Government had, by a notification, declared Cyprus to be a jurisdictional area with lack of effective exchange of information, which made Cypriot entities ineligible for any tax benefits. This notification has now been withdrawn to make the revised India-Cyprus DTAA fully operational. Subsequent to the recent amendments to India’s tax agreements with various countries, Mauritius has emerged as an attractive jurisdiction for banking transactions. The withholding tax rate for interest payments by Indian residents to Mauritius-resident banks under the recently amended India-Mauritius DTAA is 7.5%, while the withholding rates on such interest payments under the India-Singapore DTAA and the India-Cyprus DTAA remain at 10%. Corporate Law and Financing Notification of Companies Act Provisions: The new [Indian] Companies Act, 2013 ("2013 Act") has been brought into force in a phased manner since the Act received presidential assent three years ago. In December 2016, the Government notified several provisions of the 2013 Act which effect significant changes to corporate laws in India. Two key provisions that were notified are discussed below. Procedure for Court Approved Mergers: Schemes for mergers, de-mergers and compromises will now fall under the jurisdiction of the National Company Law Tribunal ("NCLT"). While state High Courts previously had jurisdiction over these matters, the NCLT is now the dedicated quasi-judicial body responsible for company law matters. The 2013 Act introduces some major changes from the framework previously provided for such schemes under the [Indian] Companies Act, 1956 ("1956 Act"). These changes include (a) recognition of cross-border mergers; (b) shorter procedure for mergers of small companies[4] and those involving holding companies and their wholly owned subsidiaries; (c) prescription of monetary thresholds for maintaining objections to the approval of schemes; and (d) clear description of mandatory filings such as valuation reports for effective compliance. Purchase of Minority Shareholding: Under the 1956 Act there was no effective procedure for the purchase of minority shareholding other than in the circumstances of a purchase of shares of dissenting shareholders under a court-approved scheme or a contract approved by a majority of the shareholders. The 2013 Act provides for the acquisition of minority shareholding without court intervention. An "acquirer" or "a person acting in concert" ("Acquirer") holding 90% or more of the issued equity share capital of a company must notify the company of his intention to acquire the minority shareholding of such company. The minority shareholding may be acquired at a price determined by a registered valuer pursuant to an offer issued by the Acquirer or, alternatively, by an offer made by the minority shareholders. Notably, there is some ambiguity in relation to this provision as it does not make such purchase of minority shareholding a mandatory obligation nor does it provide for a specified time period to accept or reject such offer. Indian Banks Permitted to Issue Rupee Denominated Offshore Bonds: The RBI has permitted Indian banks to raise capital by issuing rupee denominated offshore bonds to meet their capital requirements and for financing infrastructure and affordable housing.[5] Insolvency and Restructuring Changes in the Corporate Insolvency Framework: A substantial part of the [Indian] Insolvency and Bankruptcy Code, 2016 ("Insolvency Code") came into effect on December 1, 2016. Please refer to our update dated June 8, 2016, for an overview of the Insolvency Code. Petitions for winding-up of companies under the 1956 Act that are currently pending will now be dealt with by the NCLT. This change applies to winding up petitions that have been filed on the grounds of a company’s inability to pay its debts that are yet to be served on all respondents.   Debt Restructuring Procedures Streamlined: Since 2014 the RBI has introduced several measures to better equip lenders to deal with distressed assets. The RBI continues to review and fine tune these schemes from time to time. In 2014, the RBI had provided banks with greater flexibility in structuring and refinancing long term project loans extended to key sectors such as infrastructure, energy and resources. In November 2016 the RBI extended such flexibility to project loans across all sectors. In June 2016, the RBI had announced the scheme for sustainable structuring of stressed assets ("S4A"), which permitted banks to separate funded liabilities of a stressed borrower into sustainable and unsustainable debt. While the sustainable debt portion is required to be serviced by the borrower in accordance with existing loan terms, the S4A scheme allows for the conversion of the unsustainable debt portion into equity or quasi-equity instruments. In November 2016, the RBI increased the time period for the formulation and implementation of such S4A resolution plans from 90 to 180 days.[6] Start-ups Rules Relaxed for Angel Funding for Start-ups: SEBI has amended the SEBI (Alternative Investment Funds) Regulation, 2012 to permit angel funds (registered with SEBI) to invest in entities incorporated up to five years ago. Further, the lock-in period has been reduced from three years to one year and the minimum investment threshold has been reduced to Indian Rupees 2.5 million (approximately USD 37,000) from Indian Rupees 5 million (approximately USD 74,000). Angel funds are now also permitted to invest up to 25% of their investible corpus overseas, in order to manage risks through diversification.    [1]   A.P. (DIR Series) Circular No. 8 dated October 20, 2016 issued by RBI available at https://rbidocs.rbi.org.in/rdocs/notification/PDFs/APDR087150F21E462D4D24AEDE64BDB65893C1.PDF    [2]   Third Protocol amending the Agreement Between the Government of the Republic of Singapore and the Government of the Republic of India for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, available at https://www.iras.gov.sg/irashome/uploadedFiles/IRASHome/ Quick_Links/Protocol%20amending%20Singapore-India%20DTA%20(Not%20in%20force)%20(31%20Dec% 202016).pdf    [3]   Press release issued by the Central Board of Direct Taxes, Government of India, dated December 16, 2016 available at http://www.incometaxindia.gov.in/Lists/Press%20Releases/Attachments/567/Notification-Completion-Internal-Procedures-Revised-Double-Taxation-Avoidance-Agreement-India-Cyprus-16-12-2016.pdf    [4]   Small Companies are companies with paid-up share capital less than Indian Rupees 5 million (approximately USD 74,000)    [5]   A.P. (DIR Series) Circular No. 14 dated November 3, 2016 issued by the RBI, available at: https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT10715D00F793D6D44E88CB1666FB1A4E791.PDF    [6]   Circular issued by RBI dated November 10, 2016 (DBR.No.BP.BC.34/21.04.132/2016-17) available at: https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NOTI12242DE6B307C1D4415934A9F672CC25571.PDF Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details, please contact the Gibson Dunn lawyer with whom you usually work or the following authors in the firm’s Singapore office: India Team:Jai S. Pathak (+65 6507 3683, jpathak@gibsondunn.com)Karthik Ashwin Thiagarajan (+65 6507 3636, kthiagarajan@gibsondunn.com)Sidhant Kumar (+65 6507 3661, skumar@gibsondunn.com)  © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

December 7, 2016 |
Right Back Where We Started From? In Salman, the Supreme Court Clarifies the “Personal Benefit” Test but Otherwise Leaves Undisturbed Insider Trading Contours

On December 6, 2016, in Salman v. United States, the Supreme Court unanimously resolved a circuit split between the Courts of Appeals for the Second and Ninth Circuits over the meaning of the "personal benefit" element of insider trading law.  In doing so, the Court put to rest confusion on this aspect of insider trading jurisprudence.  But the murky nature of other aspects of insider trading was left untouched, leaving market participants, courts, and lawyers generally "right back where we started from" before Newman. Bassam Salman was convicted of trading on information he received from a corporate insider, after it was found that the insider had breached a fiduciary duty in giving the information.  In order to find that the insider breached a fiduciary duty, the jury had to find that he had received a personal benefit in exchange for the information.  It was from this finding, that the insider received a personal benefit, that Salman appealed to the Ninth Circuit, which affirmed his conviction and interpreted the "personal benefit" test broadly.  This resulted in a circuit split with the Second Circuit’s ruling in United States v. Newman, 773 F.3d 358 (2d Cir. 2014), cert. denied, 577 U.S. ___ (2015).  In Salman, the Supreme Court adopted the Ninth Circuit’s interpretation, finding that an insider-tipper receives a personal benefit where the tipper makes a gift of inside information to a trading relative or friend, and rejecting the additional requirements imposed by the Second Circuit in United States v. Newman.  This resolves the confusion over one often-contentious element of insider trading. Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 have been interpreted to prohibit individuals with material, nonpublic information who are bound by a duty of confidentiality from sharing that information with others for the purpose of trading.  In Dirks v. SEC, 463 U.S. 646 (1983), the Supreme Court explained that an individual who receives such information from an insider (the "tippee") may be liable for securities fraud where the insider who provided the information (the "tipper") breached a fiduciary duty in providing it.  The Dirks Court held that such a fiduciary breach occurs where the tipper receives a personal benefit in exchange for the information, a requirement known as the "personal benefit" test.  In 2014, the Second Circuit decided United States v. Newman.  In Newman, the Second Circuit held that no personal benefit accrues to a tipper from the gift of information to a trading relative or friend unless there is "proof of a meaningfully close personal relationship" between the tipper and tippee "that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature."  773 F.3d at 452.  The Newman standard established that providing inside information to a trading friend or relative is not by itself enough to satisfy the "personal benefit" test; there must be at least the potential of receiving some tangible benefit in return. Courts, prosecutors, and the white-collar bar viewed Newman as a milestone decision.  And its effect was immediate.  In a number of pending insider trading cases that were underway in the U.S. District Court for the Southern District of New York, prosecutors dropped charges against defendants where the evidence may not have been sufficient to meet the heightened "personal benefit" standard articulated in Newman.  Moreover, uncertainty regarding the scope of Newman quickly arose, with SEC civil enforcement actions moving forward against defendants whom federal prosecutors felt were now beyond their reach. One year after Newman, the Ninth Circuit addressed the same question in United States v. Salman, 792 F.3d 1087 (9th Cir. 2015).  The Ninth Circuit, however, reached the opposite conclusion.  In an opinion authored by Judge Jed Rakoff, a Southern District of New York judge sitting by designation on the Ninth Circuit, the Ninth Circuit interpreted Dirks more broadly, and held that the prosecution can show that a personal benefit to a tipper exists where an insider makes a gift of confidential information to a trading relative or friend.  To the extent that Newman required an additional benefit to the tipper, the Ninth Circuit declined to follow it. The Salman Decision Salman had been convicted of trading on material, nonpublic information about potential mergers and acquisitions activity, which he received from his brother-in-law, Mounir ("Michael") Kara, who, in turn, obtained the information from his younger brother, Maher Kara, an investment banker at Citigroup.  Using this information, Salman made more than $1.5 million in trading profits.  Salman promptly appealed his conviction to the Ninth Circuit, arguing that in light of Newman, his conviction should be reversed because there was no evidence that Maher received anything of "a pecuniary or similarly valuable nature" in exchange for the information he provided to Michael.  The Ninth Circuit declined to follow Newman and affirmed Salman’s conviction.  The Supreme Court granted Salman’s petition for writ of certiorari. The Supreme Court unanimously affirmed the Ninth Circuit’s decision, upholding Salman’s conviction for insider trading.  In relying squarely on the requirements of Dirks, the Court noted that a tipper’s "disclosure of confidential information without personal benefit is not enough" to constitute a breach of the tipper’s fiduciary duty, and thereby expose a tippee to liability for trading on such information.  Salman v. United States, 580 U.S. ___ (2016), slip op. at 8.  The Court described the Dirks test for whether a tipper derived a personal benefit as focusing "on objective criteria, i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings," but also allowing that a "personal benefit can ‘often’ be inferred ‘from objective facts and circumstances,’ . . . such as ‘a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient.’"  Id. at 9 (quoting Dirks, 463 U.S. at 663-64).  The Court emphasized that Dirks stands for the principle that the "elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend."  Id. (emphasis in original) (quoting Dirks, 463 U.S. at 664, 667). As such, the Court held that "Dirks makes clear that a tipper breaches a fiduciary duty by making a gift of confidential information to ‘a trading relative.’"  Id.  Giving a gift to a relative or friend–whether in the form of cash or a tip–benefits the insider.  Id. at 10.  If Maher had personally traded on the information and then gifted the proceeds to Michael, "[i]t is obvious that Maher would personally benefit in that situation."  Id. at 9.  By disclosing the information to his brother and letting him trade on it, "Maher effectively achieved the same result."  Id. The Court thus determined that Maher breached his fiduciary duty to Citigroup when he gifted inside information to his brother, Michael, knowing that Michael would trade on it.  Salman inherited this duty, and subsequently breached it himself when, with full knowledge that the information had been improperly disclosed, he traded on it anyway.  The Court rejected Newman‘s "pecuniary gain" requirement as inconsistent with Dirks.  Id. at 10. The Court agreed with Salman’s contention that, in some gift-giving cases, it may be difficult to assess whether an insider received a personal benefit for disclosing confidential information.  However, the Court noted that these hypothetical difficulties do not "render shapeless" or unconstitutionally vague the tipper-tippee liability rules, as Salman claimed, because "Dirks created a simple and clear ‘guiding principle’ for determining tippee liability."  Id. at 11.  The Court also rejected Salman’s appeal to the rule of lenity, saying that Salman failed to show "grievous ambiguity or uncertainty that would trigger the rule’s application."  Id. at 11.  The Court saw no need to address "difficult" factual questions regarding whether an insider personally benefits from a particular disclosure, because Salman’s conduct falls within the "heartland" of Dirks, involving "precisely the ‘gift of confidential information to a trading relative’ that Dirks envisioned."  Id. at 11-12. The Court’s Salman decision effectively overrules the Second Circuit’s decision in Newman insofar as Newman required prosecutors to show that a tipper received something of a "pecuniary or similarly valuable nature" in exchange for a gift of information to family or friends.  In a footnote, however, the Court stressed that its decision left untouched the secondary holding of Newman–that prosecutors must prove that downstream tippees had knowledge that the information was improperly disclosed.  Id. at 5, n.1. Moving Forward from Salman – Or Going Back to a Pre-Newman Landscape The Court’s holding in Salman already has been praised by prosecutors for its re-affirmance of the continued validity of Dirks, and for overruling the additional burdens imposed on insider trading prosecutions by Newman.  Going forward, Salman is likely to reenergize prosecutors to vigorously pursue tipping cases.  Preet Bharara, the U.S. Attorney for the Southern District of New York, lauded the "common sense" Salman opinion as a "victory for fair markets and those who believe that the system should not be rigged."  SEC Chair Mary Jo White said the decision "reaffirms our ability to continue to aggressively pursue illegal insider trading and bring wrongdoers to justice." Prior to the Court’s decision, prosecutors had been cautious about charging individuals criminally in certain tipping cases in the wake of the Newman ruling.  For example, the SEC recently filed a claim against Leon Cooperman and his firm Omega Advisors, Inc. in the Eastern District of Pennsylvania, while prosecutors from the U.S. Attorney’s Office for the District of New Jersey explicitly reserved their decision whether to bring a criminal case pending the Supreme Court’s decision in Salman.  Nevertheless, the Salman ruling is unlikely to mark a sea change for insider trading prosecutions.  First, cases most directly affected by Salman‘s holding–that is, cases in which a tip is passed to a family member or friend in exchange for a nonpecuniary personal benefit–fall outside of the core subset of insider trading prosecutions.  More typically, these prosecutions involve the provision of some consideration in exchange for inside information, or the misappropriation of inside information for trading purposes.  For example, in United States v. Riley, 90 F. Supp. 3d 176 (S.D.N.Y. 2015) (Caproni, J.), the defendant was convicted of insider trading in connection with his receipt of "three concrete personal benefits" that satisfied the requirements of Newman: assistance with the defendant’s side business, investment advice, and help in securing the defendant’s next job.  Id. at 186-89.  These types of traditional insider trading cases will not be affected by the Supreme Court’s decision in Salman to re-affirm the Dirks "personal benefit" test.  Importantly, because the Supreme Court granted certiorari in Salman, but not in Newman, the Supreme Court’s ruling does not touch the more resonant portion of the Second Circuit’s ruling in Newman: namely, the high burden it imposes to prove a downstream tippee’s scienter in insider trading cases.  As noted above, Justice Alito specifically stated that Newman‘s holding requiring evidence that defendants knew the information they traded on came from insiders or that the insiders received a personal benefit in exchange for the tips was not implicated in Salman.  580 U.S. ___, slip op. at 5 n.1.  Therefore, for cases such as Newman itself, in which there was no evidence that the downstream tippees who were multiple levels removed from the tipper knew they were trading on information obtained from insiders or that those insiders received any benefit in exchange for inside information, 773 F.3d at 453, the government will continue to have a harder time proving a defendant’s scienter, notwithstanding the Court’s decision in Salman. Conclusion With its Salman decision, the Court laid to rest part of the uncertainty that arose after Newman.  By reaffirming Dirks, the Court forcefully and resoundingly through its unanimous decision returned the legal landscape of tipper-tippee liability to its pre-Newman state.  Moving forward, in cases involving insiders who allegedly disclose confidential information to family members or friends, the prosecution need not prove that the insider-tipper received something of a pecuniary or similarly valuable nature in exchange for a tip.  Rather, in such cases, a personal benefit can be inferred merely by the close nature of the relationship. While Salman likely will affect cases involving alleged insider trading by family members or friends of tippees, Salman‘s impact in the overall landscape of insider trading enforcement may be limited, as the bulk of insider trading cases involve parties who reap clear personal benefits (most often pecuniary in nature) from disclosing confidential information.  Thus, Salman largely represents a return to the status quo that existed before Newman.  And importantly, Newman‘s other holding–that downstream tippees must have personal knowledge that the inside information was improperly disclosed–remains untouched, and may continue to constrain prosecutorial appetite to pursue some cases. The following Gibson Dunn lawyers assisted in the preparation of this client update:  Avi Weitzman, Joel Cohen, Mark Schonfeld, Marc Fagel, Jason Halperin, Jaclyn Neely, David Coon, Mark Cherry and Sara Ciccolari-Micaldi. Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding the issues discussed above.  Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Securities Enforcement practice group, or the following authors: Avi Weitzman – New York (+1 212-351-2465, aweitzman@gibsondunn.com)Joel M. Cohen – New York (+1 212-351-2664, jcohen@gibsondunn.com) Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com)Marc J. Fagel – San Francisco (+1 415-393-8332, mfagel@gibsondunn.com) Please also feel free to contact the following practice group leaders and members: New YorkReed Brodsky (212-351-5334, rbrodsky@gibsondunn.com)Joel M. Cohen (212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (212-351-3824, ldunst@gibsondunn.com)Barry R. Goldsmith (212-351-2440, bgoldsmith@gibsondunn.com)Mark K. Schonfeld (212-351-2433, mschonfeld@gibsondunn.com)Alexander H. Southwell (212-351-3981, asouthwell@gibsondunn.com)Avi Weitzman (212-351-2465, aweitzman@gibsondunn.com)Lawrence J. Zweifach (212-351-2625, lzweifach@gibsondunn.com) Washington, D.C.Stephanie L. Brooker  (202-887-3502, sbrooker@gibsondunn.com)David P. Burns (202-887-3786, dburns@gibsondunn.com) Daniel P. Chung (202-887-3729, dchung@gibsondunn.com)Stuart F. Delery (202-887-3650, sdelery@gibsondunn.com)Richard W. Grime (202-955-8219, rgrime@gibsondunn.com)Patrick F. Stokes (202-955-8504, pstokes@gibsondunn.com)F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com) San FranciscoWinston Y. Chan (415-393-8362, wchan@gibsondunn.com)Thad A. Davis (415-393-8251, tadavis@gibsondunn.com)Marc J. Fagel (415-393-8332, mfagel@gibsondunn.com)Charles J. Stevens (415-393-8391, cstevens@gibsondunn.com)Michael Li-Ming Wong (415-393-8234, mwong@gibsondunn.com) Palo AltoPaul J. Collins (650-849-5309, pcollins@gibsondunn.com)Benjamin B. Wagner (650-849-5395, bwagner@gibsondunn.com) DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com)Monica K. Loseman (303-298-5784, mloseman@gibsondunn.com) Los AngelesMichael M. Farhang (213-229-7005, mfarhang@gibsondunn.com) Douglas M. Fuchs (213-229-7605, dfuchs@gibsondunn.com) © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 27, 2016 |
Myanmar’s New Investment Law

Updated October 31, 2016 This revised alert supplements the version previously circulated on October 27, 2016.  Although the 2016 Law does not contain a commencement date, we have learnt from sources at the Directorate of Investment and Company Administration that it will come into force on April 1, 2017. I.   Introduction The Myanmar Investment Law ("2016 Law"), which replaces the Foreign Investment Law, 2012 ("2012 Law") and the Myanmar Citizen Investment Law, 2013 ("2013 Law"), has been enacted and, according to sources at the Directorate of Investment and Company Administration ("DICA"), will come into force on April 1, 2017.  This new legislation follows the landmark victory of the National League for Democracy ("NLD") in the November 2015 national elections and the largely smooth transition of power to an NLD-led government. The 2016 Law comes close on the heels of the lifting of nearly all sanctions against Myanmar by the United States of America on October 7, 2016. This action is expected to significantly increase inbound investment into Myanmar. At a landmark economic policy event in Naypyitaw on October 22, 2016 State Counsellor, Daw Aung San Suu Kyi, and Minister of Planning and Finance, U Kyaw Win, reiterated that Myanmar was open for business.  They had invited over 150 of Myanmar’s biggest tax payers to attend the event and they laid out high level plans to boost economic growth.  They emphasised that the government wanted to engage with the private sector in areas such as infrastructure development and reiterated the need to attract increased levels of responsible foreign investment.  This client alert summarises the salient features of the 2016 Law based on an unofficial translation made available by DICA. It focuses on the provisions of the 2016 Law that relate to foreign investments. II.   Background to the 2016 Law With a large and youthful population (an estimated 55% of Myanmar’s total population of over 50 million is under the age of 30) and a burgeoning middle class consumer base, Myanmar offers significant potential opportunities for foreign investors. It is no surprise that Myanmar’s gross domestic product has recorded an average growth rate of 7.9% between 2012 and 2015 and is forecast to grow by 7.8% during the fiscal year 2016-2017. The Union Government of the Republic of the Union of Myanmar ("Myanmar Government") has sought to facilitate the growth and economic transformation of Myanmar by revising several pieces of legislation.  Myanmar’s investment law and policies have been evolving over the last few years. While the 2012 Law stipulated the rules relating to foreign investment, separate legislation – the 2013 Law, regulated investments by citizens of Myanmar. However, these separate legal regimes created the perception of an uneven playing field for foreign investors on the one hand and domestic investors on the other. The 2016 Law is an attempt by the Myanmar Government to harmonise these investment laws and improve the ease of investing into Myanmar. While the Myanmar Government has sought to streamline and simplify investment procedures through the 2016 Law, the success of this endeavour will also depend on the quality of subsidiary legislation that is still in the works. The rules enacted under the 2012 Law, to the extent that they are not contrary to the 2016 Law, will continue to apply until the Myanmar Government formulates subsidiary legislation for the 2016 Law. Based on recent statements by senior Myanmar Government officials, subsidiary legislation to the 2016 Law is expected to be released by March 2017. III.   The Regulatory Structure The Myanmar Investment Commission ("MIC") continues to be the focal authority in relation to the regulation of foreign investment into Myanmar and is organised under the Ministry of Planning and Finance. The administrative activities of MIC are undertaken by DICA. MIC was reconstituted in June 2016, after the NLD-led Government came to power, and now consists of 11 members, including the Chairman. MIC’s key responsibilities include promoting investment into Myanmar and specifying investment conditions for various sectors. MIC also has primary responsibility for scrutinising investment proposals and applications for investment incentives. The 2016 Law mandates that MIC meet at least once every month to consider investment proposals and other applications, among its other duties. The 2016 Law provides MIC with a range of enforcement powers and enables it to monitor investment activities. It is empowered to impose administrative penalties against investors for violations of the 2016 Law, subsidiary legislation and investment conditions stipulated by MIC. Penalties that can be imposed by MIC include a censure, revocation of the investment permit and blacklisting of the investor. IV.   Classification of Investment Activities Unlike the 2012 Law, the 2016 Law regulates both foreign and domestic investments. It classifies investment activities into three categories: (i) promoted; (ii) restricted; and (iii) prohibited. Under Section 42 of the 2016 Law, an investment activity is considered to be restricted if such activity is: (i) reserved for the Myanmar Government; (ii) not open for foreign investment; (iii) permitted only if undertaken together with a Myanmar national or entity; or (iv) subject to the approval of a ministry of the Myanmar Government. MIC is required to issue notifications identifying promoted and restricted investment activities from time to time. Section 41 of the 2016 Law lists the types of investment activities that are prohibited. These include businesses or activities that may affect the environment, biodiversity, traditional culture and customs, and public health of Myanmar. Further, MIC is required to obtain the approval of the Pyidaungsu Hluttaw (Assembly of the Union of Myanmar) where an investment activity may significantly impact the security, economic condition and/or national interests of Myanmar. Based on recent media reports, the ‘promoted’ sectors in Myanmar are likely to include manufacturing, infrastructure, industrial zones, agriculture and food processing. V.   The Investment Approval Process The 2016 Law seeks to simplify procedures and enable more transparency in the investment approval process. In addition to allowing MIC to draw upon the expertise of external experts, MIC is also permitted under the 2016 Law to engage with investors during the course of its meetings. Further, the 2016 Law appears to decentralise the foreign investment approval process by allowing state governments to scrutinise and approve certain types of foreign investment.   A.   Investment Permits Under the 2016 Law, permits from MIC are required for business activities that: (i) are of strategic importance to Myanmar; (ii) are large-scale capital-intensive projects; (iii) could potentially impact the environment and any local community in Myanmar; (iv) utilise state-owned land or buildings; or (v) require the submission of a proposal to MIC. While some of the thresholds mentioned above appear to be ambiguously worded, MIC is expected to provide more clarity on these terms through subsidiary legislation. B.   Government Endorsements Even if the investment activity is one which does not require an investment permit, investors are required to obtain the endorsement of MIC in order to be eligible (i) to enter into long leases of land and buildings for conducting their businesses; or (ii) for fiscal exemptions and relief offered by the Myanmar Government. Upon the receipt of an endorsement from MIC, foreign investors are permitted to lease land and buildings in Myanmar for an initial period of 50 years. Investors can apply to MIC for an extension of their lease rights for an additional period of up to 20 years from the expiry of the initial lease period. Foreign investors who have obtained a permit and/or an endorsement are required to notify MIC in the event of any transfer of shares in or the business of the investee entity. Such a notice is also required where any encumbrance is created over the shares or assets of the investee company. VI.   Foreign Exchange Controls The 2016 Law facilitates cross-border fund flows in relation to permitted investment activities in Myanmar. Capital account and loan transactions are subject to greater regulation by the Central Bank of Myanmar ("CBM") than ‘ordinary’ (revenue account) transactions. The 2016 Law explicitly permits: (a)   repatriations of funds by foreign investors and transfer of capital gains and dividends earned on investments in Myanmar through normal banking channels; and (b)   current account transactions in relation to foreign investments, including payment by Myanmar nationals and entities of royalties, license fees, technical fees or management fees. The Myanmar Government retains the right to prevent or delay the transfer of funds in certain circumstances such as for the protection of rights of creditors or to ensure compliance with judicial or administrative orders. Cross-border fund transfers are subject to compliance with the Foreign Exchange Management Law, 2012 and Myanmar’s tax laws. The free flow of funds in relation to investment activities in Myanmar will also depend on the efficiency with which the CBM functions and the ready availability of the Myanmar kyat and ‘freely usable currencies’ such as the U.S. dollar in Myanmar. VII.   Employment Requirements The 2016 Law provides investors with greater flexibility than under the 2012 Law in relation to skilled jobs. A business commenced in Myanmar under the 2012 Law was required to employ a prescribed minimum number of Myanmar nationals in skilled jobs. The 2016 Law prescribes no such quotas in favour of Myanmar nationals. Businesses set up under the 2016 Law are permitted to employ foreigners in positions requiring managerial, technical and operational expertise. Foreign investors will have to comply with a myriad of labour laws and regulations in Myanmar, including the Employment and Skills Development Law, 2013 and the Social Security Law, 2012. Further, closure of a business in Myanmar is permitted only upon compliance with local laws, including the provision of notice and payment of severance to employees of the business. VIII.   Investment Incentives Foreign investors may apply to MIC for various economic incentives under the 2016 Law. These incentives generally take the form of exemptions and relief from income tax, customs duties and other internal taxes in Myanmar.      A.   Zonal Income Tax Exemptions The 2016 Law follows a more nuanced scheme when compared with the 2012 Law in relation to the grant of income tax exemptions to foreign investors. While the 2012 Law granted a blanket five-year income tax exemption to all foreign investors, the 2016 Law envisages the classification of geographical regions within Myanmar into three zones for the purpose of granting tax exemptions. The zonal classification listed below seeks to address regional disparities within Myanmar. (i)   Zone 1 (Least Developed): Investments in this zone may be granted a tax exemption for a period of seven consecutive years; (ii)   Zone 2 (Moderately Developed): Investments in this zone may be granted a tax exemption for a period of five consecutive years; and (iii)   Zone 3 (Adequately Developed): Investments in this zone may be granted a tax exemption for a period of three consecutive years. The zonal income tax exemption commences from the year of commencement of the business in Myanmar. MIC, in consultation with the Myanmar Government, is empowered to alter these zonal classifications from time to time. The Secretary of MIC recently indicated that these zonal classifications are likely to take into account disparities within each State of the Union of Myanmar. Further, such income tax exemptions will only be granted to businesses in sectors that are sought to be promoted by the Myanmar Government. B.   Customs and Internal Taxes MIC is empowered under the 2016 Law to grant, among other benefits, exemptions and reliefs from customs duties and other internal taxes on: (i)   capital goods and construction materials imported during the start-up phase of an investment activity that are not locally available; and (ii)   raw materials or inputs imported for the purpose of manufacturing goods to be exported. C.   Other Income Tax Exemptions In order to encourage Myanmar businesses to reinvest in and develop themselves, MIC may on receipt of an application: (i)   grant income tax exemptions for profits that are reinvested in the same business or a similar type of business within a period of one year; (ii)   permit depreciation at a rate that is faster than the actual life of the capital asset; and (iii)   permit the deduction of research and development expenses from assessable income. The Myanmar Government has the right to claw-back exemptions or relief utilised by a foreign investor if such investor discontinues its business activity before the expiry of the period for which it has obtained a permit/endorsement. IX.   Investment Protection and National Treatment The 2016 Law provides more clarity in relation to foreign investment guarantees than the 2012 Law. In addition to providing a guarantee against direct expropriation of investments made by foreign investors, the 2016 Law also addresses the issue of indirect expropriation. The 2016 Law provides that no measures will be taken that will result in indirect expropriation or termination of the business unless such action is (i) necessary for the public interest; (ii) non-discriminatory; (iii) in accordance with applicable laws; and (iv) done upon prompt payment of market-based compensation. The 2016 Law also affords investors an opportunity to challenge measures that they determine to be indirect expropriation of the investor’s business in Myanmar. The 2016 Law also enshrines the national treatment standard for foreign direct investment in Myanmar. Section 47 of the 2016 Law requires the Myanmar Government to offer treatment to foreign investors and their businesses in Myanmar that is no less favourable than that offered to Myanmar nationals. As is often the case with such guarantees, this national treatment standard is applicable post-establishment of the business in Myanmar. Notwithstanding the national treatment standard, the 2016 Law permits the Myanmar Government to offer more favourable lease conditions, exemptions and relief to local Myanmar investors. X.   Conclusion The 2016 Law is an effort to facilitate foreign investor participation in the on-going economic transformation of Myanmar. While the Myanmar Government has attempted to simplify foreign investment procedures through this new legislation, its success in facilitating more foreign investment into Myanmar will depend on the level of clarity that is provided by subsidiary legislation to the 2016 Law and the efficiency with which various governmental agencies in Myanmar implement the law and regulations in practice. For example, merely decentralising the investment approval process to agencies other than MIC might be counterproductive, especially where such other agencies (both at the Union and State levels) lack the capacity or the tools to efficiently process investment proposals. Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details, please contact the Gibson Dunn lawyer with whom you usually work or the following authors. Co-author Robert Pé is a former senior adviser on legal affairs to Burmese/Myanmar leader and Nobel laureate, Daw Aung San Suu Kyi. Robert S. Pé – Hong Kong (+852 2214 3768, rpe@gibsondunn.com)Karthik Ashwin Thiagarajan – Singapore (+65 6507 3636, kthiagarajan@gibsondunn.com) © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 10, 2016 |
China Begins Major Overhaul of its Foreign Investment Regulatory Regime

It has been close to two years since China announced that it would make major changes in its foreign investment related laws and regulations.  The first step of such changes took effect on October 1, 2016, after the Standing Committee of the National People’s Congress (China’s parliament) passed resolutions (the "NPC Resolutions") to amend certain provisions of the FIE Laws (as defined below).  On October 8, 2016, in implementing the NPC Resolutions, the PRC National Development and Reform Commission ("NDRC") and the PRC Ministry of Commerce ("MOFCOM") issued Public Announcement No. 22 [2016] ("Announcement 22"), and MOFCOM issued the Interim Measures for the Record-filing Administration of the Incorporation and Change of Foreign Invested Enterprises (the "Interim Measures").  In essence, Announcement 22 and the Interim Measures have changed the regulation of certain matters relating to foreign investments in China from one that requires "prior approval" to one based on "subsequent filing".  This is consistent with the Chinese government’s stated goal to adopt a more market-based regulatory regime for foreign investments and to accord foreign investors a greater degree of national treatment in China. Background China currently has three major pieces of legislation governing foreign investments (the "FIE Laws") and related implementing rules (the "Implementing Rules"):  the Sino-Foreign Joint Venture Law passed in 1979 (the "Equity JV Law"), the Foreign Enterprise Law passed in 1986 (the "WFOE Law") and the Sino-Foreign Co-operative Joint Venture Law passed in 1988 (the "Co-operative JV Law").  A particular form of entity is allowed to be set up in China under each of these laws.  Under the WFOE Law, for example, a foreign investor can set up a wholly foreign owned enterprise (a "WFOE").  Similarly, under the Equity JV Law and the Co-operative JV Law, foreign investors can set up equity joint ventures or co-operative joint ventures with Chinese partners (the "Joint Ventures").  WFOEs and Joint Ventures are collectively called foreign invested enterprises ("FIEs"). There are three fundamental features of this regulatory regime.  First, foreign investors can only invest in sectors that are not prohibited to foreign investments.  China has and periodically updates a foreign investment catalogue (the "Investment Catalogue"), which divides foreign investments into three listed categories:  encouraged, restricted and prohibited.  Those that do not fall under any of these categories are treated as permitted.  A potential foreign investor has to find out first of all whether and under what restrictions (if any) it can make an investment in a particular sector. Second, prior to the adoption of Announcement 22 and the Interim Measures, regardless of the form of the FIE (a WFOE or a Joint Venture) and regardless of which category was involved (permitted, encouraged or restricted), the establishment of an FIE must go through a complicated three-step approval process.  To begin with, in respect of a greenfield project, the sponsors were required to obtain project-specific approvals/filings (the "Project Approval") from NDRC (including its local counterparts).[1]  After obtaining the Project Approval (or under circumstances where the Project Approval was not required, as in the case of a consulting WFOE), the sponsors must submit the incorporation documents (such as the articles of association and, if applicable, the joint venture contract) to MOFCOM (including its local counterparts) for review and approval (the "Establishment Approval").  Finally, based on the Establishment Approval, the sponsors had to register the FIE with the State Administration of Industry and Commerce (including its local counterparts, "SAIC") and obtain a business license (the "Company Registration").  An FIE only came into existence upon completion of the Company Registration. Third, prior to the adoption of Announcement 22 and the Interim Measures, there was a large number of matters relating to foreign investments that required prior approval or registration from various governmental authorities before they could become effective, such as any change in the business scope, amount of registered capital, pledge of registered capital, legal representative or shareholders of an FIE.  This caused many difficulties in how companies conducted their businesses.  In the first place, it often took a long time to obtain the required approvals.  While the FIE Laws and the Implementing Rules required that the relevant authorities issue or reject application for approvals within specified periods of time, such requirements were often ignored in practice, and the parties involved almost never complained for fear that they might not receive the approvals if they did. In addition, the approval authorities often engaged in substantive review of the commercial contracts entered into between the relevant parties.  For instance, MOFCOM sometimes required parties involved in a Joint Venture to change the commercial terms already agreed between them if such terms in its view were prejudicial to the Chinese party’s interests.  Another example was that MOFCOM officials often preferred simple templates for commercial contracts such as the joint venture contracts and equity interest transfer agreements.  To the extent the parties involved had agreed to terms that were not contained in such templates, MOFCOM officials often demanded that those terms be deleted or amended, even if they were among the most standard provisions in international transactions (such as adjustments in purchase price in an M&A transaction and the right by one party to a Joint Venture to put its shares to the other parties).  This forced parties in many cases to deal with these issues in parallel offshore agreements governed by non-PRC law even though the enforceability of such agreements in China was questionable. Moreover, the approval requirements added complications to commercial transactions and resulted in unnecessary transaction costs.  For example, because transfer of interest in an FIE required governmental approval and registration and such approval and registration themselves constituted transfer of title, parties in an M&A transaction often spent a long time negotiating when the purchase price should be paid.  A buyer would be reluctant to pay the price before obtaining the approval and registration because there was a risk that the approval and registration may not be granted.  Similarly, a seller often would not be willing to submit documents for approval and registration before it received the payment due to the concern that the buyer may not pay the purchase price after its interest in the FIE was already transferred.  In other words, it was basically impossible to have an M&A closing where transfer of title and payment of purchase price could happen simultaneously.  As a result, the parties often ended up negotiating escrow or security arrangements that were unnecessarily complicated and costly. New Changes The major changes adopted in Announcement 22 and the Interim Measures include: Negative List; Filing One primary change is the division of foreign investments into two categories: those that require special permits (commonly known as the "Negative List")[2] and those that do not.  Pursuant to Announcement 22, the Negative List consists of (i) sectors under the prohibited and restricted categories in the current Investment Catalogue and (ii) those sectors under the encouraged category that have special shareholding or management restrictions (such as requiring Chinese parties to have a controlling interest in a Joint Venture).  Foreign investments in any sectors on the Negative List are still prohibited or require prior approvals.  Procedures for applying for such approvals under the current FIE Laws and the Implementing Rules shall continue to apply without being affected by Announcement 22 or the Interim Measures. On the other hand, if a sponsor wishes to set up an FIE in a sector not on the Negative List, instead of applying to MOFCOM for the Establishment Approval, it can now submit the required documents and proceed with a filing procedure through an online FIE Information Comprehensive Administration System (the "Comprehensive Administration System").  The same filing process also applies to any amendments to the incorporation documents, including transfer of interests in an FIE. Filing Procedures To establish an FIE, the sponsors can make the filing through the Comprehensive Administration System either before the Company Registration or within 30 days thereafter.  This is a significant change, as the sponsors can now elect to set up an FIE without having to submit any documents to MOFCOM first. In case the documents filed with MOFCOM are subsequently amended (as in the case where there is a transfer of equity interest in an FIE), the FIE is required to file such amendments through the Comprehensive Administration System within 30 days thereafter.  Importantly, such amendments will become effective not upon filing with MOFCOM but upon the adoption of the relevant resolutions by the FIE.  Within three working days after receiving the filing materials, MOFCOM should complete the filing and publish the results through the Comprehensive Administration System or, if applicable, inform the filing parties that the relevant matters are not subject to filing.  The sponsors or the FIE can then obtain a filing receipt from MOFCOM.  Supervision As part of the filing process, the sponsors of an FIE or the FIE are required to warrant (among other things) that all information submitted through the Comprehensive Administration System is complete, true and accurate and that the FIE’s business activities do not involve any activity on the Negative List. If a party fails to make the required filing or if any false or misleading information is submitted, it will be ordered to take remedial actions.  It may also be subject to a fine not exceeding RMB30,000.  If other laws or regulations are also violated, other governmental authorities will enforce related remedies as well.   More Reforms Required There is little doubt that Announcement 22 and the Interim Measures represent a significant liberalization of China’s foreign investment regulatory regime.  Foreign investors now should find it much easier to set up an FIE and negotiate and execute M&A transactions.  On the other hand, it is important to point out that Announcement 22 and the Interim Measures are only a first step.  For instance, Announcement 22 specifically provides that the filing procedures under the Interim Measures do not apply to acquisitions by foreign investors of non-FIEs in China, which seriously restricts the scope of the Interim Measures and is a disappointment to market practitioners.  In addition, Foreign investments in China are subject to regulations by a number of agencies in addition to NDRC and MOFCOM, such as the State Administration of Foreign Exchange ("SAFE").  These agencies will need to adopt corresponding changes in order for Announcement 22 and the Interim Measures to achieve their intended results.  Furthermore, there are still many provisions in the FIE Laws and the Implementing Rules that are not "standard" compared with many other jurisdictions; nor do they apply to non-FIEs in China.  One example is that, under the Implementing Rules, certain matters relating to a Joint Venture are required to be decided by its board on a unanimous basis, including amendments to its articles of association, its termination or dissolution and the increase or decrease of its registered capital. More changes in these laws and regulations are obviously required to bring the Chinese system more in line with the international norm. In January 2015, China published a draft Foreign Investment Law (the "Draft Law") for public comments, which specifically provides that, except in cases where special entry permits are required, FIEs shall enjoy national treatment just as the non-FIE domestic companies.  The Draft Law is intended to replace the FIE Laws entirely such that FIEs will be governed by the PRC Company Law in the same way as all the non-FIE domestic companies.  However, currently there is no indication as to when the Draft Law will be adopted.   [1]  The Project Approval requirement has not changed as a result of Announcement 22 or the Interim Measures.   [2]  In recent years, China has experimented with a similar negative list-based system in a number of free trade zones where sponsors of an FIE can go through a simplified "filing" (as opposed to "approval") process to establish FIEs in sectors not on the negative list.  Announcement 22 and the Interim Measures essentially have made this system applicable to the whole country.              Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about this development.  Please contact the Gibson Dunn lawyer with whom you usually work or the following: Yi Zhang – Hong Kong (+852 2214 3988, yzhang@gibsondunn.com)Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)Joseph M. Barbeau – Beijing, Hong Kong, Palo Alto (jbarbeau@gibsondunn.com) © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 3, 2016 |
India – Quarterly Legal and Regulatory Update (October 2016)

The Indian Market The Indian economy continues to be an attractive investment destination due to its sustained stable growth and implementation of further liberalization policies by the Government of India ("Government"). Statistics indicate that India’s gross domestic product grew 7.6 per cent in 2015-16, up from 7.2 per cent a year ago. The full-year growth was fuelled by close to 8 per cent growth rate in the fourth quarter of 2015-16, the fastest in the world for the January-March quarter. As is evident from various amendments, the Government is focussed on making India a favoured destination for foreign investment. Following our previous update dated May 17, 2016 (which sets out an overview of key legal and regulatory developments in India from October 1, 2015 to April 30, 2016), this update provides a brief overview of the key legal and regulatory developments in India from May 1, 2016 to August 31, 2016. Key Legal and Regulatory Developments Foreign Investment Amendments to the Foreign Direct Investment Policy: The Foreign Direct Investment Policy of the Government ("FDI Policy") is the primary regulation governing foreign investment in India which is reviewed and amended by the Government annually. The Government introduced several amendments to the FDI Policy through the annual Consolidated Foreign Direct Investment Policy Circular, 2016 issued on June 7, 2016 ("2016 FDI Policy") and a subsequent press note issued on June 24, 2016 ("Press Note").[1] The amendments introduced by the 2016 FDI Policy and the Press Note, enable increased levels of foreign investment in a number of business sectors such as broadcasting, airports and pharmaceuticals, and further, simplify various sector-specific conditions. For a detailed analysis, please refer to our client alert dated July 1, 2016 at:  http://www.gibsondunn.com/publications/Pages/Indian-Government-Amends-Foreign-Direct-Investment-Policy-July-2016.aspx Deferred Consideration in Cross-border Share Purchase Transactions Allowed: The Reserve Bank of India ("RBI") has amended the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 to permit, under the automatic approval route, deferment of purchase consideration in share purchase transactions involving foreign investment[2]. Under the earlier regime, in a transaction where a non-resident purchased shares of an Indian company from a resident, there was a requirement that the entire agreed consideration be paid upfront at the time of the share transfer. Therefore, hold-backs, e.g., on account of post-closing adjustments or indemnity payments, were not permitted in such transactions unless the prior approval of the RBI was obtained. With this amendment, a non-resident is now permitted to hold-back a part of the agreed consideration (typically under an escrow mechanism) or require the resident to return the consideration received by it (on account of indemnity payments), subject to the following conditions:     (a)    at least 75% of the agreed consideration must be paid up-front, i.e. up to 25% of the agreed consideration can be held back. In this case, the balance consideration (after adjustments) must be paid within 18 months from the date of the share purchase agreement;     (b)    if the total consideration is paid up-front, up to 25% of the consideration can be returned to the non-resident by the resident on account of indemnity payments within 18 months from the date of payment of consideration. In both of the above circumstances, the total consideration received by the resident from the non-resident, upon the expiry of the 18 month-period mentioned above, must be equal to or more than the statutory floor price determined in accordance with the RBI’s pricing guidelines[3]. Prior approval of the RBI continues to be required for payment of deferred consideration, which does not conform to the above conditions. While the amendment will facilitate acquisitions in India by permitting better risk allocation between cross-border buyers and sellers, a few issues should be carefully considered during negotiations:     (a)    The 18 month-period in relation to a hold-back is to be reckoned from the "signing" or "execution" date of the share purchase agreement, not from the "closing" date (the actual date on which the seller transfers the shares to the buyer in return for the consideration). It is not uncommon for the time gap between execution and closing to exceed six months, depending on the complexity of the transaction and the need for regulatory approvals. Consequently, the longer the gap between execution and closing of the transaction, the shorter the actual period of hold-back will be. A non-resident will be able to avail the full 18-month hold-back period only in transactions that are executed and closed simultaneously;     (b)    As indicated above, the RBI has reiterated (in the amendment) that the total consideration paid by a non-resident to a resident must be equal to or more than the consideration determined in accordance with RBI’s pricing guidelines. Therefore, the price commercially agreed to between the parties is subject to the statutory floor price prescribed by the RBI, which needs to be paid by a non-resident to a resident. As a result, there may arise a situation where the hold-back amount will need to be paid by the non-resident to comply with the pricing guidelines of the RBI, even if such buyer is contractually permitted to retain the amount (for example, on account of indemnity payments). How this issue will be dealt with practically will need to be seen as transactions start to close subsequent to the new amendment. India-Mauritius Double Taxation Avoidance Agreement Amendment: India and Mauritius signed a protocol (the "Protocol") amending the India-Mauritius Double Taxation Avoidance Agreement ("India-Mauritius DTAA").[4] This radically changes the tax liability on capital gains arising from alienation of shares of an Indian resident company by a Mauritian tax resident. Under the erstwhile regime, such gains were taxable in the country of residence i.e. Mauritius, resulting in zero taxation. Now, the Protocol imposes taxes on such gains at the source i.e. at the level of the Indian resident company at the applicable domestic tax rate. This amendment effectively takes away the capital gains exemptions that were available investing through the Mauritius route. The Protocol has been made effective on investments made on or after April 1, 2017. Therefore, investments made prior to March 31, 2017 and related exits/share transfers will remain unaffected by this change. Corporate Law & Financing Clarification on Rupee Denominated Offshore Bonds: The Ministry of Corporate Affairs has clarified that issuance of rupee denominated offshore bonds will not be governed by the requirements of private placement or public offer under the [Indian] Companies Act, 2013.[5] Also, the securities regulator in India, Securities and Exchange Board of India ("SEBI") has issued a notification to clarify that the SEBI (Foreign Portfolio Investors) Regulations, 2013, will not apply to such offshore bonds.[6] Cumulatively, these clarifications have eliminated the confusion with regard to the regulations applicable to rupee denominated offshore bonds and clearly establish the jurisdiction of the RBI in this matter, under its Master Direction on External Commercial Borrowings issued in January 2016. Reforms in Debt Recovery and Enforcement of Security Interest Proceedings: The Indian Parliament has amended the [Indian] Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and the [Indian] Recovery of Debts due to Banks and Financial Institutions Act, 1993. These amendments are aimed at reducing the time taken in debt recovery proceedings by reforming procedures followed by tribunals established for this purpose. These amendments include provisions on electronic filings and record keeping for all debt recovery tribunals. Additionally, these amendments provide greater powers to secured creditors to enforce their collateral interest and take over the management of defaulting corporate debtors. Insolvency and Bankruptcy Code, 2016:  The Insolvency and Bankruptcy Code, 2016 (the "Code") has been notified in the [Indian] official gazette on May 28, 2016. The Code overhauls laws governing insolvency in India and is a major initiative of the government towards improving the ease of doing business in the country. The Code applies to companies, partnerships, limited liability partnerships and individuals. The Code replaces the existing insolvency framework which was confusing and fraught with substantial delays. Insolvency proceedings against a corporate debtor commence with a resolution process that seeks to resolve the insolvency of a debtor as a going concern by formulating a resolution plan. If this process fails to achieve a resolution, the debtor is subjected to liquidation proceedings to settle pending claims against it within a specific time frame. The process of corporate insolvency is subject to the overarching supervision of the National Company Law Tribunal ("NCLT"). Further, the Code envisions the establishment of an Insolvency and Bankruptcy Board which is mandated with the task of training and regulating the functioning of insolvency professionals who will have an important role in administering the insolvency proceedings along with the NCLT. For a detailed analysis, please refer to our client alert dated June 08, 2016 available at: http://www.gibsondunn.com/publications/Pages/Indian-Parliament-Passes-Insolvency-and-Bankruptcy-Code-2016.aspx National Company Law Tribunal Notified: Corporate litigation in India has substantially been reformed with the constitution of the NCLT and the National Company Law Appellate Tribunal ("NCLAT") with benches across major cities.[7] The NCLT has jurisdiction over matters that were earlier dealt with by the Company Law Board and the High Courts, in addition to the functions assigned to it under the Code (as discussed above). This includes court approved mergers, winding-up, reduction of share capital, oppression of minority shareholders and mismanagement of companies, among others. The NCLAT will decide on appeals of the NCLT’s decisions.    [1]   Press Note 5 (2016 Series) dated June 24, 2016.    [2]   Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Seventh Amendment) Regulations, 2016, notified on May 20, 2016.    [3]   The fair value of the shares of the Indian company determined by a chartered accountant of a merchant banker registered with the Securities and Exchange Board of India, in accordance with any internationally accepted pricing methodology.    [4]   Press Release dated May 10, 2016 issued by the Central Board of Direct Taxes available at http://www.incometaxindia.gov.in/Lists/Press%20Releases/Attachments/468/Press-release-Indo-Mauritius-10-05-2016.pdf    [5]   General Circular No. 09/2016 issued by the Ministry of Corporate Affairs on August 3, 2016 available at http://www.mca.gov.in/Ministry/pdf/GeneralCircular09_03082016.pdf    [6]   Circular Issued by the Securities and Exchange Board of India dated August, 4, 2016 available at http://www.sebi.gov.in/cms/sebi_data/attachdocs/1470299109414.pdf    [7]   [Indian] Gazette Notification dated June 1, 2016 (S.O. 1932(E)). Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details, please contact the Gibson Dunn lawyer with whom you usually work or the following authors in the firm’s Singapore office: India Team:Jai S. Pathak (+65 6507 3683, jpathak@gibsondunn.com)Priya Mehra (+65 6507 3671, pmehra@gibsondunn.com)Bharat Bahadur (+65 6507 3634, bbahadur@gibsondunn.com)Karthik Ashwin Thiagarajan (+65 6507 3636, kthiagarajan@gibsondunn.com)Sidhant Kumar (+65 6507 3661, skumar@gibsondunn.com)  © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 9, 2016 |
IRS Releases Final Regulations Clarifying the Definition of Real Property for REITs

On August 31, 2016, the Internal Revenue Service (the "IRS") and the Department of the Treasury ("Treasury") issued final regulations clarifying the definition of "real property" for real estate investment trust ("REIT") purposes.  The final regulations largely follow the proposed regulations issued in May 2014, with limited changes.  The IRS and Treasury received numerous written and electronic comments and held a public hearing on the proposed regulations, but declined to incorporate most comments into the final regulations.  We have summarized below a general overview of the final regulations and some noteworthy features and observations. General Overview of the Final Regulations One of the requirements that a taxpayer must satisfy to qualify as a REIT is that, at the close of each quarter, at least 75 percent of the value of its total assets must be represented by real estate assets, cash and cash items, and government securities.  Under the Internal Revenue Code, "real estate assets" include real property (including interests in real property and interests in mortgages on real property).  The final regulations define the term "real property" for purposes of this quarterly asset test, as well as for other relevant REIT purposes, through the following series of defined terms: "Real property" includes "land" and "improvements to land." "Land" includes air space and water space superjacent to land (even if the taxpayer owns only the air space or water space and does not own an interest in the underlying land) and natural products (e.g., crops, water, ores and minerals) that have not been severed from the land. "Improvements to land" means "inherently permanent structures" and their "structural components." An "inherently permanent structure" is any permanently affixed "building" or "other inherently permanent structure." Affixation may be to land or to another inherently permanent structure and may be by weight alone. A "building" is a structure that encloses a space within its walls and is covered by a roof, such as a house or warehouse.  It’s worth noting that an open air stadium does not qualify as a building because it does not have a roof, but it may qualify as real property as an other inherently permanent structure. An "other inherently permanent structure" is a structure that is permanently affixed to land or to another inherently permanent structure and that serves a passive function (e.g., supporting or sheltering) rather than an active function (e.g., manufacturing or producing). The regulations specifically identify cell transmission towers, silos and oil and gas storage tanks, among others, as other inherently permanent structures as long as they are permanently affixed.  The final regulations make clear that the list of qualifying assets contained in the regulations is not all-inclusive.  Therefore, other assets may qualify as other inherently permanent structures if they meet a facts and circumstances test described in the final regulations. "Structural components" are distinct assets that are integrated into an inherently permanent structure, serve the structure in its passive function, and even if capable of producing income (other than as consideration for the use or occupancy of space), do not produce or contribute to the production of any such income.  Whether a distinct asset is a structural component is determined under a facts and circumstances test.  For example, while an elevator in an office building may transport people (an active function), it can qualify as a structural component as it facilitates the occupancy of space in the building (a passive function) and generally would not produce or contribute to the production of income other than for the use or occupancy of space.  Moreover, for a structural component (e.g., an air-conditioning system) owned by a REIT to qualify as an interest in real property, the REIT must also have an ownership interest in the inherently permanent structure that the structural component serves (e.g., the building in which the component is installed).  In addition, if a REIT holds an interest in a mortgage secured by a structural component, that mortgage will be treated as a real estate asset only if the mortgage is also secured by a real property interest in the inherently permanent structure that the component serves.   Noteworthy Features and Observations Mixed Guidance about Solar Energy Systems A number of commenters had suggested that solar panels should be included within the definition of real property (as inherently permanent structures).  In finalizing the proposed regulations, the IRS and Treasury rejected those comments, affirming the view that solar panels generally are active business assets that are not, standing alone, real property, though the final regulations note that the mounts for the solar panels and exit wires may qualify as real property under the facts and circumstances test applicable to other inherently permanent structures. In contrast, certain smaller-scale solar energy systems that are designed to serve a single building owned by a REIT may be eligible to be treated as structural components under the final regulations, at least where the quantity of any excess electricity transferred to the local utility company during the year does not exceed the quantity of electricity purchased from the local utility for the same year.  The preamble to the final regulations notes that the IRS and Treasury are still considering under what circumstances a sale of excess electricity to a utility would impact the classification of a solar energy system as a structural component.  As a result of the prevalence of such sales and the lack of clarity regarding when a solar system will qualify as real property, the final regulations leave a cloud of uncertainty over whether a REIT’s investment in solar energy systems will be treated as investments in real property. Passive Transport Assets are Potentially Real Property The proposed regulations had indicated that assets serving a transport function were not real property as a result of serving an active function.  The final regulations retain the concept that transport is an active function, but the preamble to the final regulations clarifies that transport means to cause to move.  Examples in the final regulations make clear that providing a conduit (e.g., a pipeline) or route (e.g., a road or railroad track) is a permitted passive function, but note that equipment like compressors that facilitate the movement of gas in a pipeline are not structural components.  The clarification of the meaning of transport should be helpful for REITs investing in certain energy and infrastructure assets.  Indefinite Inherently Permanent Structure Requirement Clarified The proposed regulations required that to qualify as real property, an inherently permanent structure that is affixed to real property must be expected to be affixed indefinitely.  Commenters had expressed concern that a structure would need to be affixed forever to satisfy this requirement.  The final regulations retain this requirement, but the preamble to the final regulations clarifies that the IRS and Treasury do not believe that a structure must be affixed forever to be an inherently permanent structure, stating that the relevant inquiry is whether the facts and circumstances indicate that the structure will be affixed indefinitely to land or another inherently permanent structure. Additions to Enumerated List of Inherently Permanent Structures The final regulations expand on the list of structures that are buildings that, if permanently affixed, qualify as real property, by adding to the list of buildings motels, enclosed stadiums/arenas and enclosed shopping malls.  Intangible Assets The final regulations confirm that an intangible asset is real property or an interest in real property if the asset derives its value from real property, is inseparable from the real property, and does not independently produce or contribute to the production of income (other than income derived as consideration for the use or occupancy of space).  For example, a license or similar right that is solely for the use, enjoyment or occupation of land and that is in the nature of a leasehold or easement generally is an interest in real property, while a license to operate a business is not real property.  Commenters had requested that intangible assets related to above-market leases (where the REIT was the lessor) and below-market leases (where the REIT was the lessee) be conclusively treated as real property assets.  The IRS and Treasury rejected those comments, providing instead that an interest in an above-market or below-market lease is an intangible interest that qualifies as an interest in real property only to the extent that the lease derives its value from rents from real property.  An example to the final regulations makes clear that the value attributable to an above-market lease may be bifurcated and treated as partially an interest in real property and partially a non-real estate asset. Impact on Prior Private Letter Rulings One commenter to the proposed regulations had requested that the final regulations provide that taxpayers would be able to continue to rely on previously-issued private letter rulings, even if those rulings were inconsistent with the final regulations.  The IRS and Treasury explicitly rejected this request in the preamble to the final regulations, indicating that to the extent a previously issued letter ruling was inconsistent with the final regulations, the letter ruling would be revoked prospectively from the date of the final regulations.  Accordingly, REITs with letter rulings should review them carefully to confirm that the rulings are not inconsistent with the final regulations. The following Gibson Dunn lawyers assisted in preparing this client alert:  Brian Kniesly, Jeff Trinklein, Eric Sloan, Arthur Pasternak, Benjamin Rippeon, David Sinak, Paul Issler, Michael Cannon and Mark Dreschler. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments.  For further information, please contact the Gibson Dunn lawyer with whom you usually work or any of the following members of the Tax Practice Group: Art Pasternak - Co-Chair, Washington, D.C. (+1 202-955-8582, apasternak@gibsondunn.com)Jeffrey M. Trinklein - Co-Chair, London/New York (+44 (0)20 7071 4224 / +1 212-351-2344), jtrinklein@gibsondunn.com)Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@gibsondunn.com)David B. Rosenauer - New York (+1 212-351-3853, drosenauer@gibsondunn.com)Eric B. Sloan – New York (+1 212-351-2340, esloan@gibsondunn.com)Romina Weiss - New York (+1 212-351-3929, rweiss@gibsondunn.com)Benjamin Rippeon – Washington, D.C. (+1 202-955-8265, brippeon@gibsondunn.com)Hatef Behnia – Los Angeles (+1 213-229-7534, hbehnia@gibsondunn.com)Paul S. Issler – Los Angeles (+1 213-229-7763, pissler@gibsondunn.com)Dora Arash – Los Angeles (+1 213-229-7134, darash@gibsondunn.com)Scott Knutson – Orange County (+1 949-451-3961, sknutson@gibsondunn.com)David Sinak – Dallas (+1 214-698-3107, dsinak@gibsondunn.com)      © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 6, 2016 |
SEC Proposes New Rule Requiring Registered Investment Advisers to Adopt Written Business Continuity and Transition Plans

On June 28, 2016, the SEC formally proposed a new rule ("Rule 206(4)-4") under the Investment Advisers Act of 1940, as amended (the "Advisers Act"), that would require registered investment advisers ("RIAs") to adopt and implement written business continuity and transition plans and to review no less frequently than annually the adequacy and effectiveness of such plans.  The proposed rule is subject to a 60-day comment period, which will expire on September 6, 2016.[1] As proposed, Rule 206(4)-4 would require RIAs to adopt written business continuity and transition plans "reasonably designed to address operational and other risks related to a significant disruption in the investment adviser’s operations."  Such plans would be required to address at least the following two elements of disruption risk: Business continuity after a significant business disruption; and Business transition in the event the RIA is unable to continue providing investment advisory services to clients. Each of these requirements is elaborated on below. Proposed Rule 206(4)-4 would require the business continuity plans adopted by an RIA to include written policies and procedures addressing at least the following elements in the event of a significant business disruption: Maintenance of critical operations and systems, including the protection, backup and recovery of client records and other critical data; Pre-arranged alternative worksites for the RIA’s personnel; Communication with the RIA’s clients, employees, service providers, and regulators; and Identification and assessment of third party services critical to the operation of the RIA. In general, these requirements are not new.  Since the adoption of the Compliance Program Rule (Rule 206(4)-7) in 2003, RIAs have in practice been required to adopt written business continuity and disaster recovery plans pursuant to SEC Staff interpretive guidance.  Although proposed Rule 206(4)-4 would impose more specificity as to the required elements of a business continuity and disaster recovery plan than has previously been the case, most RIAs should already have plans in place that comply in most material respects with the required elements of the proposed new Rule.  Proposed Rule 206(4)-4 would also require RIAs to adopt a written plan of transition "that accounts for the possible winding down of the RIA’s business or the transition of the RIA’s business to others in the event the RIA is unable to continue providing investment advisory services."  Such a plan would be required to include policies and procedures addressing at least the following: The safeguarding, transfer and/or distribution of client assets during transition; Facilitation of the prompt generation of any client-specific information necessary to transition each client account; Information regarding the corporate governance structure of the RIA;[2] Identification of any material financial resources available to the RIA; and An assessment of applicable law and contractual obligations governing the RIA and its clients (including any pooled investment vehicles) implicated by the RIA’s transition. These business succession requirements are new, and most RIAs would need to develop compliance policies and procedures to address them.  Proposed Rule 206(4)-4 grows out of a regulatory trend that focuses on operational risk in the financial services industry as a potential source of systemic risk to the U.S. financial system as a whole, particularly in light of the industry’s heavy dependence on technology.  As the SEC notes in the Proposing Release for Rule 206(4)-4, many financial regulators already have rules in place requiring the financial firms under their oversight to adopt written business continuity and transition plans.  In addition, in 2014, the Financial Stability Oversight Council ("FSOC"), a body created under Dodd-Frank to monitor for and coordinate the Federal regulatory responses to potential systemic risks to the U.S. financial system, issued a request for public comment on the financial products and activities of the asset management industry, including operational risks and transition planning.  The SEC’s focus on cybersecurity as one of its top examination priorities over the past several years can also be seen as part of this trend.  Clients should reach out to their Gibson Dunn contacts if they have any questions regarding proposed Rule 206(4)-4 or any other regulatory matters.                 [1]              A copy of the SEC’s Proposing Release for Rule 206(4)-4 may be found on the SEC’s website at https://www.sec.gov/rules/proposed/2016/ia-4439.pdf.                  [2]              In its Proposing Release, the SEC states that the purpose of this requirement is to identify key decision-makers within an RIA’s organization and to address whether and how any inter-relationships between an RIA and its affiliates might affect the transition process.  The Release goes on to state that an RIA’s transition plan should include an organization chart and other information about the RIA’s ownership and management structure, including the identity and contact information for key personnel, and the identity of any affiliates whose dissolution or distress could lead to a change in or material impact on the RIA’s operations. Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, or any of the following leaders and members of the firm’s Investment Funds practice group: Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, jbellah@gibsondunn.com)Edward D. Sopher – New York (+1 212-351-3918, esopher@gibsondunn.com)Y. Shukie Grossman – New York (+1 212-351-2369, sgrossman@gibsondunn.com)Edward D. Nelson – New York (+1 212-351-2666, enelson@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, wthomas@gibsondunn.com)Gregory Merz – Washington, D.C. (+1 202-887-3637, gmerz@gibsondunn.com)   © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 1, 2016 |
Indian Government Amends Foreign Direct Investment Policy (July 2016)

The Foreign Direct Investment Policy ("FDI Policy") is the primary regulation governing foreign investment in India. The Government of India ("Government") introduced several amendments to the FDI Policy through the annual Consolidated Foreign Direct Investment Policy Circular, 2016 issued on June 7, 2016 ("2016 FDI Policy") and a subsequent press note issued on June 24, 2016 ("Press Note")[1]. The 2016 FDI Policy supersedes the FDI Policy of 2015, which was issued by the Government in May 2015 ("2015 FDI Policy") and consolidates several amendments issued by the Government since May 2015. The Press Note effects changes to the 2016 FDI Policy. For the purposes of this alert, it is relevant to note that under the FDI Policy, there are two routes for foreign strategic investors to invest in an Indian company: Government Route: Where the prior approval of the Government is required for foreign investment in certain specific business sectors or beyond certain prescribed investment thresholds; and Automatic Route: Where foreign investment is freely permitted without the prior approval of the Government. This alert is a brief summary of the changes brought about by the 2016 FDI Policy and the Press Note: Sector Former FDI Policy Revised FDI Policy   Cap Route Cap Route Broadcasting Carriage Services 49% Automatic 100% Automatic Above 49% Government Brownfield Airports 74% Automatic 100% Automatic Above 74% Government Domestic Passenger Airlines 49% Automatic 49% Automatic Above 49% Government Private Security Agencies 49% Government 49% Automatic Above 49% up to 74% Government Brownfield Pharmaceutical Projects 100% Government 74% Automatic Above 74% Government   Single Brand Retail Trading: Under the Press Note, Indian entities with foreign investment of 51% or more that are engaged in single brand retail trading involving ‘state-of-art’ or ‘cutting- edge’ technologies are exempted from the local sourcing requirement (of 30% of the value of the goods purchased) for a period of 3 years. The exemption is available only in circumstances where local sourcing of products is not possible. This exemption period will commence from the date of the opening of the first store. Trading of Food Products: The Government has now permitted 100% foreign investment under the Government Route for entities engaged in retail trading of food products manufactured or produced in India (including through e-commerce). Private Security Agencies: In addition to the change in the sectoral limit for foreign investment in this sector (set out in the table above), the 2016 FDI Policy has clarified that private securities agencies are entities providing private security services, including training of private security guards and deployment of armoured cars. Prior to this clarification, there was some ambiguity on whether all these activities would be treated as activities of a private security agency for the purposes of foreign investment. The entity would be required to comply with the [Indian] Private Security Agencies (Regulation) Act, 2005.   Investment by Foreign Venture Capital Investors ("FVCIs"): The 2016 FDI Policy has clarified that FVCIs are permitted to invest in Venture Capital Funds or Category I Alternative Investment Funds registered with the Securities and Exchange Board of India ("SEBI") or Indian companies engaged in ten specified sectors[2] (e.g., biotechnology, nanotechnology, IT, infrastructure etc.).  FVCIs are now also permitted to invest in ‘start-up’ entities[3] engaged in any sector. This clarification has been made to make the 2016 FDI Policy consistent with the regulations issued by the Reserve Bank of India ("RBI") on foreign investment for FVCIs. Courier Services: The 2016 FDI Policy reiterates that foreign investment in courier services is permitted up to 100% under the Automatic Route and is not subject to any foreign investment restrictions or conditions. Defence: Under the 2016 FDI Policy, foreign investment of up to 49% is permitted under the Automatic Route. Foreign investment exceeding 49% was permitted in this sector only if such investment was likely to result in access by the Indian company to ‘modern’ and ‘state-of-art’ technology. Pursuant to the Press Note, the Government can now approve foreign investment exceeding 49% in this sector if it determines that such investment will result in access by the Indian company to ‘modern’ technology or for other reasons to be recorded by the Government. While this appears to be a relaxation of the 2016 FDI Policy requirements, the Government is yet to define the term ‘modern’. The revised FDI Policy also applies to entities involved in the manufacture of small arms and ammunition covered under the [Indian] Arms Act, 1959. The following is a brief summary of the various amendments/notifications issued by the Government in the last year (after the 2015 FDI Policy was issued). These have now been consolidated and set out in the 2016 FDI Policy. We have separately discussed each of these amendments/notifications (as and when these came into effect) in our client alerts circulated since May 2015.   Composite Caps: Under previous FDI Policies, there were investment caps or ceilings in specific industry sectors beyond which foreign investors were not permitted to invest. For example, there was a 74% cap on investment in private banks. Within these overall caps, there were further sub-ceilings for various categories of foreign investors (i.e., a regular foreign investor, a foreign portfolio investor, etc.). The sub-ceilings within the overall sectoral cap have been eliminated and the 2016 FDI Policy now only provides for composite caps for foreign investment across sectors. Foreign investment through Partly-Paid Shares and Warrants: Foreign investment by way of partly-paid shares and warrants can now be made under the Automatic Route in industry sectors that are eligible for foreign investment under the Automatic Route. Under the 2015 FDI Policy, the prior approval of the Government was required for subscribing to partly-paid shares or warrants. This enables foreign investors to acquire an interest in an Indian company with the ability to fund the company fully at a later stage. Some of the key conditions that investors must comply with at the time of subscribing to partly-paid shares or warrants are: (a) the total price for these instruments must be determined at the time of their subscription; (b) at least 25% of the total consideration must be received upfront; and (c) the balance consideration must be received within 12 months for partly-paid shares and within 18 months for warrants.  Share Transfers between Non-Residents: A non-resident is permitted to transfer shares of an Indian company to another non-resident without the need to comply with the pricing guidelines of the RBI. These pricing guidelines apply to transfer of shares of an Indian company between residents and non-residents and vice-versa. There are also no reporting requirements for a transfer of shares between non-residents. There was, however, some ambiguity on whether the prior approval of the Government was required for a transfer of shares of an Indian company between two non-residents if that company is engaged in a Government Route sector. The 2016 FDI Policy now expressly clarifies that prior approval of the FIPB will be required for a transfer of shares of an Indian company between two non-residents only if that company is engaged in a sector under the Government Route. Real Estate Investment Trusts & Infrastructure Investment Trusts: The 2016 FDI Policy now states that real estate investment trusts, infrastructure investment trusts and alternative investment funds are recognized as eligible entities for receiving foreign investment. The establishment and operation of these trusts and funds are regulated by the SEBI. These trusts provide a tax efficient means for investment in capital intensive sectors and incentivize greater foreign investment. Limited Liability Partnerships: The 2016 FDI Policy states that foreign investment is now permitted in limited liability partnerships ("LLPs") without Government approval in business sectors where 100% foreign investment is permitted under the Automatic Route. In addition, LLPs are permitted to make further downstream investments in any company or LLP in India engaged in a business sector where 100% foreign investment is permitted under the Automatic Route. While this has been done to bring LLPs at par with companies under the FDI Policy for the purpose of receiving foreign investment, LLPs continue to be subject to certain restrictions under the [Indian] Limited Liability Partnership Act, 2008. For example, debt investment in LLPs continues to be prohibited. Pre-Commencement of Business Foreign investment: The 2016 FDI Policy states that foreign investment in a company not engaged in any business activity and with no downstream investments (at the time that foreign investment is received by such company) is permitted under the Automatic Route if such company proposes to engage in activities that are otherwise permitted under the Automatic Route. Previously, foreign investment in any company without operations required prior approval of the Government. Changes in Sectoral Caps and Conditions: In addition to the changes discussed above, the Government has introduced several amendments over the last year to increase sectoral caps for foreign investment and to simplify investment conditions. For example, foreign investment caps applicable to insurance companies, pension funds, defence manufacturing and construction have been increased, conditions imposed on single brand retail trading entities with foreign investment have been simplified and the Government’s position on foreign investment in entities engaged in e-commerce activities has been clarified. The 2016 FDI Policy incorporates all these changes, amendments and clarifications[4].    [1]   Press Note 5 (2016 Series) dated June 24, 2016    [2]   As notified in the Annexure to Schedule 6, Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (Notification No. FEMA 20/2000-RB dated 3rd May 2000).    [3]   A "start-up" has been defined under the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 to mean (i) an entity incorporated/registered in India for a period of up to 5 years from the date of its incorporation/ registration; (ii) having a  turnover, in any financial year, of less than INR 250,000,000 (approx. USD 3.67 Million) and (iii) working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.    [4]   For further detailed analysis on these changes please refer to our client alerts dated May 18, 2016 http://www.gibsondunn.com/publications/Pages/India-Legal-and-Regulatory-Update.aspx  and October 21, 2015 http://www.gibsondunn.com/publications/Pages/Legal-Developments-in-India–2015-Nine-Month-Update.aspx Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details, please contact the Gibson Dunn lawyer with whom you usually work or the following authors in the firm’s Singapore office: India Team:Jai S. Pathak (+65 6507 3683, jpathak@gibsondunn.com)Priya Mehra (+65 6507 3671, pmehra@gibsondunn.com)Bharat Bahadur (+65 6507 3634, bbahadur@gibsondunn.com)Karthik Ashwin Thiagarajan (+65 6507 3636, kthiagarajan@gibsondunn.com)Sidhant Kumar (+65 6507 3661, skumar@gibsondunn.com)  © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 14, 2016 |
IRS Releases Temporary and Proposed Regulations Extending REIT Built-in Gain Recognition Period for Property Acquired from a C Corporation and Tightening the Rules for REIT Spinoffs

On June 7, 2016, the Internal Revenue Service (the "IRS") and the Treasury Department issued temporary and proposed regulations (the "New 337 Regulations") under section 337[1] that (i) extend the period during which a real estate investment trust (a "REIT") is subject to U.S. federal income tax in respect of built-in gains recognized on property acquired from a C corporation and (ii) tighten the rules for tax-free spinoffs involving REITs.  We summarize below the provisions of the regulations. Extension of Built-in Gain Recognition Period to Ten Years The New 337 Regulations extend from five years to ten years the period during which a REIT will be subject to U.S. federal income tax in respect of any "recognized C corporation built-in gain."  For this purpose, "recognized C corporation built-in gain" is gain recognized by a REIT on the taxable disposition of property acquired from a C corporation to the extent the gain is attributable to the period during which the property was held by the C corporation.  Under Treasury Regulations, if a REIT acquires property in a "conversion transaction" from a C corporation and later disposes of the property in a taxable transaction, the REIT generally is required to pay U.S. federal income tax on the gain recognized, unless the REIT elects to recognize any gain in the property at the time of the conversion transaction.  A "conversion transaction" generally includes both the conversion of a C corporation to a REIT and most transfers of property to a REIT in which gain is not recognized.  Importantly, a REIT generally is subject to U.S. federal income tax on property acquired in a conversion transaction only to the extent of the built-in gain in the property at the time of the conversion transaction and only if the property is disposed of during the "recognition period."[2]    It should be noted that, before the promulgation of the New 337 Regulations, the recognition period for REITs was defined by reference to the rules with respect to S corporations under section 1374.  S corporations are subject to similar treatment as REITs in respect of conversions from C corporations.  Prior to 2009, the recognition period under section 1374 was ten years.  The recognition period under section 1374 was temporarily reduced for years beginning after 2008 and was permanently reduced to five years in December 2015, pursuant to the Consolidated Appropriations Act of 2016 (also known as the "PATH Act").  The New 337 Regulations would no longer define the recognition period by reference to section 1374, but would separately define the recognition period as a period of ten years from the date a REIT acquires property in a conversion transaction.  This change is effective for conversion transactions that occur after August 7, 2016. Tightening of REIT Spinoff Rules The New 337 Regulations also tighten the taxation of REITs involved in tax-free spinoffs under section 355. The PATH Act revised section 355 to eliminate tax-free treatment if either the distributing corporation or the controlled corporation (i.e., the corporation that was spun-off) is a REIT.  Further, the PATH Act modified section 856 to prohibit a corporation from electing REIT status during the ten-year period following a section 355 tax-free spinoff.  According to the preamble to the New 337 Regulations, the IRS and Treasury are concerned that the PATH Act does not completely prohibit taxpayers from effecting tax-free separations of REIT-qualifying assets from non-REIT-qualifying assets.  Accordingly, the New 337 Regulations provide that: (1) if a REIT acquires property of a C corporation in a conversion transaction within ten years after a section 355 spinoff to which the C corporation (or any affiliate, predecessor, or successor) was a party, the C corporation will recognize any net-built in gain on the property acquired by the REIT in the conversion transaction; and (2) if a REIT acquires property in a conversion transaction, the REIT will recognize any remaining pre-conversion built-in gain on the property if the REIT (or any affiliate, predecessor, or successor) is a party to a section 355 spinoff occurring within ten years after the conversion transaction. Consistent with the PATH Act, these rules do not apply if a REIT spins off another REIT or, in certain circumstances, a taxable REIT subsidiary. The spinoff rules apply if the conversion transaction or the section 355 spinoff occurs after June 6, 2016, although an IRS official has indicated that the IRS will make a correction to the New 337 Regulations that will exempt conversion transactions following spinoffs that occurred before December 7, 2015.    [1]   Unless indicated otherwise, all section references are to the Internal Revenue Code of 1986, as amended.    [2]   These rules also apply to regulated investment companies. The following Gibson Dunn lawyers assisted in preparing this client alert:  Brian Kniesly, Eric Sloan, Art Pasternak, Jeff Trinklein and Daniel Zygielbaum. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments.  For further information, please contact the Gibson Dunn lawyer with whom you usually work or any of the following members of the Tax Practice Group: Art Pasternak - Co-Chair, Washington, D.C. (+1 202-955-8582, apasternak@gibsondunn.com)Jeffrey M. Trinklein - Co-Chair, London/New York (+44 (0)20 7071 4224 / +1 212-351-2344), jtrinklein@gibsondunn.com)Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@gibsondunn.com)David B. Rosenauer - New York (+1 212-351-3853, drosenauer@gibsondunn.com)Eric B. Sloan – New York (+1 212-351-2340, esloan@gibsondunn.com)Romina Weiss - New York (+1 212-351-3929, rweiss@gibsondunn.com)Benjamin Rippeon – Washington, D.C. (+1 202-955-8265, brippeon@gibsondunn.com)Hatef Behnia – Los Angeles (+1 213-229-7534, hbehnia@gibsondunn.com)Paul S. Issler – Los Angeles (+1 213-229-7763, pissler@gibsondunn.com)Dora Arash – Los Angeles (+1 213-229-7134, darash@gibsondunn.com)Scott Knutson – Orange County (+1 949-451-3961, sknutson@gibsondunn.com)David Sinak – Dallas (+1 214-698-3107, dsinak@gibsondunn.com)      © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 6, 2016 |
Middle East Financial Services Hub – A Snapshot of the DIFC Landscape

The Dubai International Financial Centre ("DIFC") was established over a decade ago as a financial services hub for the Middle East region. It has attracted over 400 global and regional financial services firms and has established Dubai as the leading regional financial centre. This note provides a snapshot of the DIFC and the regulatory landscape of carrying out financial services activities in and from the DIFC. This note is not meant to be exhaustive. 1.    What is the DIFC? The DIFC is a geographically defined financial free zone in Dubai in which the civil and commercial laws of the United Arab Emirates do not apply. It has a unique set of civil and commercial laws that are inspired by English Common Law. It was established as a financial services hub for the Middle East region. 2.    What are some of the key factors that attract firms to the DIFC? A regulatory framework designed for financial services firms. Effective regulatory safeguards that are attractive to clients and investors. Strength in numbers and by association due to being in the company of over 400 global and regional financial services firms. No foreign ownership restrictions. No restriction on capital or profit repatriation. A 40-year guarantee of zero taxes on corporate income and profits. A set of civil and commercial laws inspired by English Common Law. An independent judicial system. A financial services regulatory approach which is closer to that of the UK FCA than that of other regional financial services regulators. A relatively predicable licensing process and timeline (see below). An English language jurisdiction. Dubai’s travel connections and proximity to clients and investors based in the UAE and the other GCC countries. 3.    Who regulates financial services in the DIFC? The Dubai Financial Services Authority ("DFSA") is the independent financial services regulator in the DIFC. 4.    When is a DFSA licence required? A firm carrying on a financial service in or from the DIFC must be authorised to do so by the DFSA. 5.    What is a "financial service"? A financial service is any one of 24 activities specified by the DFSA Rulebook which is carried on by way of business in or from the DIFC. Common financial services activities carried on in or from the DIFC include "Advising on Financial Products or Credit", "Arranging Credit or Deals in Investments", "Managing Assets" and "Managing a Collective Investment Fund". The term "by way of business" means engaging in, holding oneself out as willing to engage in or regularly soliciting other persons or entities to engage in transactions constituting a financial services activity. There are a number of instances where a firm does not require a licence such as, for example, engaging in financial service activities with group companies only. 6.    What is the geographical scope of a DFSA licence? A DFSA-authorised firm is allowed to carry on its activities ‘in or from the DIFC’. Carrying out the same activities ‘onshore’ in the UAE (and, indeed, in the rest of the Middle East) will generally require the firm to obtain separate ‘onshore’ licences or use licensed intermediaries unless an exemption is available. 7.    How long does authorisation take? The DIFC and DFSA formation and licensing process is likely to take 4-6 months. The process is relatively predicable but is document heavy and involves extensive interaction with the DIFC and DFSA. 8.    What are the key steps in the authorisation process? The key steps are as follows: Submission of a letter of intent to the DIFC containing the proposal to establish in the DIFC. Preparation of the DFSA application and related documentation (including a regulatory business plan and compliance policies and procedures). Interaction with the DFSA to finalise the application. Submission of the DFSA application. Formal review of the application by the DFSA (usually takes 3-4 months). Approval in principle. Incorporation and licensing of the DFSA-authorised firm. 9.    Are there any mandatory licensed functions? All DFSA-authorised firms must appoint a senior executive officer, a finance officer, a compliance officer and a money laundering reporting officer – the latter two positions may be combined. The persons holding such positions must be authorised by the DFSA (i.e., be DFSA-authorised individuals). All except the finance officer must be resident in the UAE. The DFSA may temporarily waive the residency requirement on a case by case basis. 10.   Does a DFSA-authorised firm need an office in the DIFC? All DFSA-authorised firms must have an office in the DIFC. 11.   What are the main regulatory requirements for DFSA-authorised firms? DFSA-authorised firms must comply with 12 core principles: Principle 1 — Integrity Principle 2 — Due skill, care and diligence Principle 3 — Effective and responsible management and adequate systems and controls Principle 4 — Adequate resources Principle 5 — Proper standards of market conduct Principle 6 — Clear, fair and not misleading information and due regard to client interests Principle 7 — Conflicts of Interest – identification, disclosure, prevention, management Principle 8 — Suitability of advice and discretionary decisions Principle 9 — Protection of customer assets and money Principle 10 — Open and co-operative dealings with regulators Principle 11 — Compliance with high standards of corporate governance Principle 12 — Appropriate remuneration practices 12.   What are the main regulatory requirements for DFSA-authorised individuals? DFSA-authorised individuals must comply with six core principles: Principle 1 — Integrity Principle 2 — Due skill, care and diligence Principle 3 — Proper standards of market conduct Principle 4 — Open and co-operative dealings with regulators Principle 5 — Effective management, systems and control Principle 6 — Compliance with applicable law and regulation Gibson Dunn, with more than 1,200 lawyers in 18 offices in major cities throughout the United States, Europe, the Middle East, Asia and South America, is committed to providing the highest quality legal services to its clients. Gibson Dunn has been advising leading Middle Eastern institutions, companies, financial sponsors, sovereign wealth funds and merchant families on their global and regional transactions and disputes for more than 35 years. Please contact the Gibson Dunn lawyer with whom you usually work, or the following lawyers in the firm’s Dubai office, with any questions, thoughts or comments arising from this article. Hardeep Plahe (+971 (0) 4 318 4611, hplahe@gibsondunn.com)Graham Lovett (+971 (0) 4 318 4620, glovett@gibsondunn.com)  © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 6, 2016 |
Indonesia Update: New Negative Investment List

What is the Negative Investment List? The "Negative Investment List" or "DNI[1]" is a regulation issued under Indonesian law[2] which sets out a list of industry sectors in Indonesia for which foreign investment is either prohibited, permitted or conditionally permitted.  This regulation is periodically updated to reflect the Indonesian Government’s economic policy.  In February the Indonesian Government indicated that it would be extensively revising the Negative Investment List as part of an economic stimulus package to further liberalize the Indonesian economy.  One of the issues with interpreting this list is the often unintuitive classification of industry sectors themselves, which are generic and contain no detailed definitions.  These classifications were devised by the Central Statistics Bureau and are referred as the 2015 Indonesian Business Sector Classifications ("KBLI").  Due to the lack of these definitions, other regulatory agencies often make their own determinations on what constitutes a certain business activity (see the "Commentary" section below).  If an industry sector is not referred to in the Negative Investment List, then it is usually considered wholly open to foreign investment. What has Changed? The Indonesian Government’s new 2016 Negative Investment List came into effect on May 18th, 2016[3] and this revokes and replaces the previous list issued in 2014[4].  The 2016 Negative Investment List is intended to make Indonesia more competitive within ASEAN[5] and to boost recently declining foreign direct investment ("FDI") into Indonesia. The table below summarises some of the most notable industry sectors to be affected by the 2016 Negative Investment List and its associated adjustments to foreign ownership limits[6]: Industry Sector 2014 Negative Investment List 2016 Negative Investment List Energy, Transport & Infrastructure     Geothermal Power (Power Plants of 10 MW or less) Foreign ownership of power plants in general is not permitted for plants of less than 1 MW and permitted up  to a maximum of 49% for plants of 1–10 MW Introduces a specific category of geothermal power plants which permits foreign ownership up to a maximum of 67% Toll Roads Foreign ownership permitted up to a maximum of 95% 100% foreign ownership permitted Construction Consultancy Services (For Projects of more than IDR10 billion) Foreign ownership permitted up to a maximum of 55% Maximum foreign ownership limit increased to 67% (70% for ASEAN member states) High Voltage Electricity Construction and Installation Foreign ownership prohibited Foreign ownership now permitted up to a maximum of 49% Ports Foreign ownership permitted up to a maximum of 49% No change Land Transportation Foreign ownership prohibited Foreign ownership now permitted up to a maximum of 49% Support Services related to Air Transport[7] Foreign ownership permitted up to a maximum of 49% Maximum foreign ownership limit increased to 67% Support Services related to Airports[8] Foreign ownership permitted up to a maximum of 49% Maximum foreign ownership limit increased to 67% Salvage Services or Maritime Subsea Work Foreign ownership permitted up to a maximum of 49% 100% foreign ownership permitted[9] Maritime Cargo Handling Foreign ownership permitted up to a maximum of 49% Maximum foreign ownership limit increased to 67% (70% for ASEAN member states)[10] Telecommunications     Telecommunications Equipment Testing Foreign ownership permitted up to a maximum of 49% 100% foreign ownership permitted Networks with Integrated Services Foreign ownership permitted up to a maximum of 65% Maximum foreign ownership limit increased to 67% Telecommunications Towers Foreign ownership prohibited No change Financial Services     Investment Financing, Working Capital Financing and Multipurpose Financing Not previously regulated Foreign ownership permitted up to a maximum of 85% Pension Funds Foreign ownership prohibited Now deleted i.e., 100% foreign ownership permitted Underwriting Firms Not previously regulated Foreign ownership permitted up to a maximum of 30% Non-Bank Money Changers Not previously regulated Foreign ownership prohibited Healthcare     Pharmaceutical Raw Materials Foreign ownership permitted up to a maximum of 85% 100% foreign ownership permitted Healthcare Support Services[11] Foreign ownership prohibited Foreign ownership now permitted up to a maximum of 67% Hospital Management Services Foreign ownership permitted up to a maximum of 67% 100% foreign ownership permitted Medical Device Distributorship Foreign ownership permitted up to a maximum of 33% as part of general distribution Now a specific category which permits foreign ownership up to a maximum of 49% Medical Equipment Not regulated Now includes a "Class A" sub-category for which foreign ownership is permitted up to a maximum of 33% and other classes for which 100% foreign ownership is permitted[12] Commercial and Consumer     Alcohol Industry Foreign ownership prohibited No change Cane Sugar Industry Foreign ownership permitted up to a maximum of 95% 100% foreign ownership permitted subject to certain restrictions Cold Storage Foreign ownership permitted up to a maximum of 33% 100% foreign ownership permitted Crumb Rubber Foreign ownership prohibited 100% foreign ownership permitted subject to certain restrictions[13] Department Stores (retail space 400 – 2,000m2) Foreign ownership prohibited Now open to foreign ownership up to a maximum of 67%[14] Distribution Not Affiliated with Production Foreign ownership permitted up to a maximum of 33% Maximum foreign ownership limit increased to 67% Electronic Trade Transaction Providers  (Investment of less than IDR100billion) Not previously regulated Foreign ownership now permitted up to a maximum of 49% Film/ Movie Industry Foreign ownership prohibited 100% foreign ownership permitted Film Processing Laboratories Foreign ownership permitted up to a maximum of 49% 100% foreign ownership permitted Non-Hazardous Waste Processing and Disposal Foreign ownership permitted up to a maximum of 95% 100% foreign ownership permitted Tourism Related Industries[15] Various categories depending upon the type of business with foreign ownership permitted up to a maximum ranging from 49– 51% 100% foreign ownership permitted Warehousing Foreign ownership permitted up to a maximum of 33% Maximum foreign ownership limit increased to 67%   Exceptions Portfolio investments (i.e., investments in listed companies through share purchases on the Indonesian Stock Exchange) are not covered by the restrictions in the Negative Investment List. Wholly-owned foreign ownership is generally permitted in Special Economic Zones (unless the industry sector is reserved for micro/medium sized enterprises).  Special Economic Zones are certain areas which have been granted with special economic privileges by the Government of Indonesia. A special grandfathering provision is contained within the 2016 Negative Investment List so that any existing foreign investors in industry sectors that have been affected by the new Negative Investment List are permitted to retain their previously approved investment even if that investment now exceeds the new permitted threshold or is prohibited. Commentary Despite the more liberalized scope of the Negative Investment List, there continue to be a number of other practical restrictions (or rather conditions) to foreign investment in Indonesia.  One of the most significant of these are requirements of the Indonesian Investment Coordinating Board ("BKPM") of a minimum investment amount greater than IDR2.5 billion (approximately USD 186,000) (which BKPM usually expects to be increased to IDR10 billion (approximately USD 746,000) within one year depending upon the initial approval) for the establishment of a foreign investment company.  The establishment of such a corporate vehicle is often a prerequisite for a foreign investor wishing to establish a venture in Indonesia (although see the exception above regarding portfolio investments). As mentioned above, due to the KBLI not having produced definitions of what constitutes certain businesses or industry sectors, the BKPM often exercises its discretion to interpret which precise activities come within the scope of each industry sector or business line listed in the Negative Investment List.  This often goes beyond a "filling in the blanks" type approach – for example, if a particular business is not specifically mentioned in the Negative Investment List (i.e., which should, in theory mean it is open to 100% foreign ownership), the BKPM may still decide that that business in question falls within the scope of another industry sector.  There is therefore often a need for potential investors in conjunction with their counsel to have an initial consultation with the BKPM before making an official application. In certain areas the 2016 Negative Investment List affords higher foreign ownership limits to investors of ASEAN member states.  One area which remains untested is the degree to which the BKPM may seek to pierce corporate structures established by a non-ASEAN company which owns or controls an ASEAN company and which is attempting to avail itself of the higher foreign ownership privileges accorded to an ASEAN company[16]. The new Negative Investment List has generally widened the overall scope of businesses for which foreign ownership is permitted.  While generally seen a positive move by the Indonesian Government, some aspects have come as a disappointment to some members of the business community who were anticipating a greater degree of liberalisation of certain sectors given the anticipation that a fundamental overhaul of the Negative Investment List would be forthcoming.  Although a move in the right direction, foreign participation remains restricted across a considerable part of the Indonesian economy.  It remains to be seen whether this will act as the defibrillator to the sluggish heart-beat of Asia’s fifth largest economy.                  [1]         Daftar Negatif Investasi.                 [2]         Law No. 25 of 2007 on Capital Investment.                 [3]         Presidential Regulation No. 44 of 2016 on Lists of Business that are Closed for Investment and Business that are Conditionally Open for Investment.                 [4]         Presidential Regulation No. 39 of 2014.                 [5]         In addition, the 2016 Negative Investment List is also a recognition of the Government of Indonesia’s obligations under the ASEAN Comprehensive Investment Agreement (ACIA) of 2009 whereby higher foreign ownership limits are afforded to investors from ASEAN member states.                 [6]         The table does not purport to reflect all the industry sectors or business lines affected by the 2016 Negative Investment List, but only those likely to be of specific interest to our clients.  Please contact us for queries on specific business activities.                 [7]         For example: computer reservation systems, ground services, cargo handling and aircraft leasing.                 [8]         Including freight forwarding services and airline general sales agents.                  [9]         Subject to a special license being obtained from the Ministry of Transportation.                 [10]       Limited to only 4 ports located in eastern Indonesia (Bitung, Ambon, Kupang and Sorong).                 [11]       For example, pest control and ambulance services.                 [12]       Class A medical equipment is the simplest kind and other classes B, C and D are in increasing order of complexity.  All are subject to the obtaining of a license from Ministry of Health.                 [13]       Foreign investors are still required to secure licenses from the Ministry of Industry and establish their own plantations.                 [14]       Subject to a special license must be obtained from the Ministry of Trade.                 [15]       This includes related businesses such as restaurants, recreation, arts and entertainment and sports facilities (excluding those for billiards, bowling and golf for which 2016 Negative Investment List permits foreign ownership up to a maximum of 67%).                 [16]       The investment benefits of the ASEAN Comprehensive Investment Agreement of 2009 may be denied by an ASEAN member state (the "Denying State") to either (i)  a non-ASEAN investor which owns or controls an ASEAN Investor which has no substantive operations in the Denying State, (ii) an ASEAN Investor that is owned by an investor of the Denying State and which has no substantive operations in the Denying State, or (iii) an ASEAN Investor that is owned by a non-ASEAN investor and the Denying State has no diplomatic relations with the non-ASEAN investor’s state.  Gibson Dunn partner Saptak Santra prepared this client update with the assistance of lawyers from the Indonesian law firm Kandar & Partners.  Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these issues.  For further details, please contact the Gibson Dunn lawyer with whom you usually work or the author: Saptak Santra – Singapore (+65 6507 3691, ssantra@gibsondunn.com)  © 2016 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.