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Our lawyers provide sophisticated analysis, practical guidance and thought leadership on a wide range of topics. We encourage our readers to review this collection of client alerts, articles and white papers and benefit from the authors’ exceptional experience, market knowledge, practiced judgment and singular insights.

July 20, 2010

UK Pensions Regulator Issues First Contribution Notice

Historic liabilities arising from defined benefit pension schemes continue be a significant feature of the corporate landscape in the UK.  The Pensions Regulator has sweeping powers to make orders to ensure that historic liabilities are adequately provided for.  Under the Pensions Act 2004 the Pensions Regulator has the power to make orders that could have extra-territorial application and effect.  The Pensions Regulator has, for the first time, exercised its enforcement powers to require a Dutch parent company to make a sizable lump sum contribution to make good the deficit in the pension scheme of its UK subsidiary.   The Pensions ProblemDuring the last 10-20 years a large number of employers in the UK have scaled back their employee pension arrangements.  At one time, it was common for employers to offer defined benefit pension arrangements, with scheme assets held in trust and sponsored by the employer.  A typical scheme might have provided a pension on retirement equivalent to two thirds of final salary after forty years service.  As a result of disappointing returns on equities and increased life expectancy in recent years, many of these schemes carry very significant deficits.  Many private sector schemes have closed to new members or to future service accrual but the funding of these schemes in respect of their historic liabilities remains the ongoing responsibility of the sponsoring employer.  The Pensions Regulator – Moral Hazard Provisions The Pensions Act 2004 created a form of statutory insurance in the form of the Pension Protection Fund to provide a minimum pension to all pension scheme members in the event of insolvency of the sponsoring employer.  In order to protect the fund and prevent sponsoring employers of pension schemes from walking away from their liabilities, the legislation also created a new Pensions Regulator with far reaching powers.  These included powers to issue:Financial Support Directions.  Financial Support Directions  may be issued when the sponsoring employer of a scheme is either a "service company" or is "insufficiently resourced".   Contribution Notice.  Contribution Notices may be issued when either: (a) there has been an act or omission, one of the main purposes of which was to avoid or reduce the employer's debt to the scheme; or (b) there has been an act or failure to act that is materially detrimental to the likelihood of members receiving their accrued benefits under the scheme unless the employer can show that it took all reasonable steps to avoid the detriment [1] .Both powers may only be exercised when it is reasonable to do so having regard to specified factors.  Significantly, the powers allow the Pensions Regulator to "pierce the corporate veil" by issuing notices not just to sponsoring employers but also to group companies and certain other associates.  Contribution Notices go even further and can be issued personally to directors.  Both Contribution Notices and Financial Support Directions can be issued against non-UK entities although there remains the practical issue of whether they would ultimately be enforced by overseas courts.   A Contribution Notice could accelerate payment of the entire employer debt.  By contrast, Financial Support Directions are more flexible in the financial support that can be provided[2] .   The First Contribution NoticeThe First Contribution Notice has recently been issued against a Dutch company called Michel Van De Wiele NV ("VDW").  In 1998 VDW acquired a loss making English company called Bonas Machine Company Limited ("Bonas").  Bonas sponsored a pension scheme which in 1998 had a deficit of £285,000.  In an attempt to turn Bonas around, VDW moved Bonas's manufacturing operations to Belgium, only retaining its R&D facility in the UK.  However these measures were not successful and Bonas continued to incur losses.  By November 2005 the pension scheme deficit had increased significantly.  In August 2006 a "pre-pack" administration was proposed, whereby the business and employees of Bonas would be transferred to a newly incorporated company and the pension scheme would be left as an unsecured creditor of Bonas.  Shortly afterwards the pension scheme entered into an assessment period with a view to being admitted to the Pension Protection Fund.  The Pension Regulator imposed a Contribution Notice requiring VDW to make a lump sum contribution of £5 million to the fund.  This was the amount required to purchase annuities to provide members with the benefits to which they would have been entitled to receive under the Pension Protection Fund.  In deciding to issue a Contribution Notice, the Pension Regulator's Determinations Panel was strongly influenced by the fact that that VDW had given the trustees the impression that it would continue to support the scheme and had failed to notify the Regulator of the proposed restructuring as it was required to do.  The Pension Regulator also considered making a Contribution Notice personally against the controlling shareholder and director of VDW but decided not to do so on the facts.  VDW is appealing against this decision. CommentIn the five years since the so called "moral hazard" provisions of the Pensions Act 2004 were introduced this is the first Contribution Notice that has been issued.  There have only been two Financial Support Directions issued including the recent Financial Support Direction issued against 25 companies in the Nortel group around the world.    This is not the reflection of a toothless regulator but rather that settlements have been reached against the backdrop of these powers in the vast majority of cases.  The case is a reminder that the Pensions Regulator will exercise its powers if settlement terms cannot be reached and will seek to enforce its determinations against overseas companies.  Those involved in assessing UK based corporate targets should obtain expert legal and actuarial input at an early stage to assess  the financial risks associated with any pension schemes operated by the group.  Those considering restructuring activities, including internal restructuring, within groups that include defined benefit pension schemes should tread carefully. [1]  Added by the Pensions Act 2008 and so not considered in the VDW case.   [2]  For instance  a well  capitalised member of the group could provide a corporate guarantee.Gibson Dunn's lawyers are available to assist in addressing any questions you may have.  Please feel free to contact the following attorneys in the firm's London office: Daniel E. Pollard (+44 20 7071 4257, dpollard@gibsondunn.com)James A. Cox (+44 20 7071 4250, jacox@gibsondunn.com)James Barabas  (+44 20 7071 4253, jbarabas@gibsondunn.com)Wayne McArdle (+44 20 7071 4237,  wmcardle@gibsondunn.com)© 2010 Gibson, Dunn & Crutcher LLPAttorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
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July 19, 2010

Major Multi-City Takedown Signals Prosecutors’ Continued Focus on Health Care Fraud and Compliance in the U.S.

In a sign of the Obama administration's continued emphasis on anti-fraud enforcement in the health care field, the joint Department of Justice-Health and Human Services Medicare Fraud Strike Force charged ninety-four people on Friday for their alleged participation in schemes to collectively submit more than $251 million in false claims to the Medicare program.  The takedown, which included arrests in Brooklyn, Miami, Baton Rouge, Detroit, and Houston, was the largest operation by the task force since its inception in 2007.The arrests were announced by officials at the highest level of the Department of Justice (DOJ) and the Department of Health and Human Services (HHS), including Attorney General Eric Holder, HHS Secretary Kathleen Sebelius, Assistant Attorney General Lanny A. Breuer, and various United States Attorneys, signaling that health care enforcement remains a top priority for federal prosecutors.Trend of Increased Enforcement Includes Corporate WrongdoersLast year, the DOJ and HHS created an interagency group--the Health Care Fraud Prevention and Enforcement Action Team (known as HEAT)--specifically tasked with combating health care fraud.  Health care fraud is now a top-five priority at the DOJ, as well as a key area of focus for the Federal Bureau of Investigation (FBI).  In his statement to the Senate Judiciary Committee, Assistant Attorney General Tony West, citing to the billions of dollars that are "wasted on fraud and abuse," reiterated that "the Department of Justice, through its Civil, Criminal, and Civil Rights divisions, along with U.S. Attorneys' Offices and the FBI--the entities responsible for enforcing laws against all forms of health care fraud--has prioritized much of our enforcement efforts on protecting the integrity of health care that is provided to patients."President Obama's 2010 budget invests $311 million--a 50 percent increase from 2009 funding--to strengthen program integrity activities within the Medicare and Medicaid programs.  These funds are not limited to investigating "street-level" fraud by individuals.  In Senate testimony, Assistant Attorney General Breuer stated that the DOJ is committed to prosecuting all who commit health care fraud, including "corporate wrongdoers."  And beginning last November, the DOJ has added several high-profile names to lead its Fraud Section, including a new chief of the Fraud Section, and continues to add "in-the-trenches" attorneys with a special focus on health care fraud to bolster the Section as well.  In fact, Obama administration officials have described fighting health care fraud as a priority of the DOJ, and health care fraud investigations as "among the highest priority investigations within the FBI's White Collar Crime Program."Friday's operation was aimed at physicians, medical assistants, and health care company owners and executives running Medicare fraud schemes.  But it also serves as a strong indication that the joint DOJ-HHS Medicare Fraud Strike Force and HEAT are fully active and engaged in pursuing their missions, including health care compliance enforcement.With this in mind, health care enforcement activity will likely continue to increase in the future.  As we have advised in prior client alerts, investigations by HHS, DOJ, and state attorneys general will likely continue in the "tried-and-true" areas, such as relationships with physician consultants, misbranding, false claims, and violations of the anti-kickback statute and Stark laws.  Enforcement officials have also begun adding to their list of practices under scrutiny, including, most recently, billing practices, "ghostwriting" and executive compensation at non-profit health care companies.  Furthermore, health care companies conducting business overseas are increasingly under scrutiny for possible FCPA violations.The collection of factors including the political climate, the success of recent enforcement actions, the injection of new funds and federal enforcement officials, the additional practices now facing scrutiny, and the state prosecutors and regulators who have joined the fray, all point to an obvious conclusion:  Health care compliance will continue to be a burgeoning enforcement area.  In this climate, it is more important than ever before that companies institute and maintain rigorous health care compliance systems and practices.The White Collar Defense and Investigations Practice Group of Gibson, Dunn & Crutcher LLP successfully defends corporations, senior corporate executives, and public officials in a wide range of federal and state investigations and prosecutions, and conducts sensitive internal investigations for leading companies in almost every business sector. The Group has members in every domestic office of the Firm and draws on more than 75 attorneys with deep government experience, including numerous former federal and state prosecutors and officials, many of whom served at high levels within the Department of Justice and the Securities and Exchange Commission. Our attorneys bring a unique breadth of experience and talent to handle complex health care enforcement matters, as well as to conduct delicate internal investigations in the health care arena. We have used that experience and perspective for a wide range of health care compliance counseling engagements, including, as examples, reviews of company protocols and policies concerning interactions with health care providers, conceptualizing and instituting needs assessment reviews for the utilization of physician-consultants, and conducting analyses of how compliance policies are effectuated in the field. Our practice is cross-disciplinary in nature, at times relying on experts in various areas to address issues such as health care privacy and data breaches, intellectual property licensing, and fair market value rates, including members of our Health Care and Life Sciences Practice Group.Los AngelesDebra Wong Yang (213-229-7472, dwongyang@gibsondunn.com)Marcellus McRae (213-229-7675, mmcrae@gibsondunn.com)Michael M. Farhang (213-229-7005, mfarhang@gibsondunn.com)Douglas Fuchs (213-229-7605, dfuchs@gibsondunn.com)Kevin S. Rosen (213-229-7635, krosen@gibsondunn.com)New YorkJoel M. Cohen (212-351-2664, jcohen@gibsondunn.com)Lee G. Dunst (212-351-3824, ldunst@gibsondunn.com)Mark A. Kirsch (212-351-2662, mkirsch@gibsondunn.com)Randy M. Mastro (212-351-3825, rmastro@gibsondunn.com)Orin Snyder (212-351-2400, osnyder@gibsondunn.com)Alexander H. Southwell (212-351-3981, asouthwell@gibsondunn.com)Jim Walden (212-351-2300, jwalden@gibsondunn.com)Lawrence J. Zweifach (212-351-2625, lzweifach@gibsondunn.com)Orange CountyNicola T. Hanna (949-451-4270, nhanna@gibsondunn.com)Washington, D.C.F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com)Michael Bopp (202-955-8256, mbopp@gibsondunn.com)David P. Burns (202-887-3786, dburns@gibsondunn.com)DenverRobert C. Blume (303-298-5758, rblume@gibsondunn.com)DallasRobert B. Krakow (214-698-3124, rkrakow@gibsondunn.com)© 2010 Gibson, Dunn & Crutcher LLPAttorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
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July 19, 2010

On the Frontier of Alien Tort Claims

New York partner Lee Dunst is the author of "On the Frontier of Alien Tort Claims" [PDF] published in the July 19, 2010 issue of the New York Law Journal. 
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July 16, 2010

Restructuring in SEC Division of Corporation Finance

PDF VersionOn July 16, 2010, the U.S. Securities and Exchange Commission (the "SEC") announced that the Division of Corporation Finance (the "Division") will create three new specialized offices that are intended to focus the Division's resources on critically important institutions and financial products.  The three new offices that the Division is establishing are:a financial services review office, which will focus on large and financially significant companies (such as bank holding companies and global financial services firms), develop new review techniques for these companies and facilitate information sharing related to these companies with others at the SEC who are involved in regulatory oversight of these companies;an asset-backed securities and other structured finance products office, which will review disclosures in this area and also initiate rulemaking and interpretive activities related to structured products as necessary; and a capital markets trends office, which will evaluate trends in securities offerings and capital markets in order to determine whether current rules are still appropriate, conduct market research, selectively review securities offerings materials (such as 424 prospectuses) and coordinate the Division's consideration of new securities products.The asset-backed securities and other structured finance products office and the capital markets trends office will be overseen by long-time staff member Paula Dubberly, the newly appointed Deputy Director for Policy and Capital Markets.  These changes will likely result in substantial movement among SEC staff members as new positions are created and vacancies are filled with attendant transfers and promotions.  As a result, there is a possibility that companies may experience some disruption in the staff review process in the short term and increased review and scrutiny of their filings and disclosures in the long term.  The SEC press releases can be found at http://www.sec.gov/news/press/2010/2010-124.htm and http://www.sec.gov/news/press/2010/2010-125.htm. Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding the issues discussed above.  Please contact the Gibson Dunn attorney with whom you work, or any of the following: Washington, D.C.Howard Adler (202- 955-8589, hadler@gibsondunn.com)Anne Lee Benedict (202-955-8654, abenedict@gibsondunn.com)Amy L. Goodman (202-955-8653, agoodman@gibsondunn.com)Stephen I. Glover (202-955-8593, siglover@gibsondunn.com)K. Susan Grafton (202-887-3554, sgrafton@gibsondunn.com)Elizabeth Ising D.C. (202-955-8287, eising@gibsondunn.com)Brian J. Lane (202-887-3646, blane@gibsondunn.com)Ronald O. Mueller (202-955-8671, rmueller@gibsondunn.com) John F. Olson  (202-955-8522, jolson@gibsondunn.com)  CaliforniaDhiya El-Saden (213-229-7196, delsaden@gibsondunn.com)David M. Hernand (310-552-8559, dhernand@gibsondunn.com)Jonathan K. Layne (310-552-8641, jlayne@gibsondunn.com)James J. Moloney (949-451-4343, jmoloney@gibsondunn.com)New YorkSteven P. Buffone (212-351-3936, sbuffone@gibsondunn.com)Joerg Esdorn (212-351-3851, jesdorn@gibsondunn.com)Steven Finley (212-351-3920, sfinley@gibsondunn.com)Glenn Pollner (212-351-2333, gpollner@gibsondunn.com)DenverRichard M. Russo (303- 298-5715, rrusso@gibsondunn.com)© 2010 Gibson, Dunn & Crutcher LLPAttorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
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July 16, 2010

Derivatives Regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act

Throughout the financial regulatory reform debate, designing a regulatory framework for the derivatives market has been one of the most contentious issues.  While the business community has supported bringing transparency, accountability, and stability to the market, it has been concerned that Congress and regulators could impose burdens on derivatives trading that would disincent businesses from hedging their own risks.  The derivatives title in the conference report, passed by the Senate on July 15, 2010, is generally opposed by business groups as applying many of the same costs and requirements on end-users as will be applied to swap dealers.  How much the final position will burden companies depends largely on the implementation of the law by regulators.Title VII: Wall Street Transparency and AccountabilityTitle VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act establishes a regulatory structure for derivatives.  The title requires banks to spin off certain swaps-dealing activities determined by Congress to not constitute "bona fide hedging and traditional bank activities."  It effectively requires derivative contracts that can be cleared, to be cleared—and exchange-traded.  The title provides a narrow exemption for derivatives end users from the clearing and exchange trading requirements, but does not exempt end users from margin requirements.  The title requires regulators to set minimum capital requirements and minimum initial and variation margin requirements.  While, as noted, end users will not be exempt from the bill's margin requirements, Senators Dodd and Lincoln have written a letter to Representatives Frank and Peterson clarifying that the bill was not intended to impose margin requirements directly on end users.  This, of course, does not mean costs will not be passed on to end-users from their counterparties.  The title grandfathers existing contracts for purposes of the clearing provision, but not from margin requirements  The title gives the CFTC and SEC one year to implement most of the required rulemaking and regulations.For ease of reference, the term "swap" refers both to security-based swaps and non-security-based swaps.  The "relevant Commission" for non-security-based swaps is the CFTC, and for security-based swaps, is the SEC.  HighlightsBanks must spin off "riskier" swaps dealing activities but can still conduct such activities through separately capitalized affiliates.All standardized swaps must be cleared and exchange-traded.  End users are exempt from the clearing requirement but only if (a) they are not "financial entities," (b) they are not "major swap participants," (c) they use swaps to hedge commercial risk, and (d) they can demonstrate how they meet their financial obligations associated with entering non-cleared swaps.The prudential banking regulators, the SEC, and the CFTC will set margin and capital requirements for uncleared swaps.Though margin and capital requirements will be imposed on swap dealers, and not their end-user counterparties, it is understood that these additional costs will be passed on to end-users.SummarySwap Desk Spin-Off The final conference report language requires that "riskier" trades (technically, those not permitted for a bank to hold under the National Bank Act: non-cleared CDS, CDS against ABS, commodity and agriculture swaps, equities, energy swaps, and metal swaps excluding gold/silver) must be pushed out into an affiliate, or the bank will lose Federal assistance, including FDIC insurance.The affiliate must then be separately capitalized.Less risky trades (characterized as "bona fide hedging and traditional bank activities" under the title), such as swaps on interest rates, foreign exchange swaps and forwards, gold and silver swaps, cleared investment grade CDS, and hedges of  the bank's own risk, can remain in the depository institution.  The spin-off provision will take effect two years after enactment.  It grandfathers existing contracts and those entered into during the transition period.  Sec. 716.Major Swap Participant DefinitionThe MSP definition is the key to the end user exemption in the bill.  If an entity is an MSP, it will not be exempt from clearing, margin, or capital requirements; rather, it will be regulated as if it were a swap dealer.Title VII defines an MSP as a person who is not a swap dealer andwho maintains a substantial position in swaps, excluding positions held for "hedging or mitigating commercial risk" and positions held by employee benefit plans for hedging purposes;  whose swaps create substantial counterparty exposure that could have "serious adverse effects" on U.S. market stability; orwho is highly leveraged, not subject to banking regulators' capital requirements, and who maintains an substantial position in outstanding swaps.  Unlike certain versions of the legislation considered by the House, the final text does not exclude from the MSP definition entities hedging balance sheet or operating risk, and does not allow for netting of outstanding transactions.Swap Dealer Definition The "swap dealer" definition in the bill is perhaps broader than intended as it gives the regulators the authority to include persons who "regularly enter[] into swaps."  Moreover, the provision does not clearly exempt an entity that executes swaps for its affiliates.  Amendments that would have fixed the definition were rejected by the Senate and conference.Senators Collins and Dodd entered into a colloquy demonstrating a clear intent that end users are not to be designated as "swap dealers" (and subject to bank-like regulation) because entities within the corporate structure execute swaps through an affiliate. Title VII defines a swap dealer as any person who holds itself out as a dealer in swaps, makes a market in swaps, regularly enters into swaps with counterparties in the ordinary course of business for its own account, or engages in behavior that causes it to be known as a swap dealer in the market.  The bill clarifies that no insured depository institution will be classified as a swap dealer because it offers to enter into a swap with a customer in connection with originating a loan with that customer.  Exceptions:  The definition includes an exemption for any person who enters into swaps for that person's own account, "but not as a part of a regular business."  It is unclear how this phrase will be interpreted and whether it could include entities that primarily or regularly execute swaps for its affiliates.  As noted, the Collins/Dodd colloquy addresses this question.  The conference committee added a de minimis exception for any person engaging in a de minimis quantity of swap dealing in connection with transactions with customers or on customers' behalf.   Sec. 721(a)(19) and Sec. 761(a)(6).Swap Definition—Foreign Exchange Swaps and Forwards Foreign exchange swaps and forwards are included in the definition of a "swap" and will be regulated as such, unless exempted by the Treasury in accordance with criteria and findings requirements that appear unlikely to be met.  Sec. 721(a).Clearing and Exchange Trading The CFTC and SEC shall establish a process, to be set forth in regulations within one year of enactment, for determining what types of swaps must be cleared.  The requirements for determining which types of swaps must be cleared is very likely to result in most standardized contracts being subjected to the clearing requirement.  Title VII provides that all swaps that are cleared also must be executed on an exchange or swap execution facility ("SEF"), unless no exchange or SEF will make swap available for trading. Title VII does provide a clearing exemption for end users, though it is more narrowly drawn than in earlier iterations of the derivatives legislation.  Title VII provides that end users are exempt from the clearing requirement if they are (a) not financial entities (defined to include MSPs, swap dealers (predominantly 4(k) companies, private funds, and commodity pools, and employee benefit plans), (b) not "major swap participants," (c) use swaps to hedge commercial risk, and (d) can demonstrate how they meet their financial obligations associated with entering non-cleared swaps.  A late amendment to the final text provides that captive finance companies—those affiliate companies wholly owned by a parent company, whose purpose is to provide financing for customers purchasing the parent company's products—will be exempt from clearing requirements for swaps entered to mitigate risk.  Sec. 723 and Sec. 763(a).Margin and Capital Requirements Prudential regulators, in consultation with the CFTC and SEC, must set minimum capital and initial and variation margin requirements for banking institutions; the CFTC or SEC must set the requirements for non-bank institutions.  As written, the margin requirements will apply even if an end user is a counterparty to the swap.  The language states that the regulators "shall adopt rules for swap dealers and major swap participants . . . imposing . . . both initial and variation margin requirements on all swaps that are not cleared by a registered derivatives clearing organization."  We have been told by some that the conferees did not intend to authorize the imposition of margin on uncleared swaps to which an end user is a counterparty, but the language states otherwise and the aforementioned Dodd/Lincoln letter states only that margin cannot be imposed directly on end users.The text explicitly acknowledges that the rules must allow for the use of noncash collateral to meet the margin requirements.  Sec. 731 and Sec. 764.General language on setting levels of margin and capital in the text drops references in the Senate bill to establish levels that are "substantially higher" than for cleared swaps.  The conference report requires margin and capital levels to be set in order to "help ensure the safety and soundness of the swap dealer or major swap participant" and "be appropriate for the risk associated with the non-cleared swaps."  Sec. 731.The capital section retains problematic language that requires the CFTC or bank regulator to take into account "other activities" when imposing capital requirements on a swap dealer or MSP for a category or class of swap activities.  Sec. 731.Grandfathering The final text explicitly states that existing contracts do not have to be cleared or exchange traded, though they must be reported.  The bill, however, does not explicitly state that margin requirements will not apply to existing trades conducted by MSPs and swap dealers.  Sec. 723 and Sec. 763(a).CFTC Chairman Gensler and his staff have indicated that they are not certain that the bill provides authority to impose retroactive margin requirements but that, in any event, they do not intend to impose margin requirements retroactively even it they do have such authority.  But the SEC and the prudential banking regulators also have authority to impose margin requirements.An effort was made by Senator Collins to secure colloquy language making it clear that the bill is not intended to authorize the imposition of margin on existing derivatives contracts.  Senators Dodd and Lincoln refused to provide assurances to end users by entering into the colloquy.Standards of ConductThe final text does not impose a fiduciary duty on MSPs or swap dealers when trading with federal agencies, state and municipal governments, pension plans, or endowments ("Special Entities").  Instead, the text sets out different standards of conduct for swap dealers and MSPs with respect to swaps involving Special Entities versus others as counterparties, and those in which a swap dealer or MSP is acting as an advisor to a Special Entity.  Sec. 731 and Sec. 764.Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) or C. F. Muckenfuss (202-955-8514, cmuckenfuss@gibsondunn.com) in the firm's Washington, D.C. office, Kimble Charles Cannon (310-229-7084, kcannon@gibsondunn.com) in the firm's Los Angeles office, or any of the following members of the firm's Financial Regulatory Reform Group:Public Policy ExpertiseMel Levine - Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson - Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman - Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt - Washington, D.C. (202-887-3660, aplatt@gibsondunn.com)Michael Bopp - Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller - Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)Brian Lane - Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson - Washington, D.C. (202-955-8249, lferguson@gibsondunn.com)John H. Sturc - Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Dorothee Fischer-Appelt - London (+44 20 7071 4224, dfischerappelt@gibsondunn.com)Alan Bannister - New York (212-351-2310, abannister@gibsondunn.com)Adam H. Offenhartz - New York (212-351-3808, aoffenhartz@gibsondunn.com)George B. Curtis - Denver (303-298-5743, gcurtis@gibsondunn.com)Paul J. Collins - Palo Alto (650-849-5309, pcollins@gibsondunn.com)Robert C. Blume - Denver (303-298-5758, rblume@gibsondunn.com)David P. Burns - Washington, D.C. (202-887-3786, dburns@gibsondunn.com)Charles R. Jaeger - San Francisco (415-393-8331, cjaeger@gibsondunn.com)  Broker-Dealer and Investment Adviser Compliance ExpertiseK. Susan Grafton - Washington, D.C. (202-887-3554, sgrafton@gibsondunn.com)Barry Goldsmith - Washington, D.C. (202-955-8580, bgoldsmith@gibsondunn.com)George Schieren - New York (212-351-4050, gschieren@gibsondunn.com)Mark K. Schonfeld - New York (212-351-2433, mschonfeld@gibsondunn.com)Financial Institutions Law ExpertiseC.F Muckenfuss - Washington, D.C. (202-955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini - Washington, D.C. (202-887-3693, cbellini@gibsondunn.com)Amy Rudnick - Washington, D.C. (202-955-8210, arudnick@gibsondunn.com)Dhiya El-Saden - Los Angeles (213-229-7196, delsaden@gibsondunn.com)Kimble Charles Cannon - Los Angeles (310-229-7084, kcannon@gibsondunn.com) Corporate ExpertiseHoward Adler - Washington, D.C. (202-955-8589, hadler@gibsondunn.com)Richard Russo - Denver (303-298-5715, rrusso@gibsondunn.com)Dennis Friedman - New York (212-351-3900, dfriedman@gibsondunn.com)Robert Cunningham - New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn - New York (212-351-3851, jesdorn@gibsondunn.com)Wayne P.J. McArdle - London (+44 20 7071 4237, wmcardle@gibsondunn.com)Stewart McDowell - San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. - Washington, D.C. (202-887-3735, wthomas@gibsondunn.com)Private Equity ExpertiseE. Michael Greaney - New York (212-351-4065, mgreaney@gibsondunn.com)Private Investment Funds ExpertiseEdward Sopher - New York (212-351-3918, esopher@gibsondunn.com)Jennifer Bellah Maguire - Los Angeles (213-229-7986, jbellah@gibsondunn.com)Real Estate ExpertiseJesse Sharf - Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson - London (+44 20 7071 4222, asamson@gibsondunn.com)Fred Pillon - San Francisco (415-393-8241, fpillon@gibsondunn.com)Dennis Arnold - Los Angeles (213-229-7864, darnold@gibsondunn.com)Michael F. Sfregola - Los Angeles (213-229-7558, msfregola@gibsondunn.com)Andrew Lance - New York (212-351-3871, alance@gibsondunn.com)Eric M. Feuerstein - New York (212-351-2323, efeuerstein@gibsondunn.com)David J. Furman - New York (212-351-3992, dfurman@gibsondunn.com)L. Mark Osher - Los Angeles (213-229-7694, mosher@gibsondunn.com)Drew C. Flowers - Los Angeles (213-229-7885, dflowers@gibsondunn.com)Teresa J. Farrell - Orange County (949-451-3895, tfarrell@gibsondunn.com)Deborah A. Cussen - San Francisco (415-393-8226, dacussen@gibsondunn.com)Crisis Management ExpertiseTheodore J. Boutrous, Jr. - Los Angeles (213-229-7804, tboutrous@gibsondunn.com)Bankruptcy Law ExpertiseMichael Rosenthal - New York (212-351-3969, mrosenthal@gibsondunn.com)David M. Feldman - New York (212-351-2366, dfeldman@gibsondunn.com)Oscar Garza - Orange County (949-451-3849, ogarza@gibsondunn.com)Craig H. Millet - Orange County (949-451-3986, cmillet@gibsondunn.com)Thomas M. Budd - London (+44 20 7071 4234, tbudd@gibsondunn.com)Gregory A. Campbell - London (+44 20 7071 4236, gcampbell@gibsondunn.com)Janet M. Weiss - New York (212-351-3988, jweiss@gibsondunn.com)Matthew J. Williams - New York (212-351-2322, mjwilliams@gibsondunn.com)J. Eric Wise - New York (212-351-2620, ewise@gibsondunn.com)Tax Law ExpertiseArthur D. Pasternak - Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler - Los Angeles (213-229-7763, pissler@gibsondunn.com)J. Nicholson Thomas - Los Angeles (213-229-7628, nthomas@gibsondunn.com) Jeffrey M. Trinklein - New York (212-351-2344, jtrinklein@gibsondunn.com)Romina Weiss - New York (212-351-3929, rweiss@gibsondunn.com)Benjamin H. Rippeon - Washington, D.C. (202-955-8265, brippeon@gibsondunn.com)Executive and Incentive Compensation ExpertiseStephen W. Fackler - Palo Alto (650-849-5385, sfackler@gibsondunn.com)Charles F. Feldman - New York (212-351-3908, cfeldman@gibsondunn.com)Michael J. Collins - Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller - Los Angeles (213-229-7579, sfeller@gibsondunn.com)Amber Busuttil Mullen - Los Angeles (213-229-7023, amullen@gibsondunn.com) © 2010 Gibson, Dunn & Crutcher LLPAttorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice. 
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July 16, 2010

The Regulation of Advisers to Private Funds: Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 15, 2010, the Senate voted (60-39) to approve the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act"), which is expected to be signed into law next week by President Obama.  Included among the Act's sweeping changes to the regulation of the U.S. financial markets is the Private Fund Investment Advisers Registration Act of 2010, which requires that investment advisers to hedge funds, private equity funds, real estate funds, and certain other private funds with assets under management ("AUM") of $150 million or more register with the Securities and Exchange Commission (the "SEC"), comply with certain SEC books, records, and reporting requirements, and be subject to periodic SEC examination.  Advisers to venture capital funds will not be required to register with the SEC, but will be required to maintain records and provide annual and other reports prescribed by the SEC.  These amendments become effective one year after the enactment of the Act. The Act provides exemptions from registration for family offices, and certain foreign private advisers with fewer than 15 clients and investors, and also provides a limited intrastate exemption.  A.  Exemptions 1.  Elimination of Private Adviser Exemption The Act amends section 203(b)(3) of the Investment Advisers Act of 1940 (the "Advisers Act") to eliminate the 15 or fewer client exemption that currently allows many advisers to avoid registration with the SEC.  Accordingly, advisers to hedge funds and private equity funds will be required to register with the SEC if they have at least $150 million of AUM.  Sec. 403.  A "private fund" is defined as an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (the "1940 Act"), but for section 3(c)(1) or 3(c)(7) thereof.  Sec. 402. Analysis:  This provision will require the registration of many previously exempted investment advisers to hedge funds and private equity funds, although the threshold for SEC registration will be reset to at least $100 million AUM.  2.  Limited Foreign Private Adviser Exemption The exemption for foreign private advisers is narrower than under current section 203(b)(3) of the Advisers Act because, among other things, it requires the adviser to look through the private fund and count the number of U.S. investors in the fund as well as the fund itself in determining whether the adviser exceeds the limit of 15 clients and investors in the United States.  Sec. 403.  To be exempt, an investment adviser must meet the definition of "foreign private adviser," which means that it: has no place of business in the United States; has, in total, fewer than 15 clients and investors in the United States in private funds advised by the investment adviser; has aggregate AUM attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser of less than $25 million, or such higher amount as the SEC may determine through rulemaking; and neither holds itself out generally to the public in the United States as an investment adviser; nor acts as an investment adviser to (i) any investment company registered under the 1940 Act, or (ii) a company that has elected to be a business development company under the 1940 Act (a "Business Development Company").  Sec. 402.Analysis:  This provision could potentially bring many foreign investment advisers with very few United States contacts under the ambit of SEC registration.  The narrowing of this exemption may ultimately affect foreign advisers' decisions on whether to seek U.S. investors. 3.  Limited Intrastate Exemption The intrastate exemption found in section 203(b)(1) of the Advisers Act for advisers to funds whose clients are all residents of the state within which the adviser has its principal office and place of business is narrowed to exclude investment advisers to private funds, except for foreign private advisers, as discussed above.  Sec. 403. 4.  Limited Small Business Investment Company Adviser Exemption New section 203(b)(7) exempts from registration investment advisers who solely advise:small business investment companies that are licensees under the Small Business Investment Act of 1958 ("Small Business Companies"); entities that have received from the Small Business Administration notice to proceed to qualify for a license as a Small Business Company, which notice or license has not been revoked; or applicants that are affiliated with one or more Small Business Companies that have applied for another license, which application remains pending. Advisers that are Business Development Companies, however, are not exempt.  Sec. 403.5.  Venture Capital Fund Advisers New section 203(l) of the Advisers Act exempts venture capital fund advisers from registration under the Advisers Act with respect to investment advice provided to venture capital funds.  Even though not required to register with the SEC, venture capital fund advisers will be required to maintain such records and to provide annual or other reports to the SEC as the SEC deems necessary or appropriate in the public interest or for the protection of investors.  The SEC is required to define the term "venture capital fund" within one year of enactment of the Act.  Sec. 407. Analysis:  The availability of this exemption will depend on the SEC's definition of "venture capital funds."  Venture capital firms will want to provide input on the SEC's proposals to make sure that they are included within the definition, and advisers to other private funds will want to evaluate whether the funds that they manage are more appropriately described as "venture capital funds."   Moreover, the benefit of this exemption largely will depend upon the scope of the recordkeeping and reporting requirements promulgated by the SEC for venture capital funds. 6.  Private Fund Advisers with AUM of Less Than $150 Million The SEC has authority, pursuant to new section 203(m) of the Advisers Act, to exempt from registration any investment adviser that solely advises private funds, as defined above, and has AUM in the United States of less than $150 million.  Even if exempted from registration, such advisers must maintain records and provide to the SEC such annual or other reports as the SEC determines are appropriate.  In developing registration requirements and examination procedures for these "mid-sized" private fund advisers, the SEC is required to take into account fund size, governance, investment strategy, and level of systemic risk posed by the fund.  Sec. 408. Analysis:  As with advisers to venture capital funds, mid-size private fund advisers will need to await the SEC's coming rulemaking as to recordkeeping and reporting requirements that will be imposed on such advisers. 7.  Family Offices Section 202(a)(11)(G) of the Advisers Act was amended to exempt from the definition of "investment adviser" (and therefore, from registration) any family office, as that term is defined by the SEC.  This definition is to be consistent with SEC exemptive orders in effect at the time of enactment of the Act and to recognize the range of organizational, management and employment structures and arrangements utilized by family offices.  Even if an investment adviser is exempt from registration under this provision, it will be subject to the antifraud provisions of section 206 of the Advisers Act.  Sec. 409. Analysis:  Codification of the exemption through the SEC's definition of "family office" will eliminate the need for individual exemptions for family offices, but clients with family offices will want to review the SEC's definition, when proposed, to make sure that they are covered by the exemption. B.  Federal and State Jurisdiction The AUM threshold for an investment adviser to register with the SEC was raised from $25 million to $100 million in Advisers Act section 203A(a)(1).  Accordingly, investment advisers that do not satisfy the higher AUM requirement will be required to register with the states rather than with the SEC, unless they are (1) advisers to an investment company registered under the 1940 Act, (2) Business Development Companies that have not withdrawn their election under the 1940 Act, or (3) required to register with 15 or more states.  Sec. 410; Sec. 419. Analysis:  This provision will require many mid-size investment advisers to register with one or more states rather than the SEC, although the Act includes a one-year transition period during which any adviser may, at its discretion, register with the SEC.  It is possible that advisers who are currently registered with the SEC will be grandfathered in so that they can retain their registrations, even if they will not meet the new AUM requirement.As a result of the increased burden on state regulators, we may see higher state registration and licensing fees, regulatory sharing agreements between states, and other changes to help the states manage their additional responsibilities and expenses. C.  Data, Reports, and Disclosures of Private Funds New section 204(b) of the Advisers Act requires registered investment advisers to maintain records and make reports to the SEC regarding private funds advised by the adviser, as determined by the SEC to be necessary in the public interest and for the protection of investors.  The SEC is, in turn, required to provide such reports or records to the Financial Stability Oversight Council (the "Council") as the Council determines are necessary to assess the systemic risk of a private fund.  For these purposes, the records of any private fund advised by an investment adviser would be deemed the records and reports of the investment adviser.  The SEC is required to adopt rules specifying the types of records that private fund advisers must make, the retention period for such records, and the reports such advisers will be required to file.  Sec. 404. 1.  Required Information; Consultation with the Council The records and reports required to be maintained by an investment adviser and subject to SEC inspection include, for each private fund, a description of: i.  the amount of AUM and use of leverage, including off-balance sheet leverage;ii.   counterparty credit risk exposure;iii.   trading and investment positions;iv.  valuation policies and practices of the fund;v.   types of assets held;vi.  side arrangements or side letters whereby certain investors in the fund obtain more favorable rights or entitlements than other investors;vii.  trading practices; andviii.  such other information as the SEC determines, in consultation with the Council, is necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.  This could result in different reporting requirements for different classes of private fund advisers based on the type or size of the fund being advised.Sec. 404. Analysis:  The Act requires only that a description of the above information to be provided.  The level of detail and format will be determined through the SEC's rulemaking. 2.  Examinations of Records and Confidentiality Records of private funds that are maintained by a registered investment adviser are subject to periodic, special and other examination by the SEC at any time and from time to time, as the SEC may prescribe as necessary and appropriate.  The SEC is required to make available to the Council all reports, documents, records, and information filed with or provided to the SEC by an investment adviser to a private fund for systemic risk assessment purposes.  All such reports, documents, records and information obtained from the SEC under this section would be required to be kept confidential pursuant to section 204(b)(8) of the Advisers Act.  The SEC is also required to provide this information to (a) Congress, upon an agreement of confidentiality; (b) any other federal department or agency or self-regulatory organization ("SRO") requesting information or reports for purposes within the scope of its jurisdiction; or (c) pursuant to a court order in an action brought by the SEC or otherwise by the U.S. government.  The Council and any department, agency, or SRO that receives information or reports from the SEC is subject to the same level of confidentiality as the SEC.  In addition, all such parties are exempt from the requirements of the Freedom of Information Act (5 USC §552) ("FOIA"), which compels federal agencies to disclose to the public any records requested in writing, unless such records are protected by an exemption under FOIA. Any "proprietary information" of an investment adviser that the SEC ascertains from any report required to be filed with the SEC is subject to the same limitations on public disclosure as any facts ascertained during an examination as set forth in section 210(b) of the Advisers Act.  "Proprietary information" includes sensitive, non-public information regarding an adviser's investment or trading strategies, analytical or research methodologies, trading data, computer hardware or software containing intellectual property and other information the SEC determines is proprietary.  Sec. 404. Section 210(c) of the Advisers Act now authorizes the SEC to disclose the identity of an investment adviser's clients for the purpose of assessing potential systemic risks as well as in connection with a proceeding or investigation relating to the enforcement of the Advisers Act.  Sec. 405. Analysis:  It is not yet known what the examination protocols will be with respect to registered investment advisers to private funds.  While the SEC's examinations of private fund records initially may be broad, as SEC staff develops additional experience with the private funds generally and with the newly registered advisers specifically, we may see more tailored examination protocols.  The scope of information that will be required and shared among regulators in order to assess systemic risk remains a concern, particularly with respect to sensitive information such as client identity.  D.  Dual SEC-CFTC Registered Advisers Within one year of enactment of the Act, and after consultation with the Council, the SEC and the Commodity Futures Trading Commission (the "CFTC") are required to jointly promulgate rules to establish the form and content of reports required to be filed with the SEC and CFTC by investment advisers that are dually registered with both agencies.  Sec. 406. Analysis:  A key issue during the rulemaking process will be the extent of redundant SEC/CFTC regulation, including the potential for duplicative examinations. E.  Custody of Client Accounts New Advisers Act section 223 requires registered investment advisers to take SEC-prescribed steps to safeguard client assets over which they have custody, including but not limited to, verification of such assets by an independent public accountant.  Sec. 411. The U.S Comptroller General is required to conduct a study on the compliance costs associated with the current SEC rules regarding custody of funds or securities of clients of investment advisers as well as the additional costs if the provisions relating to operational independence are eliminated.  The report is due to the Senate Committee on Banking, Housing, and Urban Affairs and the House Committee on Financial Services within three years of enactment of the Act.  Sec. 412. F.  SRO for Private Funds The Comptroller is required to conduct a study on the feasibility of forming an SRO to oversee private funds.  The report is due within one year of enactment of the Act.  Sec. 416.   Analysis:  This study is in addition to the SEC's study of the regulation and oversight of broker-dealers and investment advisers, which is due in six months, and is expected to address the issue of an SRO for investment advisers.  If the Comptroller recommends the formation of an SRO, it is unclear at this point who would comprise the entity, the scope of its regulatory authority, and whether the states would incorporate the concept of an SRO into their regulatory regimes.  Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding the impact of these issues for broker-dealers.  Please contact K. Susan Grafton (202-887-3554, sgrafton@gibsondunn.com), any of the following, or the Gibson Dunn lawyer with whom you work:Washington, D.C.Amy L. Goodman (202-955-8653, agoodman@gibsondunn.com)K. Susan Grafton (202-887-3554, sgrafton@gibsondunn.com)C. William Thomas, Jr. (202-887-3735, wthomas@gibsondunn.com) New YorkDennis J. Friedman (212-351-3900, dfriedman@gibsondunn.com)Edward D. Nelson (212-351-2666, enelson@gibsondunn.com)Edward D. Sopher (212-351-3918, esopher@gibsondunn.com)Los AngelesJennifer Bellah Maguire (213-229-7986, jbellah@gibsondunn.com)David M. Hernand (310-552-8559, dhernand@gibsondunn.com)  © 2010 Gibson, Dunn & Crutcher LLPAttorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
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