British advisers’ burden lies over the ocean

Elizabeth Shea Fries discusses the American financial reforms with Vanessa Drucker in New York.

Elizabeth Shea Fries is a Boston-based partner in the business law department of the Goodwin Procter, a law firm, a member of its financial services group, and chair of its hedge funds practice.
Elizabeth Shea Fries is a Boston-based partner in the business law department of the Goodwin Procter, a law firm, a member of its financial services group, and chair of its hedge funds practice.

Q. The Dodd-Frank Act, the American legislation for financial reform, will radically alter the American competitive investment landscape. How does it affect British investment advisers?

A. British advisers with American clients will now become subject to dual regulation, involving potential costs and burdens, unless they can satisfy four conditions.

They must be able to show that one, they have no place of business in the United States, that two, they are managing no more than $25m (£16m) for US clients, that three, they have fewer than 15 US investors or clients, and four, they aren’t holding themselves out to the public in the US as an investment adviser, or advising any US mutual fund. This exemption is fairly paltry and not particularly helpful, and it will be easy to incur foot faults.

Remember that these four conditions are conjunctive, in other words you have to meet all of them. So if you have 16 clients, and each one has only invested a few dollars with you, you may come under American regulations now.

Q. What would that involve? How expensive will it be?

A. You will need a chief compliance officer in place, and a set of policies and procedures designed according to American securities law. Those policies cover record keeping, personal trading, advertising, insider trading and various other activities. You would also become subject to examination by the Securities and Exchange Commission [SEC].

Q. Does the Financial Services Authority (FSA) not already address most of those matters?

A. The FSA duplicates many of the requirements, but has a slightly different scope. Even if you are already covering your bases with the FSA, you will now need to perform additional things that may not seem meaningful. For example, you may find American reporting requirements on personal trading are much more precise and detailed.

Q. Surely some of these regulations already affected British fund managers, before this new statute became law.

A. True. In the past if non-US advisers had more than 15 clients in the US, they would have been subject to the 1940 Investment Advisers Act, and if they managed over $25m for US accounts, they needed to register with the SEC. That stays the same. What does change is that the authorities will look through funds and vehicles to the underlying clients, such as Ucits and registered funds offered in non-US jurisdictions. Anyone who has a pooled vehicle, including retail funds, may be affected.

Think about large global organisations that have both US registered investment advisers as well as a UK investment adviser responsible for non US-product – as many multinationals do. Suppose a firm has allowed US institutional investors into Ucits, it might now need to get rid of them, or else have to register the UK adviser. (article continues below)

Q. How about advisers who are focused on individual accounts, like wealth managers?

A. The new rules force you to look through vehicles. The legislation doesn’t distinguish institutional funds from retail funds, which could well cater to people who move in and out of the US, not necessarily even US citizens.

One test is where your clients are calling in from, or simply where you are mailing materials to them. If you are sending statements to the US you may have more American clients than you know. In fact, pure wealth managers are more likely to have direct client relationships, and know where their clients are. Retail funds with a number of small investors are the ones who may have the most trouble tracking them down. It takes a long time to sort through by address, because if you write to them a lot will not respond, and you will have to go back again and again to get to the bottom. After all, you certainly don’t want to kick out the wrong people.

The statute suggests on its face that British expats living in the US could be a problem. One of the uncertainties that forthcoming regulation must resolve is how to decide whether someone counts as a US client.

Q. It sounds alarming. If I am concerned about who is in my client base, what should I do?

A. There’s no reason to panic and start getting rid of investors immediately. You need to get a sense of the order of magnitude of the problem. The first step is to figure out whether you want to expand your American business, when you look at the costs and benefits involved. If you have been actively marketing in the US, and you are sure you want a fully-fledged operation there, recognise that you must now register with any additional costs. You can do that and keep going. If you have been dipping a toe in the water, you may decide this is the time to dive in. If, though, you are accommodating just a few cases that might be deemed US accounts, you will have to choose whether to get rid of those investors by next July, when the law goes into effect. Meanwhile, you’ll probably want to keep a close eye on developments, through industry groups.

Q. Which would be the best groups to contact?

A. Check with industry groups in which you participate to determine whether they are engaged in advocacy, such as trying to call attention to unforeseen consequences, which legislators may not have been contemplated. There is time to seek SEC relief before the law takes effect in July 2011, and there will be opportunities for interpretive rulemaking by the SEC, which may even grant further exemptions.

Some of the most active hedge fund industry groups are AIMA [Alternative Investment ­Management Association], and MFA [Managed Funds Association]. The IMA [Investment Management Association] is more focused on pure wealth management.