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Michigan Administrative Order on Investment Advisers Aligns with Dodd-Frank

By Jim Hamilton

The sixth transition order to come out of the Michigan Office of Financial & Insurance Regulation since the State's adoption of the Uniform Securities Act of 2002 on October 1, 2009 amends the parts of the first and fourth transition orders [pars. 32,663 & 32,666, respectively, in the Blue Sky Law Reporter] pertaining to custody and performance-based compensation for investment advisers, and adjusts the "institutional investor" definition in Michigan's investment adviser de minimis exemption, effective March 11, 2011. The amendments comprising the sixth transition order are necessary to incorporate changes the Dodd-Frank Wall Street Reform and Consumer Protection Act made to federal investment adviser rules that will take effect July 21, 2011.

Custody of client funds and securities. Investment advisers may take and maintain custody of their clients' funds and securities, so long as the advisers meet at least one of the following three requirements:

1. The advisers satisfy the requirements of Rule 206(4)-2 in the Investment Advisers Act of 1940 in a way that their taking and maintaining custody would not be considered fraudulent, deceptive or manipulative if Rule 206(4)-2 were applied to them, or the advisers are not precluded from taking and maintaining custody under federal laws or regulations that apply to federal covered investment advisers if those laws and regulations were applied to the advisers.

2. The advisers provide advisory services exclusively to "private funds," defined in Section 402(a) of the Dodd-Frank Act as "investment funds that would be required to register under the Investment Company Act of 1940 but for Section 3(c)(1) or 3(c)(7) of that Act. " For the advisers to meet this requirement, a private fund's equity holders must each be either "qualified clients" as defined in Rule 205-3(d)(1) of the Investment Advisers Act of 1940 or "accredited investors" as defined in Rule 501(a) of the Regulation D of the Securities Act of 1933. In addition, custody of the equity holders' funds or securities must be maintained under the terms of one or more written agreeements, e.g., limited partnership, limited liability or similar organizational agreement between the advisers and their equity holder clients.

3. The advisers are permitted by rule or order of the Michigan Commissioner for the Office of Financial & Insurance Regulation to take and maintain custody of client funds or securities and comply with that rule or order.

Performance-based compensation. Investment advisers' compensation for advisory services may not be a share of capital gains or appreciation on the funds in a client's account, but an investment advisory contract may provide that an adviser receive the same performance-based compensation permitted for a federal covered investment adviser under either the Investment Advisers Act of 1940 or corresponding rules such as Rule 205-3, and the adviser may, in fact, receive the compensation. Note that an "investment advisory contract" from Rule 205-3 may include a limited partnership, limited liability or similar organization agreement, and a "qualified client" from Rule 205-3 includes an "accredited investor" as defined in Rule 501(a) of Regulation D under the Securities Act of 1933.

"Institutional investor" definition in IA de minimis exemption. Michigan grants a de minimis exemption from registration for persons that (a) do not hold themselves out to the general public as investment advisers, and that (b) during the preceding 12 months did not have more than five clients who are natural persons, residents of Michigan and accredited investors as defined in Rule 501(a) of federal Regulation D of the Securities Act of 1933, in addition to federal covered investment advisers, institutional investors and certain bona-fide preexisting clients. An "institutional investor" for purposes of this exemption now includes a "private fund," defined in Section 402(a) of the Dodd-Frank Act as an "investment fund that would be required to register under the Investment Company Act of 1940 but for Section 3(c)(1) or 3(c)(7) of that Act" whose equity holders are either "qualified clients" as defined in Rule 205-3(d)(1) of the Investment Advisers Act of 1940 or "accredited investors" as defined in Rule 501(a) of the Regulation D of the Securities Act of 1933.

For the sixth transition order see the third bullet point (second PDF) under "What's New" in the middle of the following home page: http://www.michigan.gov/ofir

Full post as published by Jim Hamilton's World of Securities Regulation on March 16, 2011 (boomark / email).