Oxford Legal Research Library: 5 The Regulatory Duties Arising from the Provision of Investment Advisory and Management Services in: The Law of Private Investment Funds

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 Content type: Book content Product: Financial Law [FBL] Published in print: 15 February 2018 ISBN: 9780198807247 5 The Regulatory Duties Arising from the Provision of Investment Advisory and Management Services From: The Law of Private Investment Funds (3rd Edition) Timothy Spangler Previous Edition (2 ed.) Subject(s): Investment business — Collective investment scheme — Private fund — UK Financial Conduct Authority (FCA).

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 (p. 108) 5 The Regulatory Duties Arising from the Provision of Investment Advisory and Management Services A. Introduction 5.01 B. FCA regulation 5.04 Collective investment schemes 5.17 Public investment funds 5.26 Regulation of the fund manager 5.34 Fiduciary duty in the financial services regulatory regime 5.46 C. FCA's regulatory response to private investment funds 5.48 D. SEC compliance 5.57 'Investment advisers' definition 5.59 Exemptions from registration 5.61 Anti-fraud provisions 5.64 The 'brochure rule' 5.67 Other disclosure requirements 5.69 Books and records 5.72 Prohibited contractual and fee provisions 5.74 Advertising restrictions 5.77 Suitability requirements 5.80 Duty of best execution 5.81 Aggregation of client orders 5.82 Insider trading procedures and duty of supervision 5.83 Anti-fraud 5.84 E. Fiduciary duties in the financial services regime 5.90 F. Conclusion 5.94 A. Introduction 5.01 Investment managers of private investment funds that are authorized or regulated as investment advisers or managers can owe regulatory duties arising under the financial services regimes of FSMA in the United Kingdom and the Advisers Act in the United States, even where the funds they manage are unregulated. 5.02 In the case of public funds, detailed product-level regulations have been adopted to ensure that risks associated with conflicts of interest, lack of transparency, and mismanagement, as well as portfolio risk, are adequately addressed. In the case of private funds, the participants are expected to rely on their own ability to negotiate adequate levels of protection to address those risks. As a consequence of limiting the extent to which private funds may be marketed and establishing (p. 109) particular status and/or size requirements in participants (e.g., investment professionals), the presumption of the regulator is that such investors have adequate negotiating leverage to address any governance concerns that they may have. The reach of regulators in the area of private.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 investment funds, therefore, is limited and, more importantly, indirect. Regulators must make do with the powers they are able to exercise at the level of the authorized fund manager. 5.03 However, because the particularities of private investment funds differ substantially from other types of investment products governed by these regimes, fund managers and other market participants have claimed that regulators and policy makers lack a full understanding of the nature of these industries and their business models.1 In particular, the risks inherent in a particular asset class (e.g., private equity) may be lower than the risks inherent in another (e.g., hedge funds),2 and therefore a different approach may need to be followed with regard to each asset class. B. FCA regulation 5.04 The Financial Services Authority (FSA) ceased to exist on Monday 1 April 2013. In its place came two new regulators: the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). This new regime is intended to provide a clearer division of responsibilities between regulators, and a clearer commitment by regulators to investigate and take enforcement action.3 5.05 Fortunately the transition ran relatively smoothly. The permissions for firms regulated by the FSA were automatically transferred to the FCA. Firms' registration numbers were carried across. Firms were granted 12 months from 1 April 2013 to make the changes on the required disclosure. Pending applications for authorization, or variations of permission, were transitioned to the new regulator. 5.06 The FCA's Handbook was split between the FCA and PRA to form a Handbook for each regulator. Firms were assigned to one of four 'conduct classifications, C1–C4. C1 and C2 firms have a dedicated supervisor at the FCA and are subject to proactive supervisory engagement. C3 and C4 firms are supervised by a team of sector specialists at the FCA and do not have a dedicated supervisor. 5.07 Importantly, the new bodies introduced by the Financial Services Act 2012 are continuing the FCA's mission to ensure compliance and accountability in the regulated sector. The top concerns of the FCA—based on announcements from (p. 110) staff members —are money laundering risk, corruption risk, investment fraud against consumers, and insider dealing. Prior to its replacement, the FSA had already set in motion its initiative on these issues. The FCA and the PRA have considerable momentum stemming from the preceding efforts of the FCA. 5.08 The FCA is responsible for regulation of the conduct of firms authorised under the Financial Services and Markets Act 2000 (FSMA).4 Specifically, it is responsible for:5 (a) regulation of conduct in retail and wholesale financial markets; (b) supervision of the trading infrastructure that supports retail and wholesale financial markets; and (c) prudential regulation of firms not regulated by the PRA. The FCA has three operational objectives: (a) to secure an appropriate degree of protection for consumers (the 'consumer protection objective'); (b) to protect and enhance the integrity of the UK financial system (the 'integrity objective'); and 1 2 3 4 5.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 (c) to promote effective competition in the interests of consumers in the markets for regulated financial services and services provided by recognized investment exchanges in carrying on certain regulated activities (the 'competition objective'). 5.09 The FCA also has responsibility for taking regulatory action to counter financial crime. This includes a duty to have regard to measures to minimize the extent to which regulated business could be used for purposes connected with financial crime. The FCA is also required to maintain arrangements designed to enable it to determine whether people that are not authorised persons are complying with regulatory requirements and, where appropriate, for enforcing compliance. 5.10 The PRA is responsible for the authorization, prudential regulation, and day-to-day supervision of all firms subject to significant prudential regulation, including banks, building societies, insurers, and certain systemically important investment firms. Firms that fall within the regulatory scope of the PRA are known as 'PRA-authorized firms', or 'dual- regulated firms', as the FCA is their conduct regulator. Concerns about inconsistent application where firms are regulated by both the PRA and the FCA were addressed by requiring cross-consultation between the two regulators before either gives an entity notice of a direction under the power. (p. 111) 5.11 In terms of authorization, Section 19 of FSMA contains what is known as the 'general prohibition', stating that 'no person may carry on a regulated activity in the United Kingdom, or purport to do so, unless he is an authorised person or an exempt person'. 5.12 Regulated activities constitute activities of a specified kind carried on by way of business6 and relating to investments of a specified kind.7 In the area of fund management, such specified activities could potentially include: (a) dealing in investments as principal 8 or agent; 9 (b) arranging deals in investments; 10 (c) managing investments; 11 (d) safeguarding and administering investments; 12 (d) establishing, operating, or winding up collective investment schemes (CISs); 13 and (f) advising on investments. 14 5.13 Once authorized, a firm would be subject to the FCA Handbook. The COBS rules, in particular, include the use of a customer agreement specifying the relevant investment objective, compliance with best execution rules, and conflict of interest requirements. 5.14 In connection with private investment funds, FSMA addresses two principal regulated activities: (a) management of an investment portfolio with discretion; and (b) establishing and operating a CIS. 15 5.15 The UK approach, therefore, by delineating between these two functions draws a subtle distinction between the management of individual accounts and the (p. 112) management of asset pools. As a result, the FCA implicitly recognizes the further difference 6 7 8 9 10 11 12 13 14 15.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 between a bilateral advisory relationship and multilateral CIS, and the layers of duty that the latter entails over the former due to its collective nature. 5.16 Under the FCA Rules, the 'operator' of a CIS is the person responsible for the management of the property held for or within the scheme. Establishing, operating, or winding up a CIS is a regulated activity under the Act, and any person wishing to act as an operator must be authorized by the FCA. In the case of a private investment fund structured as a partnership, the usual structure would be for the general partner (which is usually no more than a shelf company in view of its potential liabilities as a general partner) to appoint an appropriate FCA-regulated person to be the manager of the partnership. However, it is possible for the general partner (if appropriately regulated) to be the manager, and therefore the operator, of the limited partnership. Collective investment schemes 5.17 A collective investment scheme (CIS) includes any arrangement with respect to property whose purpose or effect is to enable persons taking part in the arrangement to participate in the profits or income arising from the acquisition, holding, management, or disposal of the property.16 The arrangement must be such that participants17 do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or give directions. Such arrangements must have either or both of the following characteristics: (a) the contributions of the participants and the profits or income out of which payments are to be made to them are pooled; or (b) the property is managed as a whole by or on behalf of the operator of the scheme. 5.18 The limitation on the participants' day-to-day control over the property gives rise to the concept of management by another person. A series of questions follows from this limitation about the role and scope of activities of the relevant parties. Section 235(2) makes a distinction between 'day-to-day control' and 'the right to be consulted or to give directions'. Making this distinction in practice can prove difficult. The issue of whether participants have the necessary control over the management of the property to bring the arrangements out of the definition of a CIS, rather than limited consultation or direction rights, will be a fact-driven enquiry to determine where on the continuum of control a particular arrangement falls. (p. 113) 5.19 Certain types of arrangements are specifically excluded from the definition of CIS, including: (a) bodies corporate (except for open-ended investment companies and LLPs); (b) arrangements entered into for commercial purposes related to a business (e.g., a joint venture); and (c) arrangements not requiring the protection of these provisions (e.g., pension schemes, insurance contracts). 5.20 The FCA applies a comprehensive set of requirements (e.g., leverage, valuation, pricing) for CISs to be authorized and freely promoted to the general public. The result of this approach is the potential need for dual authorization, with the CIS obtaining authorization if it is to be marketed to retail investors, and the manager/adviser authorized separately by the FCA. Where a CIS is not to be authorized, and therefore restricted in 16 17.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 regard to whom it may be marketed, a UK-based manager is still required to obtain authorization, even where it has only one client, irrespective of its size. 5.21 Many entities will be classified as CISs because they fall within the definition of an open-ended investment company (OEIC). An OEIC is a body corporate (either domestic or foreign) that will constitute a CIS on the fulfilment of two further conditions known as the 'property condition' and the 'investment condition'.18 5.22 The property condition is satisfied where the property belongs beneficially to and is managed by or on behalf of a body corporate having as its purpose the investment of its funds with the aim of: (a) spreading investment risk; and (b) giving its members the benefit of the results of the management of those funds by or on behalf of that body. 19 Accordingly, it is not sufficient that the body corporate owns a single asset or holds an asset passively in hopes that the value will increase over time. 5.23 The investment condition is that, in relation to the body corporate, a reasonable investor would: (a) expect that he would be able to realize, within a period appearing to him to be reasonable, his investment in the scheme; and (b) be satisfied that his investment would be realized on a basis calculated wholly or mainly by reference to the value of property in respect of which the scheme makes arrangements. 20 (p. 114) Importantly, both assessments are made prior to the participant's entry into the CIS. 5.24 OEICs established in the United Kingdom are governed by special legislation,21 as a result of which an unauthorized OEIC cannot lawfully be formed in the United Kingdom.22 The formation of an OEIC, therefore, requires the company itself to be FCA-authorized and the FCA will only authorize an OEIC that complies with the OEIC Regulations. However, unauthorized OEICs may be formed in jurisdictions outside the United Kingdom as is commonly seen where offshore exempt companies are used for hedge funds. As a result, unlike UK incorporated OEICs, offshore OEICs need not be UK-authorized unless sold to the public in the United Kingdom. 5.25 Unless considerable effort is exerted otherwise, private investment funds in the United Kingdom will typically fall within the definition of unregulated CIS. For example, limited partnerships formed for investment purposes (such as most private equity funds and many real estate funds) will generally constitute a CIS under section 235 of FSMA. The nature and/or location of the property held by the limited partnership is not relevant to this analysis. Delegation of management of property by the co-owners of the property to a professional would not normally be regarded as creating a CIS to the extent that the manager is merely the agent of the co-owners. A limited partnership will normally constitute a CIS when it is operated by way of business, as the limited partners cannot have day-to-day control of the management of the partnership property without losing their limited liability.23 18 19 20 21 22 23.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 Public investment funds 5.26 Many retail investors participate in the financial markets by way of public investment funds, known as 'mutual funds' or 'collective investment schemes',24 which are registered with the national financial regulator and subject to detailed requirements on what they can do with investors' money.25 They make take the legal form of unit trusts, companies, or limited partnerships. (p. 115) 5.27 Public investment funds have traditionally been subject to intensive regulation, due to the participation in these funds of unsophisticated retail investors. As one commentator has observed: It has long been recognized that collective-investment schemes should be regulated in the interests of investor protection, particularly as collective-investment schemes are often directed at unsophisticated and inexperienced investors who do not exercise control over the investments made by the scheme or the scheme assets: the regulation of those who control large pools of liquid capital is usually irresistible to regulators fearful of abuse.26 5.28 Both retail and non-retail investors have access to publically regulated investment funds, such as mutual funds or UCITS,27 if they so wish. Only non-retail investors may elect to participate in private investment funds, and should they decide to do so, such investment must be made in the knowledge that the financial regulator has not taken on responsibility, or allocated any resources, to ensure that such funds are what they purport to be. 5.29 As opposed to the product regulations which are mandated for funds in which retail investors may participate,28 non-retail investors must research and negotiate fund terms, and ultimately decide on their participation (if at all), themselves. 5.30 Common to both types of funds, however, are issues of disclosure and the utility of disclosure as a regulatory tool.29 As one commentator observed: Disclosure interferes only to a limited extent with the autonomy of the investment firm and the investors. It can empower investors to achieve their investment objectives and support regulatory efficiencies by accommodating asymmetric investor ability.30 5.31 While much of securities regulation generally, and the indirect regulation of private investment funds specifically,31 has tended to be based in large part on disclosure requirements, in the case of public investment funds, regulators have (p. 116) preferred interventionist asset allocation rules, which explicitly constrain what these funds can do.32 Traditionally, financial regulators were reluctant to apply detailed, invasive regulation on private investment funds,33 although by 2010, in the aftermath of the global financial crisis, both the United States and the European Union generally moved towards an incremental increase in the regulation of private fund managers although did not go so far as to impose product-level restrictions on the funds themselves. 5.32 Important distinctions exist between public funds and private funds, including in their management and governance structure. As one commentator observed, when comparing mutual funds34 to hedge funds: Unlike mutual funds, which must comply with detailed requirements for independent boards of directors, and whose shareholders must explicitly approve 24 25 26 27 28 29 30 31 32 33 34.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 certain actions, domestic hedge funds are usually structured as limited partnerships to achieve maximum separation of ownership and management.35 5.33 Until the global financial crisis, claims have been made that hedge funds had adequately addressed potential conflicts of interest without such intrusive devices.36 However, it is unlikely that such assertion would be accepted on its face in the years to come. Regulation of the fund manager 5.34 The UK regulatory perimeter is set by the Regulated Activities Order (RAO). A private equity or hedge fund manager will generally need authorization from (p. 117) the FCA if it carries on regulated activities in or from the United Kingdom. At present, the FCA Handbook does not contain formal definitions of either term. 5.35 As an authorized firm, a private fund manager will be subject to the relevant parts of the Handbook, including the High Level Standards, Prudential Standards, and Business Standards. The requirements on individual firms will be driven by the nature of the firm's business model and the specific activities the firm undertakes or the permissions the firm has. 5.36 The High Level Standards include the Principles for Businesses Sourcebook (PRIN) and the Senior Management Arrangements, Systems and Controls Sourcebook (SYSC) together with other material. PRIN sets out the fundamental obligations of all firms under the regulatory system. SYSC sets out the FCA's rules and guidance on high level systems and controls, and the firm's apportionment of responsibility. There are no specific exemptions or concessions from SYSC for private fund managers, but the nature of the systems and controls a firm will need to maintain depends on a number of factors, including the nature, scale, and complexity of its business; the diversity of its operations; the volume and size of its transactions; and the degree of risk associated with each area of its operation. 5.37 The prudential treatment of a private fund manager within the regulatory scope of the FCA is determined primarily by whether its activities bring it within the scope of the Markets in Financial Instruments Directive (MiFID). If it is, for example, because it carries out portfolio management or the reception and transmission of orders, then it will be subject to the Capital Requirements Directive (CRD) which specifies certain minimum capital requirements, depending on the activities of the firm. MiFID, however, provides for a number of exemptions from its scope, for example for firms that act as operators of collective investment undertakings. 5.38 A firm that is within the scope of MiFID37 will at present be subject to requirements at least equivalent to the CRD. Such a firm will need to have a minimum level of own funds that exceeds the higher of a prescribed amount, and the sum of an expenditure-based requirement and risk-based capital requirements which are related to the firm's exposure to market and credit risks. 5.39 As most clients of private fund managers will be classed as professional clients or eligible counterparties, regulation of their activities is generally light. General COBS requirements include provisions on such matters as: client categorization, providing information to clients, suitability, best execution, and conflicts of interest management. (p. 118) 5.40 Importantly, the fund is generally the customer of the manager/operator, rather than the investors in the fund.38 The identity of either the customer or manager may determine the scope of the role of the manager. The manager may be the general partner of 35 36 37 38.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 the limited partnership, or the manager may be employed by the general partner to manage the investments of the partnership. 5.41 Under COBS 18.5.3R, references to a 'customer' are construed as references to any scheme in respect of which the operator acts or intends to act and which benefits from the operator's activity. Therefore, the customer of the manager is the limited partnership itself, for example, and not each partner of the limited partnership. This is the case whether the manager manages the limited partnership itself (i.e., acts as the operator of the CIS) as distinct from the investments made by the limited partnership. 5.42 However, under COBS 18.5.3R(2), when the manager is required to provide information to, or obtain consent from, a customer, the manager must ensure that the information is provided to, or consent obtained from, the partners in the limited partnership, or even potential partners. This requirement applies only to unregulated CISs and is usually dealt with by inserting a reference to the relevant matter in the limited partnership agreement. 5.43 Where the manager or general partner appoints a specialist investment adviser, the investment adviser will be acting as an agent for the limited partners, who may each become clients of the investment adviser, as the definition of 'client' includes indirect clients. The fund manager must determine into which category of client a private investment fund falls, as this is a requirement under the FCA Rules, and is necessary to establish the extent of the duties owed to the client under the FCA Rules.39 5.44 Retail clients are given the most regulatory protection and eligible counterparties the least. If a private investment fund can be treated as a professional client, or if it elects to be treated as such under FCA Rules, some of the rules can be either modified or excluded altogether. 5.45 Under the FCA Rules, before it provides services an authorized firm must provide a client with certain information, setting out the services to be provided and other details prescribed by the FCA Rules. If the customer is a professional client, there is no requirement to provide any further information. If the customer is categorized as a retail client, he must receive a written 'client agreement' which must be provided before the firm conducts any business for the customer, or immediately afterwards in certain limited cases (for example, if the client requested conclusion of the agreement via telephone). (p. 119) Fiduciary duty in the financial services regulatory regime 5.46 As one central purpose of financial services regulation is to ensure that there are adequate levels of investor protection present in the financial market, it is unsurprising that certain rules and guidance address behaviours and impose obligations in terms similar in practice to professional negligence and fiduciary duties. Accordingly, valid questions may be asked about how duties arising at general law (including fiduciary duties derived from equity) interact with regulatory obligations arising under statute. 5.47 The rules and guidance contained in the FCA Handbook can provide the means for attaching precisely defined elements of fiduciary duty to regulated firms in prescribed contexts, grounded in the pragmatic realities of the financial markets. Disclosure and prior consent are established as key components in managing conflicts. Concepts of fiduciary duty are found within the FCA's own Principles for Businesses. The FCA's rules and guidance acknowledge that the obligations owed thereunder to clients may be modified by agreement of the parties in certain instances. This position is comparable in some respects to the legal position that the court will look to the contractual relationship between the fiduciary and the beneficiary in determining the scope of fiduciary duties.40 39 40.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 C. FCA's regulatory response to private investment funds 5.48 In recent years, the FCA has been increasingly active in analysing the growth of hedge funds and private equity funds, as well as questioning its own role as a regulator with regard to each. Due to the comparative lack of widespread allegations of fraud and related malfeasance such as have occurred in the United States, the FCA's analysis of the private investment fund arena has in many respects been prospective in focus and slightly academic in tone. Although not at the forefront of the analysis, the question of the governance challenge has arisen repeatedly in the various stages of the consultation process. 5.49 In June 2005, at a time when hedge funds were more widely reported on and discussed in the press than ever before, the FCA published a discussion paper, 'Hedge funds: a discussion of risk and regulatory engagement' (DP 05/04), on a number of issues relating to hedge funds' structure and operation, seeking views on what further action should be taken to increase regulatory transparency and (p. 120) improve regulatory effectiveness with regards to hedge funds, in light of their growing importance to the United Kingdom and international financial systems. In particular, the FCA discussed the risks posed by hedge funds in relation to: (a) financial stability and market confidence; (b) market cleanliness; (c) financial crime; and (d) consumer protection. 5.50 Of particular concern to regulators is the susceptibility of hedge funds to commit market abuse, due to their traditionally close (and highly profitable) relationships with prime brokers and other key counterparties. Regulators, including the FCA, are more closely examining current hedge fund practices in relation to trading on non-public information, as well as market manipulation.41 5.51 In its March 2006 feedback statement on DP05/4, the FCA indicated that in the future its focus would include asset valuations (including the conflicts of interest that arise as a result of performance fees payable on unrealized gains), the use of side letters, and reporting requirements.42 5.52 Also in June 2005, the FCA published a second discussion paper, 'Wider range retail investment products: consumer protection in a rapidly changing world' (DP05/03), examining the regulatory regime that applied then to sophisticated investment products, and the inconsistencies that arise from this product-oriented approach. The problems it identified included the risk that consumers might be confused by different forms and distribution channels of wider-range products, or might be missing out on investment opportunities because of the restrictions on the marketing of unregulated products. Several possible courses of action were raised, including: (a) developing a new category of sophisticated products that highlight these risks more effectively; and (b) lifting the marketing restrictions on unregulated funds. 41 42.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 5.53 The FCA's feedback statement on this DP proposed three means of addressing the risks it had identified: (a) reinforcing its existing consumer information and awareness work, stressing the increasing need for consumers to invest proportionately in investment products; (b) looking further at the question of product provider responsibility, as part of its work on 'treating customers fairly'; (p. 121) (c) extending the range of non-UCITS (undertakings for collective investments in transferable securities) retail schemes to include funds of unregulated CISs. 43 As the FCA had consulted at some length in 2002 on the manner in which hedge fund managers were regulated, its willingness to re-examine these questions demonstrated encouraging open-mindedness.44 5.54 In November 2006 the FCA published a discussion paper, DP06/6: 'Private equity—a discussion of risk and regulatory engagement' on the impact that the growth in the private equity market has had on the UK's wholesale markets, and how the FCA is meeting the challenges this poses. DP06/6 sought feedback from the industry and public policy makers on whether it has correctly identified the risks posed by the growth in the private equity market and the suitability of its regulatory approach in addressing these risks. 5.55 The FCA believed that the private equity market is an increasingly important component of international capital markets and makes a key contribution to the efficiency of these markets.45 However, market developments prompted the FCA to consider whether it exercised an appropriate level of regulatory engagement with the sector. The FCA acknowledges that too much regulation can be detrimental to capital market efficiency, but too little regulation can damage market confidence. Importantly, the FCA established an alternative investments centre of expertise by integrating private equity firms and supervision staff into the existing hedge fund managers' supervision team. 5.56 In June 2007 the FCA issued a feedback statement on its discussion paper DP06/6, also entitled 'Private equity: a discussion of risk and regulatory engagement'.46 Importantly, there are no radical policy proposals or imminent threats to the industry. The influence the FCA has with respect to private equity is, perhaps more than any other sector of the financial services industry which it regulates, diluted by shared responsibility with others. Although the FCA regulates private equity advisers and the banks that finance their deals, in the public debate it is the emotive issues such as beneficial tax treatment on carried interest and leveraged deals, as well as employment sensitivities with respect to companies the subject of highly leveraged deals, which have attracted most of the flak. Tax is the responsibility of the Treasury and HMRC, and the role of private equity in the economy a political concern. (p. 122) D. SEC compliance 5.57 The Securities and Exchange Commission (SEC) regulates investment advisers and managers primarily under the Advisers Act and the rules adopted under that statute.47 The Advisers Act is intended to protect investors whose assets are managed by investment advisers either directly as regards their own individual portfolio, or indirectly in connection with pooled vehicles.48 5.58 One of the central elements of the regulatory programme is the requirement that a person or firm meeting the definition of 'investment adviser' under the Advisers Act register 43 44 45 46 47 48.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 with the SEC, unless exempt or prohibited from registration. A person or firm is required to register with the SEC if he or it is: (a) an 'investment adviser' under section 202(a)(11) of the Advisers Act; (b) not excepted from the definition of investment adviser by section 202(a)(11)(A)– (E) of the Advisers Act; (c) not exempt from SEC registration under section 203(b) of the Advisers Act; and (d) not prohibited from SEC registration by section 203A of the Advisers Act. 'Investment advisers' definition 5.59 Section 202(a)(11) of the Advisers Act generally defines an 'investment adviser' as any person or firm that: (a) for compensation (b) is engaged in the business of (c) providing advice, making recommendations, issuing reports, or furnishing analyses on securities, either directly or through publications. A person or firm must satisfy all three elements to be regulated under the Advisers Act. 5.60 The SEC construes these elements quite broadly. With respect to 'compensation', the receipt of any economic benefit suffices. To be deemed compensation, a fee need not be separate from other fees charged, it need not be designated as an (p. 123) advisory fee, and it need not be received directly from a client. With respect to the 'business' element, an investment advisory business need not be the person's or firm's sole or principal business activity. Rather, this element is satisfied under any of the following circumstances: the person or firm holds himself or itself out as an investment adviser or as providing investment advice; the person or firm receives separate or additional compensation for providing advice about securities; or the person or firm typically provides advice about specific securities or specific categories of securities. Finally, a person or firm satisfies the 'advice about securities' element if the advice or reports relate to securities.49 Exemptions from registration 5.61 A person or firm meeting the definition of investment adviser in section 202(a)(11) does not need to register with the SEC if the person or firm qualifies for one of the exemptions from registration. Investment advisers exempt from registration are still subject to certain anti-fraud provisions included in section 206 of the Advisers Act. 5.62 As discussed in Chapter 9, the previously generous exemption used by many hedge fund and private equity fund managers was repealed by Dodd-Frank.50 Under that former exemption, an adviser would be exempt if: (a) during the previous 12 months it has had fewer than 15 clients; (b) does not hold itself out generally to the public as an investment adviser; and (c) does not act as an investment adviser to a registered investment company or business development company. 5.63 Dodd-Frank provided only limited exemptions to registration. 49 50.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 Anti-fraud provisions 5.64 Section 206 of the Advisers Act prohibits misstatements or misleading omissions of material facts and other fraudulent acts and practices in connection with the conduct of an investment advisory business.51 As a fiduciary, an investment (p. 124) adviser owes its clients undivided loyalty, and may not engage in activity that conflicts with a client's interest without the client's consent.52 Section 206 applies to all firms and persons meeting the Advisers Act's definition of investment adviser, whether registered with the Commission, a state securities authority, or not at all. 5.65 As commentators have noted: The antifraud provisions of Section 206 have served for more than forty years as the basis for seemingly countless actions against investment advisors. Lurking behind the use of provisions in this way is their breadth and the relative ease with which the SEC can prove that an investment adviser has violated them.53 5.66 In addition to the general anti-fraud prohibition of section 206, specifications under the Advisers Act regulate, respectively: investment adviser advertising;54 custody or possession of client funds or securities;55 the payment of fees by advisers to third parties for client referrals;56 and disclosure of investment advisers' financial and disciplinary backgrounds.57 The 'brochure rule' 5.67 Rule 204-3 under the Advisers Act, commonly referred to as the 'brochure rule', generally requires every SEC-registered investment adviser to deliver to each prospective advisory client a written disclosure statement, or 'brochure', describing the adviser's business practices and educational and business background. 5.68 The information required by the brochure rule is included as Part II of Form ADV, the registration form for investment advisers. To comply with the brochure rule, an investment adviser may either deliver Part II of Form ADV, or another document containing at least the information disclosed in Part II of Form ADV. Other disclosure requirements 5.69 Rule 206(4)-4 under the Advisers Act requires every SEC-registered investment adviser that has custody or discretionary authority over client funds or securities, or that requires prepayment six months or more in advance of more than US$500 of advisory fees, to disclose promptly to clients and prospective clients any financial conditions of the adviser that are reasonably likely to impair the ability of the adviser to meet contractual commitments to clients. The rule also requires (p. 125) advisers (regardless of whether the adviser has custody or requires prepayment of fees) to disclose promptly to clients legal or disciplinary events that are material to an evaluation of the adviser's integrity or ability to meet its commitments to clients.58 5.70 The SEC takes the position that an investment adviser must disclose to clients all material information regarding its compensation, such as if the adviser's fee is higher than the fee typically charged by other advisers for similar services. An investment adviser must disclose all potential conflicts of interest between the adviser and its clients, even if the adviser believes that a conflict has not affected and will not affect the adviser's recommendations to its clients.59 51 52 53 54 55 56 57 58 59.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 5.71 An investment adviser, regardless of whether registered or unregistered, may be subject to disclosure obligations not only under the Advisers Act, but also under other federal statutes.60 Books and records 5.72 Section 204 of the Advisers Act and Rule 204-2 thereunder require that SEC- registered investment advisers maintain and preserve specified books and records, and make them available to SEC examiners for inspection. 5.73 Rule 204-2 requires every SEC-registered investment adviser to retain copies of all advertisements and other communications (collectively, 'advertisements') that the adviser has circulated, directly or indirectly, to ten or more persons (excluding persons connected with the adviser). Generally, the adviser also must create and retain all documents necessary to substantiate any performance information contained in advertisements. Prohibited contractual and fee provisions 5.74 Section 205(a)(2) of the Advisers Act requires each investment advisory contract entered into by an investment adviser to provide that the contract may not be assigned without the client's consent. Section 202(a)(1) of the Advisers Act defines 'assignment' generally to include any direct or indirect transfer of an investment advisory contract by an adviser or any transfer of a controlling block (p. 126) of an adviser's outstanding voting securities.61 Section 205(a)(3) of the Advisers Act provides that if an investment adviser is organized as a partnership, each of its advisory contracts must provide that the adviser will notify the client of a change in its membership. 5.75 Section 205(a)(1) of the Advisers Act prohibits an investment adviser from receiving any type of advisory fee calculated as a percentage of capital gains or appreciation in the client's account (performance fee arrangement). The Advisers Act contains exceptions to this prohibition for contracts with registered investment companies and clients having more than US$1 million in managed assets, if specific conditions are met; private investment companies excepted from the Investment Company Act under section 3(c)(7) of that Act; and clients that are not US residents. 5.76 In addition, Rule 205-3 under the Advisers Act permits investment advisers to charge performance fees to: (a) clients with at least US$750,000 under management with the adviser or more than US$1,500,000 of net worth; (b) clients who are 'qualified purchasers' under section 2(a)(51)(A) of the Investment Company Act; and (c) certain knowledgeable employees of the investment adviser. Advertising restrictions 5.77 Rule 206(4)-1 under the Advisers Act prohibits SEC-registered investment advisers from using any advertisement that contains any statement of material fact that is untrue or that is otherwise misleading. The rule broadly defines 'advertisement' to include any notice, circular, letter, or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, that offers any investment advisory service. An advertisement may not: (a) use or refer to testimonials; 60 61.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 (b) refer to past, specific recommendations made by the adviser that were profitable, unless the advertisement sets out a list of all recommendations made by the adviser within the preceding period of not less than one year, and complies with other, specified conditions; (c) represent that any graph, chart, formula, or other device can, in and of itself, be used to determine which securities to buy or sell, or when to buy or sell (p. 127) such securities, or can assist persons in making those decisions, unless the advertisement prominently discloses the limitations thereof and the difficulties regarding its use; and (d) represent that any report, analysis, or other service will be provided without charge unless the report, analysis, or other service will be provided without any obligation whatsoever. 5.78 The SEC takes the position that an adviser may advertise its past performance (both actual performance and hypothetical or model results) only if the advertisement meets certain conditions and restrictions. An advertisement using performance data must disclose all material facts necessary to avoid any unwarranted inference. 5.79 An investment adviser may not advertise its performance data if the adviser: (a) fails to disclose the effect of material market or economic conditions on the results advertised; (b) fails to disclose whether and to what extent the advertised results reflect the reinvestment of dividends or other earnings; or (c) suggests or makes claims about the potential for profit without also disclosing the potential for loss. Suitability requirements 5.80 As fiduciaries, investment advisers owe their clients a duty to provide only suitable investment advice. This duty generally requires an investment adviser to determine that the investment advice it gives to a client is suitable for the client, taking into consideration the client's financial situation, investment experience, and investment objectives.62 Duty of best execution 5.81 As a fiduciary, an adviser has an obligation to obtain 'best execution' of clients' transactions. In meeting this obligation, an adviser must execute securities transactions for clients in such a manner that the clients' total cost or proceeds in each transaction is the most favourable under the circumstances. In assessing whether this standard is met, an adviser should consider the full range and quality of a broker's services when placing brokerage, including, among other things, execution capability, commission rate, financial responsibility, responsiveness to the adviser, and the value of any research services provided.63 (p. 128) Aggregation of client orders 5.82 In directing orders for the purchase or sale of securities to a broker-dealer for execution, an adviser may aggregate or 'bunch' those orders on behalf of two or more of its accounts, so long as the bunching is done for purposes of achieving best execution, and no client is systematically advantaged or disadvantaged by the bunching. An adviser may include accounts in which it or its officers or employees have an interest in a bunched 62 63.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 order. Advisers must have procedures in place that are designed to ensure that the trades are allocated in such a manner that all clients are treated fairly and equitably. Insider trading procedures and duty of supervision 5.83 Section 204A of the Advisers Act requires investment advisers (whether SEC- registered or not) to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material or non-public information by the investment adviser or any of its associated persons. Investment advisers also have a duty to supervise persons associated with the investment adviser with respect to activities performed on the adviser's behalf. Anti-fraud 5.84 Rule 206(4)-8 prohibits advisers to investment companies and other pooled investment vehicles from (i) making false or misleading statements to investors in those pools, or (ii) otherwise defrauding them. The SEC enforces the rule through administrative and civil actions against advisers under section 206(4) of the Advisers Act. There would be no private cause of action against an adviser under the proposed rule. 5.85 Any investment adviser to a pooled investment vehicle is covered by the rule, including advisers that are not registered or required to be registered under the Advisers Act. The rule does not distinguish among types of pooled investment vehicles and is designed to protect investors both in investment companies and in pools that are excluded from the 1940 Act definition of investment company under section 3(a) by reason of either section 3(c)(1) or 3(c)(7) of the 1940 Act. 5.86 The wording of the rule, which is similar to that in many other US anti-fraud laws and rules, prohibits false or misleading statements of material facts by investment advisers. Unlike rule 10b-5 under the Exchange Act and other rules that focus on securities transactions, however, rule 206(4)-8 is not limited to fraud in connection with the purchase and sale of a security. Accordingly, rule 206(4)-8(a)(1) prohibits advisers to pooled investment vehicles from making any materially false or misleading statements to investors in the pool regardless of whether the pool is offering, selling, or redeeming securities. (p. 129) 5.87 As a result, the rule covers a wide range of potential communications to both existing investors and prospective investors, including: (a) statements regarding the investment strategy of the fund; (b) the experience and credentials of the adviser and its principals; (c) risks associated with the fund; (d) performance of the fund or other funds advised by the adviser; and (e) valuation of the fund and its investments. Private placement memoranda, requests for proposals, account statements, and any other form of communication would be covered by the proposed rules on an ongoing basis. 5.88 Importantly, however, rule 206(4)-8 does not create a fiduciary duty to investors or prospective investors in the pooled investment vehicle not otherwise imposed by law. 5.89 Further, as part of the Dodd-Frank reforms, the generous exemptions provided under the Advisers Act that allowed fund managers to operate private funds without being SEC registered were repealed and replaced with a new regime that will pull more fund managers into registration.64 64.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 E. Fiduciary duties in the financial services regime 5.90 A central purpose of financial services regulation is to ensure that there are adequate levels of investor protection present in the financial market. It is, therefore, unsurprising that certain rules and guidance address behaviours and impose obligations in terms similar in practice to professional negligence and fiduciary duties. Accordingly, valid questions may be asked about how duties arising at general law (including fiduciary duties derived from equity) interact with regulatory obligations arising under statute.65 5.91 The rules and guidance contained in the FCA Handbook, for example, can provide the means for attaching precisely defined elements of fiduciary duty to regulated firms in prescribed contexts, grounded in the pragmatic realities of the financial markets. Disclosure and prior consent are established as key components in managing conflicts. 5.92 The FCA's rules and guidance acknowledge that the obligations owed thereunder to clients may be modified by agreement of the parties in certain instances. This (p. 130) position is comparable in some respects to the legal position that the court will look to the contractual relationship between the fiduciary and the beneficiary in determining the scope of fiduciary duties.66 However, an FCA-authorized firm may not seek to exclude or restrict any duty or liability it may have to a customer under FSMA and the FCA rules.67 5.93 Importantly, a potential mismatch exists for a regulated firm, such as a fund manager, between the requirement to manage conflicts of interests under the FCA Handbook (such as the Principles of Business and the relevant COB rules) and the obligations at law to avoid conflicts of interest. However, on the basis of Kelly v Cooper and Clarke Boyce v Mouat, the Law Commission concluded that the mismatch can be addressed to a reasonable degree by using exclusionary clauses and informed consent mechanisms.68 However, the implementation of MiFID has reduced the scope for such contractual consent. F. Conclusion 5.94 Although investment managers of private investment funds that are authorized or regulated owe regulatory duties to their funds, even where the funds they manage are unregulated, the reach of regulators in the area of private investment funds is limited and indirect. Regulators must generally make do with the powers they are able to exercise at the level of the authorized fund manager, rather than at the level of the fund. 5.95 Because the particularities of private investment funds differ substantially from other types of investment products governed by financial services regimes, fund managers and other market participants have claimed that regulators and policy makers lack a full understanding of the nature of these industries and their business models. 5.96 The FCA has been increasingly active in analysing the growth of private investment funds, as well as questioning its own role as a regulator with regard to both hedge funds and private equity funds. Due to the comparative lack of widespread allegations of fraud and related malfeasance such as have occurred in the United States, the FCA's analysis to date has in many respects been prospective in focus and slightly academic in tone. Although not at the forefront of the analysis, the (p. 131) question of the governance challenge has arisen repeatedly in the various stages of the consultation process. 5.97 The SEC, by comparison, has dedicated considerable amounts of time and effort over the past five years to hedge funds and the proper regulatory response to their rapid growth in the United States.69 The debate, both internal and external, has focused primarily on deterring fraud while at the same time not undermining an essential sector of the modern financial infrastructure. Unfortunately, although seeking to address many of the concerns that follow from the governance challenge, the SEC's various pronouncements and rule- 65 66 67 68 69.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 making efforts have to date failed to propose or analyse possible solutions that address the structural causes of the governance challenge. 5.98 Given that the effective reach of financial regulators will be limited both in practice and by design, investors must pay close attention to the legal structures of the fund vehicles themselves in order to ensure that the governance challenge they face is adequately addressed in each fund. Footnotes: 1 See DP06/6 at 4. 2 Ibid. at 6. 3 See Chapter 15. 4 Financial Services and Markets Act 2000 (as amended) s.1L. 5 Memorandum of Understanding between the Financial Conduct Authority and the Bank of England, including the Prudential Regulation Authority. 6 Whether or not the activities described above will constitute 'by way of business' is ultimately a question of judgement and will be determined by reference to a number of factors including: (a) degree of continuity; (b) commercial element; (c) scale of activity; and (d) proportion to other unregulated activities. The Financial Services and Markets Act 2000 (Carrying on Regulated Activities by Way of Business Order 2001) (SI 2001/1177), Art 3. 7 The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544) as amended (the Regulated Activities Order). 8 RAO, Art 14. 9 RAO, Art 21. 10 RAO, Art 25. 11 RAO, Art 37. 12 RAO, Art 40. 13 RAO, Art 57. 14 RAO, Art 53. 15 RAO, Art 25. 16 FSMA, s 235 and SI 2001/1062 (as amended by SI 2001/3650). The definition is similar to the definition formerly contained in s 75 of the Financial Services Act 1986. 17 RAO, Art 40. 18 FSMA, s 236. 19 FSMA, s 236(2). 20 FSMA, s 236(2). 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 21 The Open-ended Investment Company Regulations 2001 (SI 2001/1228) (the OEIC Regulations) which were promulgated pursuant to FSMA, s 262. 22 The operator of an OEIC is the company itself. FSMA, s 237(2). 23 Partnership Act 1890, s 1; Limited Partnership Act 1907, s 4. Interestingly, this would not be the case for a limited liability partnership (LLP) established under the Limited Liability Partnership Act 2000, as members may have day-to-day control of property. 24 'Collective investment scheme' is a British term that refers to open-ended investment vehicles. See Niamh Moloney, EC Securities Regulation (Oxford University Press 2008) at 231 ('A collective-investment scheme is a popular form of investment vehicle which allows investors with limited funds to access the capital markets through a fund which pools investors' funds and spread risk across a range of investments according to defined asset- selection and risk criteria'). 25 For a detailed discussion of these requirements, see Niamh Moloney, How to Protect Investors: Lessons from the EC and the UK, Chapter 3 (Cambridge University Press 2010). 26 Moloney, EC Securities Regulation at 234. 27 Moloney, How to Protect Investors: Lessons from the EC and the UK at 134 ('Product design regulation, typically linked to the authorization of the product for public marketing and so associated with segnatation-based regulation, is one of the three areas of retail market protection along with the regulation of distribution and disclosure'). 28 Ibid. at 1420 ('CIS product regulation requires the regulator to make choices concerning the structure and engineering of financial products which are likely to be made more efficiently by the industry'). 29 See Houman B. Shadab, 'The Law and Economics of Hedge Funds: Financial Innovation and Investor Protection', 6 Berkley Business Law Journal 240 (2009). 30 Moloney at 290–1. 31 See Nabibu et al, 'The Hedge Fund Regulation Dilemma: Direct vs. Indirect Regulation'; Paul M. Jonna, 'In Search of Market Discipline: The Case for Indirect Hedge Fund Regulation', 45 San Diego Law Review 989 (2008); Giorgio Tosetti Dardanelli, 'Direct or Indirect Regulation of Hedge Funds: A European Dilemma', 2011 European Journal of Risk Regulation 463 (2011); Randy Haight, 'Community of Support: Moving Towards Indirect Regulation of the Hedge Fund Industry', Global Markets Law Journal 1 (2014). 32 See Moloney at 235. ('Collective-investment regulation for the retail markets is typically based on prescriptive asset-allocation rules, or portfolio-shaping rules, which are considerably more interventionist and paternalistic than the disclosure strategies often employed in securities regulation.') 33 As Moloney observed in 2008, '[t]he Commission appears similarly reluctant to impose regulation on the institutional market for alternative investments and, in particular, on the high profile hedge fund and private equity sectors . . . ' Moloney, EC Securities Regulation at 333. However, Moloney concluded that ultimately concerns over hedge fund transparency and their impact on market stability, and persistent criticisms of private equity, could lead to EC regulation. Ultimately, the adoption of AIFMD in 2010 proved this view correct. 34 For a short description of mutual fund structure and operation, see Martin E. Lybecker, 'Enhanced Corporate Governance for Mutual Funds: A Flaws Concept that Deserves Serious Reconsideration', 83 Wash Uni Law Quarterly 1045, 1045–52 (2005). As Lybecker observes, '[m]utual funds are the most popular retail investment in America, a testament to the simplicity and transparency of the mutual fund concept'). Ibid. at 1046. For a discussion 21 22 23 24 25 26 27 28 29 30 31 32 33 34.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 of EU public funds, and in particular UCITS, see Niamh Moloney, How to Protect Investors: Lessons from the EU and the UK. 35 Jerry W. Markham, 'Mutual Fund Scandals—A Comparative Analysis of the Role of Corporate Governance in the Regulation of Collective Investments', 3 Hastings Business Law Journal 67, 101–2 (2006). 36 Ibid. at 155. ('Hedge funds have become one of the most successful investment mediums in the country without SEC regulation. The hedge funds have conflicts of interest but have dealt with them adequately without a mandated number of outside directors'). 37 A firm usually falls within MiFID because it arranges or manages investment transactions that are not restricted to its operation of collective investment undertakings. 38 See DP06/6, p 18. 39 See paragraph 5.41 above. 40 Kelly v Cooper [1993] AC 205; Clarke Boyce v Mouat [1994] 1 AC 428. As a result, the contractual relationships of a private investment fund serve as an essential determinant of the scope of fiduciary duties and the effectiveness of any informed consent. 41 FCA's Financial Risk Outlook for 2006. 42 FCA feedback statement 06/2. 43 FCA feedback statement 06/3 March 2006. 44 FCA DP 16: 'Hedge Funds and the FCA'. 45 DP06/6 at 57. 46 Feedback Statement 07/3 'Private equity: a discussion of risk and regulatory engagement' (June 2007). 47 The primary sources of federal investment adviser regulation are the Advisers Act, 15 USC 80b-1 et seq, and the rules thereunder, Title 17, Part 275 of the Code of Federal Regulations. In addition, the SEC and its Division of Investment Management (the Division) provide interpretive guidance in instructions to forms under the Advisers Act, 'no-action letters', 'interpretative letters', and 'releases', all of which are publicly available. 48 See SEC v Saltzman, 127 F Supp 2d 660, 6 69 (ED pA 2000); SEC v Michael W Berger, Manhattan Investment Fund, Ltd and Manhattan Capital Management, Inc 244 F Supp 2d 180, 192 (SDNY 2001). 49 The SEC has stated that providing one or more of the following also could satisfy this element: advice about market trends; advice in the form of statistical or historical data (unless the data is no more than an objective report of facts on a non-selective basis); advice about the selection of an investment adviser; advice concerning the advantages of investing in securities instead of other types of investments; and a list of securities from which a client can choose, even if the adviser does not make specific recommendations from the list. 50 See Wulf A. Kaal and Dale Oesterle, 'The History of Hedge Fund Regulation in the United States', Handbook on Hedge Funds, Oxford University Press (2016). 51 Importantly, s 206 applies to all investment advisers, whether registered or unregistered. See SEC v KL Group LLC, Litigation Release No 19117 (3 March 2005); SEC v Barry Alan Bingham and Bingham Capital Management, Litigation Release No 19345 (23 August 2005); SEC v Conrad P Seghers and James R Dickey, Litigation Release No 18749 (17 June 2004). 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51.

[Audio] From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved. Subscriber: King's College London; date: 22 October 2023 52 In SEC v Capital Gains Research Bureau, Inc 375 US 180 (1963), the US Supreme Court held that, under s 206, advisers have an affirmative obligation of utmost good faith and full and fair disclosure of all material facts to their clients, as well as a duty to avoid misleading them. 53 Barry P. Barbash and Jai Massari, 'The Investment Advisers Act of 1940: Regulation by Accretion', 39 Rutgers Law Journal 627, 630 (2007–08). 54 Rule 206(4)-1. 55 Rule 206(4)-2. 56 Rule 206(4)-3. 57 Rule 206(4)-4. 58 The rule lists a number of legal and disciplinary events for which there is a rebuttable presumption of materiality for these purposes (although an event may still be material even if it is not on the list). 59 This obligation to disclose conflicts of interest includes the obligation to disclose any benefits the adviser may receive from third parties as a result of its recommendations to clients. 60 For example, s 13(f) of the Exchange Act, and Rule 13f-1 thereunder, generally require an investment adviser exercising investment discretion, or sharing investment discretion with others, over equity securities (which would include convertible debt and options) having a fair market value in the aggregate of at least US$100 million to file, on a quarterly basis, a Form 13F disclosing the holdings that it manages on its own behalf and on behalf of clients. 61 Rule 202(a)(1)-1 under the Advisers Act, however, provides that a transaction that does not result in a change of actual control or management of the adviser would not be deemed to be an assignment for these purposes. 62 Investment Advisers Act Release No 1406 (16 March 1994). 63 See Exchange Act Release No 23170 (23 April 1986). 64 See Kaal et al, 'The History of Hedge Fund Regulation'. See also section 9.05 et seq. 65 The work of the Law Commission on the question provides a useful framework within which to pose and discuss these questions. 66 Kelly v Cooper [1993] AC 205; Clarke Boyce v Mouat [1994] 1 AC 428. As a result, the contractual relationships of a private investment fund serve as an essential determinant of the scope of fiduciary duties and the effectiveness of any informed consent. 67 COBS 2.1.2R. 68 See paragraphs 4.28–4.47 above. 69 See Chapter 8. 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69.