Annual Compliance Review
Investment managers registered under the Investment Advisers Act of 1940 (the "Act") are required to conduct an annual compliance review pursuant to Rule 206(4)-7 of the Act. This review includes evaluating the capacity of service providers to serve investment funds that are managed by Registered Investment Advisers. It's imperative to recognize that the service providers of a fund include its directors and they should not be omitted from this annual review. Annual compliance reviews should ensure that the fund's directors have adopted internal controls and procedures that are consistent with applicable rules and regulations, including risk management, independence, data security (particularly MNPI), business continuity, recordkeeping and other key business controls, that relate to the ability of the Adviser to meet its obligations under SEC rules and regulations. It is important for an Adviser to maintain proper documentation of this review as it is a focal area of the SEC National Exam Program.
Under this Rule, service providers (including fund directors) to investment funds managed by registered investment advisers are required to have "implemented effective compliance policies and procedures administered by competent personnel and should provide the compliance officer with periodic reports". To evidence compliance with this Rule, DMS delivers to each fund we serve, a fund-specific DMS Fund Governance Transparency Report, DMS Independent Director Report and DMS Due Diligence Report. Additional copies of these reports are readily available on request for distribution to other stakeholders as required.
Footnote: Commodity pool operations must conduct a compliance review similar to the requirement of investment managers under the Act.
Board Review
DMS recommends that board performance, including any committees, be assessed at least annually. Consider whether the composition of the board, the capacity of its members, plus the frequency (and location) of its meetings, transparency reporting and other governance output, meet stakeholders' expectations. Be aware that the Cayman Islands Monetary Authority ("CIMA") has recently issued a new Statement of Guidance ("SOG") that requires, among other standards, all CIMA regulated funds to hold board meetings at least twice per year. Compliance with the new SOG need not be onerous or expensive with proper planning. If the fund is already a registered user of DMS Board Support Services, compliance with the new SOG will be seamless.
Review the tax status of the board members annually. Ensure that any directors or officers of the fund that are U.S. persons, have provided the fund with proof that the director or officer has made any required personal tax filings to the IRS. U.S. citizens and U.S. residents who are officers, directors, or shareholders in certain foreign corporations (including offshore investment funds) are responsible for filing Form 5471 Information Return of U.S. Persons With Respect to Certain Foreign Corporations. The form and attached schedules are used to satisfy the reporting requirements of transactions between foreign corporations and U.S. persons under sections 6038 and 6046 of the Internal Revenue Code. Substantial penalties exist for U.S. citizens and U.S. residents who are liable for filing Form 5471 and who failed to do so.
The location of the board meetings is also important. In recent years, a series of U.S. court decisions have found that the center of main interests ("COMI") of various Cayman Islands funds was not in the Cayman Islands. An important consideration of these courts in determining the COMI included the finding that "none of the directors resided in the Cayman Islands and there was no evidence of any board meeting taking place there". If a Cayman Islands fund is assumed by an official authority to not conduct a trade or business in the Cayman Islands, it may cause adverse tax and regulatory consequences for the fund. DMS generally recommends that "substantially all" of the board meetings of a Cayman Islands fund be conducted in the Cayman Islands.
Review the independence and any conflicts of interest of the fund's directors. In February 2013, the SEC announced that exemptive order compliance would be a focal area of the SEC National Exam Program. SEC exemptive relief is extensive and, in many circumstances, provides significant competitive advantages to a fund while reducing its costs. However, Advisers relying on SEC exemptive relief must carefully ensure compliance with the applicable SEC rules and regulations, including the SEC independence standards. The SEC maintains strict independence standards that include, among others, requiring that the directors of a fund not be affiliated with its legal counsel.
Investor Relations Review
Review the effectiveness of fund governance transparency reporting available to investors and their expectations for 2014. Seek to promptly resolve any expectation gaps. Transparency is the new normal and a key focal area for investors. DMS hosts many investor roundtables, seminars and webinars and will continue sharing insights from these investor conversations with our stakeholders in 2014. DMS also has unique transparency tools available to help meet the most demanding investor transparency expectations, such as our proprietary DMS Independent Director Reports, and DMS Fund Governance Transparency Reports. These transparency reports give investors (and other stakeholders) precise and meaningful insight into the DMS fund governance process. DMS has found that these transparency tools have become invaluable to investors who generally do not have access to the board minutes and who are prevented from receiving any information or confirmation directly from the fund's auditor.
Fund Document Review
DMS recommends that material fund documents, including marketing and performance advertising information, be reviewed at least annually to ensure the documents are fully and fairly informing investors of current practices, considering the pace of regulatory changes in the industry, and our obligations as fiduciaries. DMS would be pleased to consult with you on any proposed changes, including benchmarking current and proposed practices against our industryleading DMS Tracker database, to ensure that the fund's documents remain compliant with best industry practices.
Rule 506 Review
SEC Rule 506 under Regulation D provides an exemption for limited offers and sales of securities, if the issuer is able to satisfy at least one condition of Rule 506 deeming the transaction a private offering. In July 2013, the SEC adopted new amendments to Rule 506 to disqualify securities offerings involving certain "felons and other bad actors". This is important because many hedge funds file Form D and rely on this "safe harbor" exemption under Rule 506(d) to raise unlimited amounts of money. Non-compliance with the new rule may mean an inability to attract investment from accredited investors plus increased exposure to SEC enforcement actions.
As the worldwide leader in fund governance, DMS has the most directors in the industry serving on the boards of investment funds as Covered Persons, and all our directors have no disqualifying events. In anticipation of the impact of the amendments, DMS prepared and distributed a Rule 506(d) Certification for each DMS Director to assist fund sponsors with complying with the new rule.
Although the SEC only requires re-certification for continuous, delayed or long-lived offerings to occur on a periodic basis, DMS recommends annual re-certification of Covered Persons as a prudent measure. Accordingly, the DMS Covered Person Certification will be provided annually to fund sponsors of continuous, delayed or longlived offerings for each DMS director.
FATCA Readiness Review
Complying with the Foreign Account Tax Compliance Act ("FATCA") is a serious governance concern as the withholding penalties and other consequences are severe and potentially irreversible (withholding penalties for non-compliance are generally non-refundable). Investors have already begun requiring funds to formally attest to their FATCA readiness in side letters.
In its simplest form, being FATCA-ready means appointing a FATCA Responsible Officer ("FRO") to a fund, and obtaining its Global Intermediary Identification Number ("GIIN"). Once this occurs, the fund will be "registered deemed-compliant" under the Cayman Islands Intergovernmental Agreement "(IGA") with the U.S. and the U.K. (more IGAs are expected). The FRO is required to be an actual director or officer of the fund and has four primary responsibilities: (1) registering a fund with the IRS and obtaining the GIIN; (2) overseeing the FATCA compliance work of the administrator; (3) answering inquiries from the various tax authorities under the IGAs; and (4) remediating any matters arising under the IGAs.
DMS has consistently recommended that a fund finalize its IRS registration prior to April 25, 2014 to receive its GIIN on June 2, 2014. This is the prudent approach. The IGA provides an additional six months to obtain a GIIN, but relying on this relatively short extension may prove commercially impractical as withholding agents generally will be required to begin withholding on withholdable payments made after June 30, 2014.
The growing industry consensus is that the GIIN requirements of each withholding agent will vary based on their own risk interpretations, so in the absence of ironclad written guarantees from each withholding agent, obtaining a GIIN is prudent commercial assurance against inadvertent withholding, delay, or disruption in the counterparty relationships of a fund. Moreover, any new counterparty account opened after July 1, 2014 must immediately be FATCA compliant so this is another important consideration in managing the counterparty risk, preserving the market access, and operating flexibility of a fund.
There is no benefit to waiting. The GIIN is available at no cost from the IRS and the DMS FATCA Task Force, comprising our dedicated in-house team of attorneys, CPAs and U.S. compliance experts, is working closely with each DMS Director to ensure that all funds that DMS serves are fully FATCA compliant, including serving as FRO as required.
It is important to remember that, although FATCA applies globally, it is ultimately U.S. tax law. DMS has found that there is still some misunderstanding and conflicting advice about FATCA and the role and responsibilities of the FRO in the Cayman Islands and other offshore jurisdictions. While this is not uncommon with new, fast-moving legislation of the scale and complexity of FATCA, for the avoidance of any doubt, it is prudent to rely only on the advice of counsel qualified in U.S. tax law.
AIFMD Review
The Alternative Investment Fund Managers Directive ("AIFMD") is a requirement for any fund launched post July 22, 2013 and marketed in an EU domestic market. For funds existing prior to this date, there is an exemption to July 22, 2014 and funds must comply during this period or permanently cease all marketing in the EU. This would not require forced redemptions of current EU investors, but it will restrict the ability of the fund to accept additional subscriptions in certain European domestic markets. To permanently continue marketing in Europe there are three options.
First, register the fund on a single country-by-country basis. This allows the fund to be marketed on a private placement basis in that specific country only. There are ongoing reporting requirements depending on the country.
Second, establish an European Alternative Investment Fund ("AIF"). This allows the fund to be marketed on a pan-European basis (with certain country specific caveats). This requires an European AIF management company which will perform the management functions (including risk), act as promoter for the fund, and appoint the sponsor as its investment manager and distributor. Third, join an approved AIF platform with the platform provider acting as the AIF management company. This AIF provider will then have all regulatory reporting requirements in addition to those responsibilities listed under option two.
The DMS AIFMD team in our three European offices is pleased to offer all three services to fund sponsors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
