Dodd-Frank Wall Street Reform and Consumer Protection Act

August 19, 2010

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was enacted. This memorandum provides a brief overview of some of the provisions of the Act that are relevant to investment advisers, including derivatives, the Volcker Rule, prudential regulation, reporting requirements and corporate governance. Many of the provisions of the Act require the adoption of regulations by various government agencies, which we anticipate will provide further clarification regarding the meaning and applicability of certain provisions. For information regarding the registration requirements applicable to investment advisers, please see our client memorandum dated July 8, 2010.


The Act contains several notable changes that may be relevant to investment advisers that engage in derivatives transactions, including the requirement that swaps generally must be cleared by a clearinghouse, real-time data reporting of swaps, increased regulation of “swap dealers” and “major swap participants” and asset segregation.

Centralized Clearing and Reporting

Certain swaps (to be determined by the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”)) will be required to be submitted to a derivatives clearinghouse for clearing. If a particular swap has not been listed by a clearing organization, the CFTC and the SEC will take such action as it deems appropriate. Each swap (whether it is cleared or not) will be reported in real-time to a registered swap data repository, or to the CFTC or the SEC if no registered swap data repository will accept the swap. The intent of these provisions is to provide a creditworthy counterparty for settlements and greater price transparency.


Swap dealers and major swap participants will be required to register with the SEC or CFTC, as applicable, and must designate a chief compliance officer. While it is unlikely that a private fund would meet the definition of a swap dealer1, a private fund could be considered a major swap participant2.

The CFTC and the SEC will promulgate rules for registered entities regarding:

  • capital requirements;
  • margin requirements for swaps that are not cleared;
  • recordkeeping, documentation and reporting;
  • business conduct (including additional rules for swaps involving “special entities” such as employee benefit plans, government agencies or advisors to special entities);
  • risk management procedures; and
  • conflicts of interest.

Segregation of Assets

If a swap is cleared, the money, securities and property of the swap customer will be separately accounted for and will not be commingled or used to margin, secure or guarantee any trades or contracts other than those for that customer’s account. If a swap is not cleared, a swap counterparty that is not a major swap participant may request that the funds or other property used to secure the obligations of the counterparty be segregated with an independent third-party custodian and designated as a segregated account for the benefit of the counterparty and other swap counterparties.

Jurisdiction of Swap Regulation

The SEC will regulate security based swaps, and mixed swaps will be jointly regulated by the SEC and the CFTC. All other swaps will be regulated by the CFTC. A security based swap will constitute a “security” under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”) and therefore will be subject to the antifraud provisions of the federal securities laws.

The Volcker Rule

Subject to certain exceptions described below, a banking entity may not acquire or retain any ownership interest in, or sponsor a hedge fund or a private equity fund3.

Permitted Activities

Notwithstanding the general prohibition on investments in hedge funds and private equity funds, banking entities may engage in the following activities:

  • Organizing and offering a hedge fund or a private equity fund, including serving as a general partner or managing member of the fund, provided that the banking entity:
    • provides bona fide trust, fiduciary, or investment advisory services and the fund is organized and offered in connection with the services;
      does not acquire or retain an equity interest, partnership interest, or other ownership interest in the fund other than a “de minimis” investment or a “seed” investment made for the purpose of establishing the fund4;
    • does not enter into certain transactions with the fund provided that there is an exception for certain prime brokerage activities;
    • does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the hedge fund or private equity fund or of any fund in which the hedge fund or private equity fund invests;
    • does not share the same name or a variation of the same name with the fund;
    • does not have directors or employees that take or retain an equity interest, partnership interest, or other ownership interest in the fund, except for any director or employee who provides advisory or other services to the fund; and
    • discloses to prospective and actual investors in the fund, in writing, that any losses in the fund are borne solely by investors in the fund and not by the banking entity.
  • Acquiring or retaining an equity, partnership or other ownership interest in, or the sponsorship of, a hedge fund or a private equity fund pursuant to certain provisions of the Bank Holding Company Act solely outside of the U.S., provided that no ownership interest in the fund is offered for sale or sold to a resident of the U.S. and the banking entity is not directly or indirectly controlled by a banking entity organized under the laws of the U.S. or any state in the U.S.

A banking entity must bring its activities into compliance with the Volcker Rule within two years of the effective date, which is the earlier of: (i) 12 months after the issuance of final rules implementing the Volcker Rule and (ii) July 22, 2012 (subject to extensions that may be granted by the Federal Reserve).

Reporting Requirements

The Act provides for increased reporting requirements that are relevant to certain investment advisers, including the following:

  • The SEC is given the authority to prescribe shorter time periods for initial filings required under Section 13 and Section 16 of the Exchange Act (i.e., Schedules 13G and 13D and Forms 3 and 4). Copies of filings made under Section 13 and Section 16 are no longer required to be sent to the issuer or the exchange where the security is traded.
  • The SEC is directed to prescribe rules providing for the public disclosure of certain information regarding short sales. This disclosure must be made at least monthly.
  • Filings under Section 13 and Section 16 of the Exchange Act must include equity securities that a person acquires beneficial ownership of through the purchase or sale of a security-based swap.
  • Each institutional investment manager subject to Section 13(f) of the Exchange Act must report at least annually how it voted on any shareholder vote regarding executive compensation or golden parachutes (in the context described below) unless such vote is otherwise required to be publicly reported.
  • A “covered financial institution” (which includes an investment adviser) with $1 billion or more in balance sheet assets will be required to disclose to its regulator the structure of its incentive-based compensation arrangements (but not the actual compensation of individuals) and the federal regulators are directed to prohibit any type of incentive-based compensation arrangements that the regulators determine encourage inappropriate risks.

Corporate Governance

Title IX of the Act, the Investor Protection and Securities Reform Act of 2010, contains many provisions applicable to corporate governance that may be of interest to investment advisers, including those regarding pay versus performance, say on pay, golden parachute and clawback provisions, proxy disclosure and whistleblowers. These provisions include the following:

  • Pay versus Performance: The SEC is directed to require all issuers subject to the SEC’s proxy solicitation rules to disclose information that shows the relationship between executive compensation actually paid and the financial performance of the issuer, accounting for any change in share value, dividends paid or other distributions. The SEC is also directed to require each such issuer to disclose (i) the median of the annual total compensation of all employees excluding the CEO (or person in an equivalent position); (ii) the annual total compensation of the CEO (or person in an equivalent position) and (iii) the ratio of (i) to (ii).
  • Say on Pay: At least once every three years, each company subject to the SEC’s proxy solicitation rules that require compensation disclosure must include in its proxy, consent or authorization for an annual or other shareholder meeting, a separate non-binding shareholder resolution to approve the compensation of executives.
  • Golden Parachutes: In any proxy or consent solicitation subject to the SEC’s proxy solicitation rules for a shareholder meeting to approve an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all of the assets of an issuer, the person making the solicitation must disclose any agreements with any executive officers of the issuer (or of the acquiring issuer) regarding any type of compensation (whether present, deferred or contingent) that is based on or relates to the transaction and the total of all such compensation. Unless they were previously subject to shareholder approval, the compensation agreements will be subject to a non-binding shareholder vote.
  • Clawback: The SEC is directed to issue rules requiring the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that does not implement a policy providing: (i) for the disclosure of incentive-based compensation policies that are based on financial information otherwise required to be reported under the federal securities laws and (ii) that in the event of an accounting restatement due to material noncompliance with any financial reporting requirement under the securities laws, the issuer will recover incentive based compensation paid to current/former executive officers, during the 3-year period preceding the date on which the issuer is required to prepare the restatement, that is in excess of what would have been paid under the restatement.
  • Hedging by Employees and Directors: The SEC is directed to issue rules under the Exchange Act requiring issuers subject to the SEC’s proxy solicitation rules to disclose in any proxy or consent solicitation material for an annual shareholder meeting whether any employee or member of the board of directors can purchase financial instruments designed to hedge against any decrease in the value of equity securities granted to the employee or board member as part of a compensation package or otherwise held by the person.
  • Proxy Access: The SEC has been granted the authority to issue rules requiring that a proxy subject to the SEC’s proxy solicitation rules include the name of a nominee submitted by a shareholder to serve on the issuer’s board of directors and permit shareholders to use proxy solicitation materials to nominate director candidates. This provision is intended to permit the SEC’s proxy access rules that were proposed in 2009 to be adopted without legal challenge.
  • Separation of Chairman/CEO Role: The SEC is directed to issue rules that require an issuer to disclose in its annual proxy the reasons why the issuer has or has not separated the role of chairman of the board of directors and chief executive officer.
  • Whistleblowers: Whistleblowers who voluntarily provide original information to the SEC that leads to the successful enforcement of a judicial, administrative or related action may be paid monetary awards. Additionally, employers are prohibited from demoting, suspending, threatening, harassing or discriminating against whistleblowers who provide information in accordance with the Act.

Prudential Regulation

The Act establishes the Financial Stability Oversight Council (the “Council”) to identify risks to the financial stability of the U.S., promote market discipline and respond to emerging threats to the U.S. financial system. The Secretary of the Treasury is the chairperson of the Council and the Council has ten voting members and five non-voting members. The voting members are the agency heads of the Department of Treasury, Federal Reserve, Office of the Comptroller of the Currency, Bureau of Consumer Financial Protection, Securities and Exchange Commission, Federal Deposit Insurance Corporation, Commodity Futures Trading Commission, Federal Housing Finance Agency, National Credit Union Administration Board and an independent member with insurance expertise. The non-voting members are the Director of the Office of Financial Research (an office established under the Treasury Department), the Director of the Federal Insurance Office, a state insurance commissioner, a state banking supervisor and a state securities commissioner.

The Council has the authority to subject banks and other nonbank financial companies (which could include investment advisers) to supervision by the Federal Reserve. Considerations used by the Council to designate a nonbank financial company for supervision by the Board may include: (i) the extent of the company’s leverage; (ii) the nature, scope, size, scale, concentration, interconnectedness and mix of its activities; (iii) its importance as a source of credit to others; (iv) management of, rather than ownership of, its assets; (v) regulation by an agency such as the SEC or the CFTC; and (vi) its liabilities, including its degree of reliance on short-term funding. An entity that is subject to supervision by the Federal Reserve may be subject to, among other requirements, stricter prudential standards, reporting requirements, examinations by the Federal Reserve, stress tests, limitations on its ability to engage in a variety of activities, and assessments.

Bureau of Consumer Financial Protection

The Act establishes the Bureau of Consumer Financial Protection (the “Bureau”) to regulate consumer financial products or services under the Federal consumer financial laws. The purpose of the Bureau is to implement and enforce Federal consumer financial law and to ensure that the markets for consumer financial products and services are fair, transparent, competitive and accessible to all consumers. The Bureau does not have any enforcement authority over investment advisers that are registered with the SEC and generally does not have enforcement authority over state registered investment advisers; however, the Bureau may have enforcement authority over unregistered investment advisers. The Bureau will conduct periodic examinations of covered institutions and may require reports from those institutions.

Other Provisions Applicable to Investment Advisers

The Act also contains certain other provisions that may be relevant to investment advisers, including the following:

  • The SEC is directed to issue rules to disqualify offerings and sales of securities made under Rule 506 of Regulation D under the Securities Act by a person who is a felon or other bad actor.
  • The SEC is authorized to bring enforcement actions against persons who aid and abet violations of the Securities Act and the Investment Company Act.
  • The SEC is authorized to impose civil penalties upon persons who aid and abet violations of the Investment Advisers Act.
  • The U.S. district courts will have extraterritorial jurisdiction over actions brought by the SEC or the U.S. alleging a violation of the anti-fraud provisions of the federal securities laws involving (i) conduct within the U.S. that constitutes significant steps in furtherance of the violation even if the securities transaction occurs outside of the U.S. and involves only foreign investors or (ii) conduct occurring outside the U.S. that has a foreseeable substantial effect within the U.S.
  • A “paying agent” is required to provide written notice to a “missing security holder”5 that the person has been sent a check that has not yet been negotiated. A paying agent includes an investment adviser that accepts payments from the issuer of a security and distributes the payments to the holders of the security.
  • The SEC is directed to establish an Investor Advisory Committee to advise and consult with the SEC regarding regulatory priorities, regulation of securities, trading strategies and fee structures and the effectiveness of disclosure, initiatives to protect investors interests and initiatives to promote investor confidence and the integrity of the securities marketplace. The members of the committee, among others, will include individuals who: (i) represent the interests of individual equity and debt investors, including investors in mutual funds; (ii) represent the interests of institutional investors, including the interests of pension funds and registered investment companies; (iii) are knowledgeable about investment issues and decisions; and (iv) have reputations of integrity.

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If you have any questions with respect to the foregoing, please contact your primary attorney in the Investment Management Group at Seward & Kissel LLP.


1 A “swap dealer” is an entity that holds itself out as a dealer in swaps, makes a market in swaps, regularly enters into swaps as an ordinary course of business or is commonly known as a dealer or market maker in swaps.

2 A “major swap participant” is any person who is not a swap dealer and (i) maintains a substantial position in swaps (to be defined by the SEC or CFTC, as applicable), excluding those held for hedging purposes, (ii) whose outstanding swaps create substantial counterparty exposure that causes significant systemic risk, or (iii) maintains a substantial position in swaps (including those held for hedging purposes) and is a financial entity that is highly leveraged relative to the amount of capital it holds and that is not subject to capital requirements established by an appropriate Federal banking agency.

3 While the term “sponsoring” is defined, the concept of having an “ownership interest” is not; consequently the scope of prohibited activities is unclear. The terms “hedge fund” and “private equity fund” mean an issuer that would be an investment company, as defined in the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of that Act, or such similar funds as may be determined by rule.

4 Not later than the 1 year after the hedge fund or private equity fund’s establishment (which period may be extended upon application by a banking entity), the banking entity’s investment in the fund cannot exceed 3% of the total ownership interests of the fund. Additionally, the aggregate investments of the banking entity and its affiliates in hedge funds and private equity funds must be immaterial (to be defined by the SEC) and cannot exceed 3% of the banking entity’s tier 1 capital. The banking entity must also actively seek to have unaffiliated investors in the fund in order to reduce or dilute its investment.

5 A security holder is considered a “missing security holder” if a check is sent to the security holder and the check is not negotiated before the earlier of: (i) the paying agent sending the next regularly scheduled check or (ii) six months have elapsed since the check was sent.