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Private Investment Forum


New Financial Reforms: Long Words/Short Details



How often have you heard recently that the 2,300 page legislation passed by Congress and signed into law by President Obama, The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”), constitutes the most sweeping bill for Wall Street since the Great Depression?

Well, it is not, according to David Weidner of the Wall Street Journal. In his view, the Gramm-Leach-Bliley Act of 1999 holds that distinction for, among other things, repealing the Glass-Steagall Act which mandated the separation of depository institutions from investment banks thus giving rise to some of the largest banking/investment enterprises in the world. Further, Mr. Weidner believes Gramm-Leach-Bliley undermined the foundations of market structure imposed by the Securities Act of 1933, the Securities and Exchange Act of 1934 and Glass-Steagall which, by the way, was only 34 pages in length. He equates the Dodd-Frank legislation to responding to a house collapse by reforming the fire department.

He has some company in his views. A former SEC Chairman opines, “This legislation fixes nothing, accomplishes nothing yet promises everything….We have the classic legislative monstrosity which Congress and the Administration will claim ‘solves’ the problem, but in reality solves nothing.”

The legislation has its supporters as well who are just as passionate… It’s politics as usual.

Notwithstanding the foregoing, it is obvious that the Dodd-Frank Act is a sweeping bill in its scope and impact on the financial services industry. The Act includes sixteen titles, and by some measures, will require the drafting of more than 300 rules and studies in addition to 20 periodic reports by regulators and agencies in order…

To promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail”, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.

To that end, Congress created a Financial Stability Oversight Council (FSOC) and the Office of Financial Research to collect data to monitor the institutions and markets deemed systemically important to the stability of our financial system. Another major agency established by the Act is the Bureau of Consumer Financial Protection. A director, appointed by the President for a term of five years, is charged with regulating consumer financial products and services.

Not surprising, much of the legislation is devoted to the regulation of swaps and swap dealers (Title VII), asset-backed securities (Title IX), banking (Title VI), mortgages (Title XIV) and insurance reforms (Title V) which, collectively, constitute the root causes of our recent financial crisis.

For this article, we will examine the aspects of the Act that relate most directly to investment firms, broker-dealers and asset managers.

Title IV. Private Fund Investment Advisers Registration Act of 2010

Registration Implications

Gone is the private adviser exemption upon which many hedge funds and private equity funds previously relied to avoid SEC registration as investment advisers. Thus, many fund managers will be required to register with the SEC by July 21, 2011. The Investment Advisers Act previously exempted advisers who had fewer than 15 clients, did not hold themselves out to the public as advisers and did not advise registered investment companies.

The minimum threshold for registration with the SEC is raised from $25 million to $100 million of assets under management (“AUM”). Advisers that do not meet the minimum threshold will be required to de-register with the SEC, unless the adviser has clients in 15 or more states. All advisers are required to register in states where they have clients or a place of business. Advisers, with less that $100 million in AUM and clients in 14 or less states, will be subject to regulation by the state where their principal place of business is domiciled. States may experience a significant impact on their examination programs as a result, especially those like New York which does not have such programs in place.

Regarding state registrations, the prior exemption for intra-state advisers is repealed for advisers that manage a private fund, the definition of which now captures most hedge funds and private equity funds doing business in the U.S.


Certain exemptions from SEC registration are available for:

  • Advisers managing only private funds with assets under management of less than $150 million in the United States
  • Family Offices, by virtue of being excluded from the definition of investment adviser
  • Advisers to “venture capital funds”, to be defined by the SEC within a year of enactment
  • Small Business Investment Company (SBIC) advisers
  • Advisers registered with the CFTC under certain circumstances
  • Foreign-based advisers that satisfy a specific set of criteria

Accredited Investor Standard Modified

Title IV of the Act increases the net worth standard of an “accredited investor” by excluding the value of one’s primary residence. Thus, an accredited investor is one whose net worth averages more than $1 million over a 4-year period. The value of an individual’s home is not factored into the calculation of net worth nor is the mortgage obligation thereon.

The SEC has been charged to review the definition of “accredited investor” beyond the net worth criteria noted above and to do so every four years with a view toward modification as appropriate in light of the regulatory and economic factors at the time.

It is unclear how this modification will limit the universe of potential investors in private funds and other securities offerings. Intuitively, one might say it should be substantial.

Fiduciary Duty

The provision in the Act that provides for a standard of conduct applicable to those who communicate investment advice to retail clients will have a key impact on both advisers and broker-dealers. The SEC is authorized to write rules imposing a standard of care in the best interest of the customer. While this standard has long been the “norm” for investment advisers, the broker-dealer world traditionally uses a suitability standard.

The SEC has issued a formal request for public comment on standards of care, and according to SEC Chairman, Mary Shapiro, they are anticipating a significant response. In her words, “At the completion of this study, we will have the authority to write rules that would create a uniform standard…and the new law requires that this standard be no less stringent than the standard applicable to investment advisers”.

Self-Regulatory Organization (SRO) for Private Funds

One of the studies mandated by the Act requires a report, by July 21, 2011, on the feasibility of forming a SRO body to oversee the private fund industry. Such an entity would likely be subject to SEC oversight and have a separate income structure, similar to FINRA. This organization is likely to become a reality as it would provide some relief for the SEC considering the regulation of all the new registrants required by the Act.

Title IX. Investor Protection and Improvements to the Regulation of Securities

Title IX enhances the authority of the SEC and addresses both the structure of credit rating agencies and the client relationships of broker-dealers and advisers.

The Act establishes investor influence communication facilities to enhance the flow of information and ideas. In addition to the Office of the Investor Advocate, the Investor Advisory Committee and the Ombudsman, the Act allows the SEC to compensate a whistleblower with up to 30% of the amount of the sanctions where any such sanction exceeds $1 million.

In addition, the Act calls for the issuance, in six to nine months, of rules associated with the securitization, regulation, disclosures, representations and warranties of asset-backed securities, a subject worthy of a separate article.

Point-of-Sale Disclosure Rules

The SEC is authorized to issue disclosure rules relative to the retail sales of investment products and services. Such rules shall include comprehensive information on the costs, risks and conflicts of interest associated with the particular product sold.

Mandatory Binding Arbitration

The SEC is empowered by the Act to limit or prohibit pre-dispute mandatory binding arbitration in connection with any securities-related dispute of a client of a broker-dealer or investment adviser.

Deadlines for SEC Enforcement

The Act provides for explicit time periods for the SEC to render decisions on examinations and enforcement actions. The SEC must, within 180 days of the completion of an examination, issue a written notification of its findings. Also, the SEC must notify a respondent(s) within 180 days after providing a Wells notice of its intention to file or not to file an action.

Bad Actors Disqualified in Certain Offerings

“Bad Actors” is defined in the Act as persons (1) who have been convicted of a felony or misdemeanor in connection with the sale of a security or a false filing with the SEC, or (2) are barred from association with regulated entities or from engaging in the business of securities, insurance, banking etc. because of fraud, manipulation or deception. Bad Actors cannot be involved in certain offerings under Regulation D of the ’33 Act. Such offerings do not qualify for the registration protections of Reg D, which are generally private placement offerings.

Title VII. Wall Street Transparency and Accountability

Title VII addresses the regulation of the OTC Swaps Market. Apart from the necessary rules regarding registration of participants, clearing and execution, regulatory jurisdiction and such, the Act states, “Except as provided otherwise, no Federal assistance may be provided to any swaps entity with respect to any swap, security-based swap, or other activity of the swaps entity.”

This section’s impact is aimed squarely at the source of bank failures of recent vintage, limiting proprietary trading in banks or investment bank entities. It requires removing most internal credit default swap and derivatives trading activities from these institutions and pushing them to affiliates to reduce the institution’s risk exposure.

Studies and Reports

As referenced above, the Act calls for considerable rule-making in connection with this legislation. A number of studies and reports are also mandated from which one might expect additional recommendations for rule-making. Here are some of the studies and reports, not previously mentioned, to be rendered along with the rule-making exercise.

  • Report on Mine Safety by the SEC (Mine Safety by the SEC?)
  • Report on Payments for Acquisitions of Licenses for Exploration by the SEC
  • Study on Core Deposits and Brokered Deposits by the FDIC
  • Study on the Inspector General’s Office by the Comptroller General
  • Study of mortgage appraisals by the GAO
  • Study on the criteria for accredited investors by the GAO
  • A study on Short Selling by the SEC
  • Study on Custody Rule costs by the Comptroller General


Given the depth, breadth and volume of work to be done, along with the number of separate agencies charged with doing the work, implementation of the Act will take some time. While we now have “a new law” for financial regulations, we are still missing many of the details that will be determined in the rules created by regulators. There is already talk that Congress may have to make some changes. As reported by The Wall Street Journal on August 11, 2010, “New Law Might Need Altering Already, as Implementing Its Restrictions on the Use of Credit Ratings Stirs Concerns.”

Stay tuned…




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