PROPOSED RULEMAKING
SECURITIES COMMISSION
[64 PA. CODE CHS. 203, 303, 304 AND 404]
Investment Advisors; Exchange Transactions
[34 Pa.B. 5168] The Securities Commission (Commission), under sections 203(r), 303(a) and (d) and 304(b) of the Pennsylvania Securities Act of 1972 (act) (70 P. S. §§ 1-203(r), 1-303(a) and (d) and 1-304(b)), proposes to amend regulations concerning the subject matter of the act to read as set forth in Annex A.
Summary and Purpose of the Proposed Rulemaking
The Commission proposes to add § 203.203 (relating to certain Rule 144A exchange transactions exempt) to provide a self-executing exemption for certain exchange transactions of debt securities in which certain accredited investors receive registered debt securities of the issuer in exchange for the issuer's debt securities that originally were issued in a private transaction under SEC Rule 144A (Rule 144A Exchange Transactions).
Since the American Institute of Certified Public Accountants no longer permits its members to issue management responsibility letters, the Commission proposes to amend § 303.012 (relating to investment advisor registration procedure) to delete use of a management responsibility letter instead of an audit report where the investment adviser applicant is a certified public accountant (CPA) or a firm consisting of CPAs. The Commission also proposes to delete the definition of ''principal'' which was used to define who could sign a management responsibility letter. Also, the Commission proposes to delete the ability of public accountants to render an audit report which is required by changes made to section 609(c) of the act (70 P. S. § 1-609(c)) by the act of November 24, 1998 (P. L. 829, No. 109) (Act 109).
The Commission proposes to amend § 303.032 (relating to examination requirements for investment advisors and investment advisor representatives) to require CPAs and attorneys to notify the Commission of eligibility for a waiver of the examination requirement for investment advisers and investment adviser representatives. Applications for registration as an investment adviser or investment adviser representative are processed electronically through the web-based Investment Adviser Registration Depository (IARD). The IARD only recognizes exam waivers for certain uniform designations which do not include attorneys or CPAs. Therefore, the only way the Commission knows that the applicants are eligible for a waiver of the exam requirement is to impose a notification requirement on the applicant.
The Commission proposes to amend § 303.042 (relating to investment advisor capital requirements) to make it clear that an investment adviser will not be deemed to have custody of a client's funds or securities and thereby be subject to a higher net worth requirement solely due to the investment adviser receiving a fee directly from the assets of the client, serving as a general partner of a pooled investment vehicle or serving as a trustee of a family beneficial trust if the investment adviser meets certain conditions.
Since the American Institute of Certified Public Accountants no longer permits its members to issue management responsibility letters, the Commission proposes to amend § 304.022 (relating to investment advisor required financial reports) to delete use of a management responsibility letter instead of an audit report where the investment adviser applicant is a CPA or a firm consisting of CPAs. Also, the Commission proposes to delete the ability of public accountants to render an audit report which is required by changes made to section 609(c) of the act by Act 109. The Commission further proposes to delete the definition of ''principal'' which was used to define who could sign a management responsibility letter. Lastly, the Commission proposes to exempt investment advisers with custody of clients' funds or securities from filing an annual audited balance sheet if they only inadvertently held clients' funds or securities and returned them to the client within 3 business days.
The Commission proposes to amend § 404.013 (relating to investment advisor custody or possession of funds or securities of clients) to permit an investment adviser to send itemized client statements to another person authorized by the client or to reasonably rely on a qualified custodian of the client's funds or securities to send an itemized statement to the client.
Persons Affected by the Proposed Rulemaking
Investment advisers who are required to be registered with the Commission and have custody of clients' funds or securities, which the Commission estimates to be less than ten registrants, will be affected by the proposed rulemaking. Also affected will be issuers that engage in a Rule 144A Exchange Transaction with a holder of debt securities in this Commonwealth.
Fiscal Impact
The new exemption for Rule 144A Exchange Transactions will eliminate a current requirement that transactions be registered under section 205 or section 206 of the act (70 P. S. §§ 1-205 and 1-206). The Commission anticipates an annual revenue loss to the General Fund of approximately $7,500. The proposed amendments applicable to the few investment adviser registrants who have custody of clients' funds or securities will not impose significant additional recordkeeping costs beyond those which currently exist.
Paperwork
The next exemption for Rule 144A Exchange Transactions will eliminate the filing of Commission Form R. The Commission proposes to eliminate Form 203-I. The proposed amendments applicable to the few investment adviser registrants who have custody of clients' funds or securities will require some new recordkeeping.
Effective Date
The proposed rulemaking will become effective upon final-form publication in the Pennsylvania Bulletin.
Regulatory Review
Under section 5(a) of the Regulatory Review Act (71 P. S. § 745.5(a)), on September 1, 2004, the Commission submitted a copy of this proposed rulemaking and a copy of a Regulatory Analysis Form to the Independent Regulatory Review Commission (IRRC) and to the Chairpersons of the House Committee on Commerce and Economic Development and the Senate Committee on Banking and Insurance. A copy of this material is available to the public upon request.
Under section 5(g) of the Regulatory Review Act, IRRC may convey any comments, recommendations or objections to the proposed rulemaking within 30 days of the close of the public comment period. The comments, recommendations or objections must specify the regulatory review criteria which have not been met. The Regulatory Review Act specifies detailed procedures for review, prior to final publication of the rulemaking, by the Commission, the General Assembly and the Governor of comments, recommendations or objections raised.
Availability in Alternative Formats
This proposed rulemaking is available in alternative formats upon request. The Commission also will receive comments on this proposed rulemaking in alternative formats. TDD users should use the AT&T Relay Center, (800) 854-5984. To make arrangements for alternative formats, contact Sam Dengel, ADA Coordinator, (717) 787-6828.
Contact Person
Interested persons should send comments concerning the proposed rulemaking within 30 days of publication to Mary E. Peters, Deputy Chief Counsel, Securities Commission, Eastgate Building, 1010 N. Seventh Street, 2nd Floor, Harrisburg, PA 17102-1410, (717) 783-4186. Mary E. Peters also is the contact person for an explanation of the proposed rulemaking.
JEANNE S. PARSONS,
SecretaryFiscal Note: 50-119. (1) General Fund; (2) Implementing Year 2003-04 is $7,500; (3) 1st Succeeding Year 2004-05 is $7,500; 2nd Succeeding Year 2005-06 is $7,500; 3rd Succeeding Year 2006-07 is $7,500; 4th Succeeding Year 2007-08 is $7,500; 5th Succeeding Year 2008-09 is $7,500; (4) 2002-03 Program--$7,500; 2001-02 Program--$7,500; 2000-01 Program--$7,500; (8) recommends adoption. This proposed rulemaking will codify the Exemptive Order issued by the Commission and published on March 4, 2004. The exemption of certain transactions from registration will cause the revenue loss previously outlined.
Annex A
TITLE 64. SECURITIES
PART I. SECURITIES COMMISSION
Subpart B. REGISTRATION OF SECURITIES
CHAPTER 203. EXEMPT TRANSACTIONS § 203.203. Certain Rule 144A exchange transactions exempt.
Under section 203(r) of the act (70 P. S. § 1-203), the Commission finds that it is neither necessary nor appropriate for the protection of investors to require registration under section 201 of the act (70 P. S. § 1-201) for the offer or sale of a security in a transaction if the following requirements are met:
(1) A person who owns outstanding debt securities (and any related guarantees) exchanges those securities for debt securities (and any related guarantees) of the same issuer which are the subject of an effective registration statement filed with the United States Securities and Exchange Commission (SEC) under section 5 of the Securities Act of 1933 (15 U.S.C.A. §§ 77(e)) (exchange transaction).
(2) The outstanding debt securities (and any related guarantees) are ''restricted securities'' as that term is defined in 17 CFR 230.144(a)(3) (relating to persons deemed not to be engaged in a distribution and therefore not underwriters).
(3) No consideration is paid by the owner of the outstanding debt securities (and any related guarantees) in connection with the exchange transaction.
(4) There are no material differences in the terms of the outstanding debt securities (and any related guarantees) and the debt securities (and any related guarantees) which are the subject of the exchange transaction.
Subpart C. REGISTRATION OF BROKER-DEALERS, AGENTS, INVESTMENT ADVISERS AND INVESTMENT ADVISER REPRESENTATIVES AND NOTICE FILINGS BY FEDERALLY-COVERED ADVISERS
CHAPTER 303. REGISTRATION PROCEDURE § 303.012. Investment adviser registration procedure.
* * * * * (b) Except as set forth in subsection (f), the following statements of financial condition shall accompany an application for initial registration as an investment adviser:
(1) An applicant that has custody of client funds or securities or an applicant that requires payment of advisory fees 6 months or more in advance and in excess of $1,200 per client shall file an audited balance sheet of the applicant prepared in accordance with generally accepted accounting principles and accompanied by a standard audit report containing an unqualified opinion of an independent certified public accountant [or an independent public accountant]. The accountant shall submit, as a supplementary opinion, comments based upon the audit as to material inadequacies found to exist in the accounting system, the internal accounting controls and the procedures for safeguarding securities and funds and shall indicate corrective action taken or proposed. The balance sheet required by this paragraph shall be as of the end of the applicant's most recent fiscal year. If that balance sheet is as of a date more than 45 days prior to the date of filing the application, the applicant also shall file a subsequent balance sheet prepared in accordance with generally accepted accounting principles as of a date within 45 days of the date of filing. This balance sheet may be unaudited and may be prepared by management of the applicant. [If the applicant is a certified public accountant or a public accountant or whose principals include one or more certified public accountants or public accountants, the applicant, in lieu of filing an audit report, may file a report modeled after the management responsibility letter contained in paragraph 9600.22 of the American Institute of Certified Public Accountant's Technical Information Service and signed by a certified public accountant or public accountant who either is the applicant or one of the principals of the applicant.]
* * * * * (e) For purposes of this section, the following terms [shall] have the following meanings:
[Principal--The chairperson, president, chief executive officer, general manager, chief operating officer, chief financial officer, vice president or other officer in charge of a principal business function (including sales, administration, finance, marketing, research and credit), secretary, treasurer, controller and any other natural person who performs similar functions.]
* * * * * § 303.032. Examination requirements for investment advisers and investment adviser representatives.
* * * * * (c) Waivers of exam requirements. Compliance with subsection (a) is waived if:
* * * * * (2) The individual is licensed as a certified public accountant, is currently in good standing and has no disciplinary history that requires an affirmative response to Items [23A-E] 14A-E or Item [23H] 14H of Form U-4 or successor items thereto, and has notified the Commission that the individual is eligible for a waiver of the examination requirement imposed by subsection (a).
(3) The individual is licensed as an attorney, is currently in good standing and has no disciplinary history that requires an affirmative response to Items [23A-E] 14A-E or Item [23H] 14H of Form U-4 or successor items thereto, and has notified the Commission that the individual is eligible for a waiver of the examination requirement imposed by subsection (a).
* * * * * § 303.042. Investment adviser capital requirements.
(a) Every investment adviser registered [or required to be registered] under section 301 of the act (70 P. S. § 1-301) shall maintain at all times the following net worth requirements:
(1) [An] The following applies when an investment adviser [that] has its principal place of business in a state other than this Commonwealth [shall maintain the net worth required by the state where the investment adviser maintains its principal place of business if the investment adviser currently is licensed in that state and is in compliance with that state's net worth requirements].
(i) If the investment adviser currently is licensed as an investment adviser in the state in which it maintains its principal place of business and is in compliance with that state's net worth requirements, the net worth required by this section shall be the same as the net worth requirement imposed by that state.
(ii) If the investment adviser currently is not licensed as an investment adviser in the state in which it maintains its principal place of business, the net worth required by this section shall be the same as if the investment adviser had its principal place of business in this Commonwealth.
* * * * * (3) An investment adviser that has its principal place of business in this Commonwealth and has custody of client funds or securities shall maintain at all times a minimum net worth of $35,000[.] unless the investment adviser meets any of the following:
(i) The investment adviser has custody solely as a result of receiving fees directly deducted from clients' funds or securities if the investment adviser:
(A) Possesses written authorization from the client to deduct advisory fees from an account held by a qualified custodian.
(B) Sends the qualified custodian written notice of the amount of the fee to be deducted from the client's account.
(C) Sends the client a written invoice itemizing the fee, including any formulae used to calculate the fee, the time period covered by the fee and the amount of assets under management on which the fee was based.
(ii) The investment adviser has custody solely as a result of serving as a general partner, manager of a limited liability company or a person occupying a similar status or performing a similar function which gives the investment adviser or its supervised person legal ownership or access to client funds or securities if:
(A) The pooled investment vehicle is subject to audit at least annually and distributes its audited financial statements which have been prepared by an independent certified public accountant in accordance with generally accepted accounting principles to all limited partners, members or beneficial owners within 120 days of the end of its fiscal year.
(B) The investment adviser:
(I) Hires an independent party to review all fees, expenses and capital withdrawals from the accounts included in the pooled investment vehicle prior to forwarding them to the qualified custodian with the independent party's approval for payment.
(II) Sends written invoices or receipts to the independent party which describe the amount of the fees (including any formulae used to calculate the fees, the time period covered by the fees and the amount of assets under management on which the fees were based), expenses or capital withdrawals for the independent party to verify that payment of the fees, expenses or capital withdrawals is in accordance with the documents governing the operation of the pooled investment vehicle and any statutory requirements applicable thereto.
(iii) The investment adviser has custody solely as a result of acting as trustee for a beneficial trust in which the beneficial owners of the trust are a parent or step-parent; grandparent or step-grandparent; spouse, brother or step-brother, sister or step-sister; or grandchild or step-grandchild of the investment adviser.
* * * * * (c) For the purpose of this section, the following terms have the following meanings:
* * * * * Independent party--A person who meets all of the following requirements:
(i) Is engaged by an investment adviser with respect to payment of fees, expenses or capital withdrawals from a pooled investment vehicle in which the investment adviser has custody solely as a result of serving as a general partner, manager of a limited liability company or a person occupying a similar status or performing a similar function which gives the investment adviser or its supervised person legal ownership or access to client funds or securities.
(ii) Does not control, is not controlled by and is not under common control with the investment adviser.
(iii) Within the preceding consecutive 12 month period, did not derive 5% or more of its gross revenues from the investment adviser who hired the person to be an independent party, including the amount to be received from the investment adviser under the terms of the independent party engagement.
* * * * * Pooled investment vehicle--
(i) A limited partnership, limited liability company or an entity with a similar legal status and performing similar functions.
(ii) The term does not include an investment company that has filed a registration statement under the Investment Company Act of 1940 (15 U.S.C.A. §§ 80a-1--80a-64).
* * * * * Qualified custodian--The following shall be considered qualified custodians for purposes of this section:
(i) A bank as that term is defined in section 102(d) of the act (70 P. S. § 1-102(d)).
(ii) A Federally covered adviser as that term is defined in section 102(f.1) of the act.
(iii) A broker dealer registered with the Commission under section 301 of the act (70 P. S. § 1-301).
Supervised person--A person who meets the definition in section 202(a)(25) of the Investment Advisers Act of 1940 (15 U.S.C.A. § 80b-2(a)(25)).
CHAPTER 304. POSTREGISTRATION PROVISIONS § 304.022. Investment adviser required financial reports.
(a) Except as provided in [subsection] subsections (b) and (c), the following investment advisers registered under section 301 of the act (70 P. S. § 1-301) shall file the following reports of financial condition with the Commission within 120 days of the investment adviser's fiscal year end:
(1) An investment adviser that has custody of client funds or securities or requires prepayment of advisory fees 6 months or more in advance and in excess of $1,200 per client shall file with the Commission an audited balance sheet as of the end of its fiscal year. The balance sheet shall be prepared in accordance with generally accepted accounting principles and contain an unqualified opinion of an independent certified public accountant [or independent public accountant]. The accountant shall submit, as a supplementary opinion, comments based on the audit as to material inadequacies found to exist in the accounting system, the internal accounting controls and procedures for safeguarding securities and funds, and shall indicate corrective action taken or proposed. [If the investment adviser is a certified public accountant or a public accountant or whose principals include one or more certified public accountants or public accountants, the investment adviser, in lieu of filing an audit report, may file a report modeled after the management responsibility letter contained in paragraph 9600.22 of the American Institute of Certified Public Accountant's Technical Information Service signed by a certified public accountant or public accountant or one of the principals of the investment adviser.]
* * * * * (c) [For purposes of this section, the following terms have the following meanings:
Principal--The chair, president, chief executive officer, general manager, chief operating officer, chief financial officer, vice president or other officer in charge of a principal business function (including sales, administration, finance, marketing, research and credit), secretary, treasurer, controller and any other natural person who performs similar functions.
Principal place of business--The meaning set forth in 17 CFR 275-203A-3(c) (relating to definitions) promulgated under the Investment Advisers Act of 1940 (15 U.S.C.A. §§ 80b-1--80b-21).] When an investment adviser registered under section 301 of the act inadvertently held or obtained a client's securities or funds and returned them to the client within 3 business days or has forwarded third party checks within 24 hours, the investment adviser will not be deemed to have custody and subject to the requirements of subsection (a) if the investment adviser maintains records which contains the following information about the securities or funds returned to the client:
(i) If a security:
(A) The name of the issuer.
(B) The type of security.
(C) The date of issuance.
(D) A certificate number or other identifying information.
(E) The denomination, interest rate and maturity date applicable to a debt security.
(F) The name in which the securities are registered.
(ii) If funds:
(A) The name of the payee or beneficial owner.
(B) The check number, transmittal number, payor name and address and any other identifying information.
(iii) The date on which the funds or securities were received by the investment adviser.
(iv) The date on which the funds or securities were sent by the investment adviser to the client.
(v) The form of delivery used by the investment adviser to transmit the funds or securities to the client and a copy of written confirmation of receipt of the funds or securities by the client.
(d) For purposes of this section, the following term has the following meaning:
Principal place of business--The meaning set forth in 17 CFR 275-203A-3(c) (relating to definitions) promulgated under the Investment Advisers Act of 1940 (15 U.S.C.A. §§ 80b-1--80b-21).
Subpart D. FRAUDULENT AND PROHIBITED PRACTICES
CHAPTER 404. PROHIBITED ACTIVITIES; INVESTMENT ADVISERS AND INVESTMENT ADVISER REPRESENTATIVES § 404.013. Investment adviser custody or possession of funds or securities of clients.
* * * * * (b) An investment adviser registered under section 301 of the act (70 P. S. § 1-301) that has custody or possession of any funds or securities in which any client has any beneficial interest shall:
* * * * * (7) At least once every 3 months, send each client or the client's authorized representative as defined in this section an itemized statement showing the funds and securities in the investment adviser's custody at the end of each period and all debits, credits and transactions in the client's account during that period or have a reasonable basis for believing that a qualified custodian will send an itemized statement to each client or the client's authorized representative during the same time interval containing substantially the same information.
(8) At least once every calendar year, engage an independent certified public accountant [or independent public accountant] to verify all client funds and securities by actual examination at a time chosen by the accountant without prior notice to the investment adviser. A report stating that an accountant has made an examination of the client funds and securities, and describing the nature and extent of the examination, [shall] must be filed with the Commission within 30 days after each examination.
(c) When an independent certified public accountant makes an examination described in subsection (b)(8) and, upon examination, finds material discrepancies, the accountant shall notify the Commission within 1 business day of the finding by means of facsimile transmission or electronic mail, followed by first class mail, directed to the Commission's Division of Licensing.
(d) For purposes of this section, a person will be deemed to have custody if the person directly or indirectly holds client funds or securities, has any authority to obtain possession of them, or has the ability to appropriate them.
(e) For the purpose of this section, the following terms have the following meanings:
Authorized representative--The person specified in a written authorization which the client has signed and filed with the investment adviser or qualified custodian authorizing the investment adviser or qualified custodian to deliver the client's account statements to that person.
Qualified custodian--The following will be considered qualified custodians for purposes of this section:
(i) A bank as that term is defined in section 102(d) of the act (70 P. S. § 1-102(d)).
(ii) A Federally covered adviser as that term is defined in section 102(f.1) of the act.
(iii) A broker dealer registered with the Commission under section 301 of the act.
[Pa.B. Doc. No. 04-1723. Filed for public inspection September 17, 2004, 9:00 a.m.]
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