SEC Affirms Its Enforcement Authority With New Anti-Fraud Rule Under the Advisers Act

The Securities and Exchange Commission (the "SEC") has a new anti-fraud tool at its disposal. As we reported to you earlier this year,1 the SEC proposed Rule 206(4)-8 (the "Rule") under the Investment Advisers Act of 1940 (the "Advisers Act") in response to a ruling by the Court of Appeals for the D.C. Circuit Court in Goldstein v. SEC.2 The SEC was concerned that the Court's ruling created uncertainties with regard to the SEC's enforcement authority and the application of certain anti-fraud provisions of the Advisers Act to advisers to investment pools.

On July 11, 2007, the SEC unanimously adopted the Rule as proposed to clarify its power to bring enforcement actions against advisers who defraud investors or prospective investors in connection with pooled investment vehicles. On August 3, 2007, the SEC issued the release adopting the Rule.3 The new Rule does not impose additional filing, reporting or disclosure obligations; nor does it create a private right of action or impose additional fiduciary duties on advisers. Advisers to pooled investment vehicles should take note, however, that the new Rule potentially increases the risk of enforcement action for negligent conduct, in addition to reckless or deliberately deceptive conduct, in connection with a finding of fraudulent activity.

Scope of the Rule

Applies to Registered and Unregistered Advisers. The Rule applies to registered and unregistered investment advisers to registered and unregistered "pooled investment vehicles" regardless of the investment strategy or structure. The Rule defines "pooled investment vehicle" to mean any investment company registered under Section 3(a) of the Investment Company Act of 1940 (the "Company Act") and any private investment pool that is excluded from the definition of investment company pursuant to either Sections 3(c)(1) or 3(c)(7) thereof.4 Consequently, the Rule applies to advisers to mutual funds, closed-end funds, hedge funds, private equity funds, and venture capital funds. Despite arguments made by the mutual fund industry that the Rule added an unnecessary layer of compliance to a highly regulated investment vehicle, the SEC declined to distinguish between registered and unregistered pooled investments. In the SEC's view, all investors should be protected, not just sophisticated and wealthy investors. The Rule does not apply to foreign advisers with respect to their dealings with non-U.S. clients.5

Applies to Investors and Potential...