The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Dodd-Frank

  • From Vol. 10 No.6 (Feb. 9, 2017)

    Steps Hedge Fund Managers Should Take Now to Ensure Their Swap Trading Continues Uninterrupted When New Regulation Takes Effect March 1, 2017

    In the aftermath of the 2008 global financial crisis, the Basel Committee on Banking Supervision and the Board of the International Organization of Securities Commissions sought to reduce systemic risk and promote central clearing by recommending mandatory margin requirements on non-centrally cleared derivatives (i.e., derivatives that trade bilaterally). See “OTC Derivatives Clearing: How Does It Work and What Will Change?” (Jul. 14, 2011). In late 2015, five federal regulators adopted a joint rule that applies these requirements to swap dealers under their supervision; the CFTC adopted its own rule. The compliance date for the variation margin requirements under these rules is March 1, 2017. See Hedge Funds Face Increased Margin Requirements Under Final Swap Rules (Part One of Two)” (Feb. 18, 2016); and Hedge Funds Face Increased Trading Costs Under Final Swap Rules (Part Two of Two)” (Feb. 25, 2016). To better understand how the rules affect the private funds industry, The Hedge Fund Law Report recently interviewed Leigh Fraser, a partner at Ropes & Gray and co-leader of the firm’s hedge fund group, regarding the steps that funds should take to ensure that their swaps trading continues on an uninterrupted basis. For additional insights from Fraser, see our three-part series on best practices in negotiating prime brokerage arrangements: Preliminary Considerations When Selecting Firms and Brokerage Arrangements” (Dec. 1, 2016); Structural Considerations of Multi-Prime and Split Custodian-Broker Arrangements” (Dec. 8. 2016); and Legal Considerations When Negotiating Prime Brokerage Agreements” (Dec. 15, 2016).

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  • From Vol. 9 No.33 (Aug. 25, 2016)

    How Hedge Fund Managers Can Balance Protecting Confidential Information Against Complying With Whistleblower Laws 

    Building upon the principles articulated in its April 2015 settlement with KBR, Inc., the SEC recently announced a settlement with BlueLinx Holdings Inc. relating to provisions the company had included in severance agreements. Those provisions restricted former employees’ abilities to disclose the company’s confidential information and to receive rewards as SEC whistleblowers. The BlueLinx and KBR consent orders together underscore the SEC’s view that any provisions that might stifle an employee’s communications with the SEC – either explicitly (as in KBR) or implicitly (as in BlueLinx) – are prohibited, regardless of the employer’s intent, its efforts (or lack thereof) to enforce them or their actual chilling effect. In a guest article, Anne E. Beaumont and Lance J. Gotko, partners at Friedman Kaplan Seiler & Adelman, describe the circumstances underlying the KBR and BlueLinx enforcement actions, including the specific contractual provisions that the SEC concluded violated the whistleblower rules, and offer practical advice to hedge fund managers on how they can avoid running afoul of applicable whistleblower rules. For additional insight from Beaumont, see “Hedge Fund Service Providers Must Exercise Caution When Communicating With Investors or Face Liability” (May 26, 2016); “BDC Finance v. Barclays: Derivatives Collateral Calls in a Chaotic Market” (Mar. 19, 2015); and “Five Steps for Proactively Managing OTC Derivatives Documentation Risk” (Apr. 25, 2014). For more on whistleblowers, see “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016); and “RCA Session Offers Insights on Dodd-Frank Whistleblower Regime, Incentives, Anti-Retaliation Protections and Risks” (Apr. 9, 2015).

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  • From Vol. 9 No.32 (Aug. 11, 2016)

    How Promoting Internal Reporting Can Reduce Risk of Regulatory Intervention for Hedge Fund Managers

    In an effort to stop financial frauds before they occur or, at the very least, minimize the extent of the fraud, Congress, through the Dodd-Frank Act, established a program that requires the SEC to pay monetary awards to whistleblowers in certain circumstances. The SEC’s whistleblower program, codified in Section 21F of the Securities Exchange Act of 1934 and rules and regulations adopted by the SEC (Whistleblower Rules), not only offers generous financial bounties to individuals who report violations, but also provides strong protections to whistleblowers from workplace retaliation. In a guest article, Mike Delikat and Renee Phillips, partners at Orrick, review the relevant aspects of the Whistleblower Rules and provide practical advice to investment managers about how they can encourage whistleblowers to report suspected violations internally, which may enable an investment manager to remedy a violation prior to or without regulatory intervention. For more on the SEC’s whistleblower program, see “SEC Chair’s Testimony Highlights SEC’s Bolstered Presence in Asset Management Space” (Jun. 16, 2016); and “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016).

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  • From Vol. 9 No.26 (Jun. 30, 2016)

    Expanded “Gatekeeper” Responsibilities May Impact Relationship Between Hedge Funds and Service Providers

    The Dodd-Frank Act expanded the SEC’s authority and oversight of the fund industry, in part by subjecting previously unregistered advisers to registration requirements. Two recent SEC enforcement actions have further increased this authority, finding that a service provider to hedge funds – not itself subject to fiduciary or other obligations under the Investment Advisers Act of 1940 (Advisers Act) – was responsible for Advisers Act violations by two of its clients. On June 16, 2016, the SEC announced the resolution of two enforcement actions against a private fund administrator that, by missing various red flags raised by activities of its private fund clients, allegedly caused those clients to violate antifraud provisions of the Advisers Act. This article analyzes the facts that led up the SEC’s allegations, resolution of the enforcement actions and potential industry implications. For more on the SEC’s focus on gatekeepers, see “How Can Hedge Fund Managers Update Their Insider Trading Compliance Programs to Reflect the SEC’s Focus on Systemic Violators, Gatekeepers, Trading Patterns, Profitable Trades and Expert Networks?” (Aug. 19, 2011).

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  • From Vol. 8 No.14 (Apr. 9, 2015)

    RCA Session Offers Insights on Dodd-Frank Whistleblower Regime, Incentives, Anti-Retaliation Protections and Risks

    The Dodd-Frank Act created incentives for whistleblowers to report violations of securities laws to the SEC and prohibits retaliation against persons who do so.  It has been nearly four years since the SEC issued its final whistleblower regulations.  A recent program offered by the Regulatory Compliance Association (RCA) provided a thorough overview of both the whistleblower bounty program and the anti-retaliation protections under the Dodd-Frank Act; considered how regulators and courts have interpreted and implemented those provisions; analyzed the interaction of the Dodd-Frank anti-retaliation provisions with those under the Sarbanes-Oxley Act; and offered strategies for mitigating whistleblower risks.  The program featured J. Ian Downes, counsel at Dechert LLP, and Kathleen M. Massey, a partner at Dechert LLP and an RCA Senior Fellow.  This article summarizes the key takeaways from the program.  This month, the RCA will be hosting its Regulation, Operations and Compliance (ROC) Symposium in Bermuda.  For more on ROC Bermuda 2015, click here; to register for it, click here.  For a discussion of another RCA program, see “RCA Asset Manager Panel Offers Insights on Hedge Fund Due Diligence,” The Hedge Fund Law Report, Vol. 8, No. 13 (Apr. 2, 2015).

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  • From Vol. 4 No.23 (Jul. 8, 2011)

    Recent No-Action Letter Suggests That the SEC Will Not Require Registration by a U.S. “Captive” Investment Advisory Subsidiary of a Foreign Insurance Company

    In a letter dated June 30, 2011, the SEC’s Division of Investment Management (Division) confirmed that it would not recommend enforcement action to the SEC if the wholly-owned U.S. asset management subsidiary of a Japanese insurance company did not register with the SEC as an investment adviser.  For hedge fund managers, there are two potentially interesting aspects of this no-action letter, and one aspect of the no-action letter that limits its application.  The two potentially interesting aspects of the no-action letter are: First, it is one of the few pieces of authority, outside of rule releases, dealing with the real world implications of the elimination of the private adviser exemption by the Dodd-Frank Act.  (This elimination will happen automatically as of July 21, 2011, though the registration due date has been delayed to March 30, 2012.)  Second, at a broad level, it deals with registration questions in the context of global affiliate relationships – an area fraught with ambiguity, and one on which hedge fund industry participants are eager for more SEC guidance.  See “Impact of the Foreign Private Adviser Exemption and the Private Fund Adviser Exemption on the U.S. Activities of Non-U.S. Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 4, No. 16 (May 13, 2011).  However, unfortunately for those seeking guidance, the SEC did not focus on either of the foregoing two topics in its analysis.  Rather, the primary basis for the SEC’s grant of no-action relief, and the focus of its analysis, was more straightforward and less generalizable.

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  • From Vol. 4 No.21 (Jun. 23, 2011)

    SEC Delays Registration Deadline for Hedge Fund Advisers, and Clarifies the Scope and Limits of Registration Exemptions for Private Fund Advisers, Foreign Private Advisers and Family Offices

    At an open meeting held on June 22, 2011, the Securities and Exchange Commission adopted and amended rules that will directly affect the registration, reporting and disclosure obligations of U.S. and non-U.S. hedge fund managers.  While the texts of most of those rules or rule amendments remain to be published as of this writing, comments by SEC commissioners at the open meeting outlined the general scope of the final rules and amendments.  Of particular relevance to hedge fund managers, the SEC addressed the following topics at the open meeting: delay of registration and reporting deadlines; who may and must register with the SEC and the states based on assets under management; the private fund adviser exemption; the foreign private adviser exemption; continuing relevance of the Unibanco no-action letter for global hedge fund sub-­advisory relationships; filing, recordkeeping and examination obligations of exempt reporting advisers; and the exemption from registration for family offices.  This article offers more detail on the SEC’s statements on each of the foregoing topics at the open meeting.

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  • From Vol. 4 No.16 (May 13, 2011)

    Impact of the Foreign Private Adviser Exemption and the Private Fund Adviser Exemption on the U.S. Activities of Non-U.S. Hedge Fund Managers

    Passage of the Dodd-Frank Act and relevant SEC rulemaking has changed the regulatory landscape for non-U.S. hedge fund managers that have or plan to establish an advisory presence in the U.S. or that have or plan to target U.S. investors.  Generally – and despite references to “international comity” in one of the relevant proposed rule releases – the Dodd-Frank Act has increased the regulatory burden on non-U.S. hedge fund managers wishing to access the U.S. market.  Or, put another way, Dodd-Frank has narrowed considerably the range of conduct in which non-U.S. managers may engage without getting caught in the purview of U.S. investment adviser registration, or many of its substantive burdens.  This article provides detailed synopses of the relevant provisions of the foreign private adviser exemption and the private fund adviser exemption, focusing in particular on: rules relating to counting clients and investors; measuring “regulatory assets under management”; definitions of “place of business,” “in the United States” and other relevant terms; and recordkeeping and reporting obligations and examination exposure of “exempt reporting advisers.”  This article concludes by discussing how the exemptions may impact U.S. activities typically engaged in by non-U.S. hedge fund managers, such as marketing to U.S. tax-exempt entities and sourcing U.S. investment opportunities.

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  • From Vol. 4 No.15 (May 6, 2011)

    Treatment of a Hedge Fund’s Claims Against and Other Exposures To a Covered Financial Company Under the Orderly Liquidation Authority Created by the Dodd-Frank Act

    On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), heralded as the most significant new financial regulation since the Great Depression.  Title II of the Dodd-Frank Act creates a framework to prevent the potential meltdown of systemically important U.S. financial businesses.  This framework includes a new federal receivership procedure, the so-called orderly liquidation authority (“OLA”), for significant, interconnected non-bank financial companies whose unmanaged collapse could jeopardize the national economy.  The OLA will form part of a new regulatory framework intended to improve economic stability, mitigate systemic risk, and end the practice of taxpayer-financed “bailouts.”  The OLA generally is modeled on the Federal Deposit Insurance Act (“FDIA”), which deals with insured bank insolvencies, and also borrows from the Bankruptcy Code.  Notwithstanding the enactment of Title II, there will be a heavy presumption that companies that otherwise qualify for protection under the Bankruptcy Code will be reorganized or liquidated through a traditional bankruptcy case.  If, however, an institution is deemed to warrant the special procedures under the OLA, Title II will apply, even if a bankruptcy case is then pending for such institution.  As discussed in this article, the decision of whether to invoke Title II will be made outside the public view.  As a result, hedge funds that have claims and other exposures to financial companies may find the playing field shifting overnight from the relatively predictable confines of the Bankruptcy Code to the novel and untested framework of the OLA.  In a guest article, Solomon J. Noh, a Senior Associate in the Bankruptcy & Reorganization Group at Shearman & Sterling LLP, provides a high-level discussion of how the following types of claims and exposures would be handled in a receivership governed by Title II based on the regulatory rules currently proposed or in effect: (i) secured claims; (ii) general unsecured claims (such as a claim arising out of unsecured bond debt); (iii) contingent claims (such as a claim relating to a guaranty); (iv) revolving lines of credit and other open commitments to fund; and (v) “qualified financial contracts” (i.e., swap agreements, forward contracts, commodity contracts, securities contracts and repurchase agreements).  Hedge funds employing a variety of strategies – notably, but not exclusively, distressed debt – routinely acquire the foregoing categories of claims and exposures.  For situations in which those claims or exposures face a firm that may be designated as systemically important, this article highlights the principal legal considerations that will inform any investment decision.

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  • From Vol. 4 No.7 (Feb. 25, 2011)

    Federal Reserve Board Proposes Rule Defining Covered Nonbank Financial Companies That May Capture the Largest Hedge Funds

    On February 8, 2011, the Federal Reserve Board (Board) issued a proposed rule (Proposed Rule) that implements two provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).  The Dodd-Frank Act requires the Board to issue regulations that establish criteria for determining whether a company is “predominately engaged in financial activities” and to define the terms “significant nonbank financial company” and “significant bank holding company” for purposes of designation by the Financial Stability Oversight Council (FSOC) of systemically important nonbank financial companies that may become subject to Board supervision.  The Proposed Rule defines a company as “predominately engaged in financial activities” if it, or its subsidiaries, derives 85 percent or more of its gross revenues or assets from activities defined as “financial in nature” under the Bank Holding Company Act of 1956 (BHCA), as amended by the Gramm-Leach-Bliley Act of 1999 and Board regulations.  The Proposed Rule also addresses how to treat the revenues and assets attributable to equity investments in other organizations that are not consolidated with the company.  The Proposed Rule would also deem a firm a “significant nonbank financial company” or “significant bank holding company” if it controls $50 billion or more in total consolidated assets, or the FSOC has designated it as “systemically important.”  We summarize the most pertinent parts of the Proposed Rule.

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  • From Vol. 3 No.33 (Aug. 20, 2010)

    Consequences for Global Hedge Fund Managers of the “Foreign Private Adviser” Exemption Included in the Dodd-Frank Act

    The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank or the Act), enacted on July 21, 2010, contains a general rule with respect to private fund adviser registration, and exemptions from that rule.  The general rule is that private fund advisers, such as hedge fund advisers, must register as investment advisers with the U.S. Securities and Exchange Commission (SEC).  The exemptions from that rule provide that certain categories of private fund advisers are not required to register.  Exempted advisers include those that act as advisers solely to venture capital funds or small business investment companies, family offices, private fund managers with less than $150 million in assets under management (AUM) in the U.S. and so-called “foreign private advisers.”  However, although styled a “limited exemption,” the narrowness of the foreign private adviser exemption may expand the range of non-U.S. hedge fund managers required to register with the SEC and broaden the SEC’s regulatory jurisdiction.  This article examines in detail the foreign private adviser exemption and its implications for global hedge fund managers.  In particular, this article: reviews the definition of “foreign private adviser” under Dodd-Frank; offers practitioner insight on how certain of the key concepts in the definition have historically been understood and are likely to be construed by the SEC; discusses the interaction between the foreign private adviser exemption and the exemption for private fund managers with less than $150 million in AUM; analyzes past SEC practice and precedent with respect to global sub-adviser and affiliate arrangements, including a discussion of a key no-action letter; discusses the SEC’s “registration lite” regime for non-U.S. managers of offshore funds with U.S. investors, as explained by the agency in the release accompanying the subsequently-vacated 2004 hedge fund adviser registration rule; explains the three ways in which non-U.S. hedge fund managers that are not eligible for the foreign private adviser exemption may nonetheless avoid registration; identifies the consequences to non-U.S. hedge fund managers who are not eligible for the foreign private adviser exemption and who nonetheless elect to remain in the U.S. market; and concludes with a discussion of the possibility that the narrowness of the foreign private adviser exemption may engender retaliatory protectionist moves by the European Union on hedge fund regulation, or at least may undermine the credibility of any U.S. objections to protectionist provisions in the EU’s Alternative Investment Fund Manager Directive.

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  • From Vol. 3 No.32 (Aug. 13, 2010)

    Dodd-Frank May Impose New Obligations on Managers of Large Hedge Funds and Plan Asset Hedge Funds that Enter into Swaps

    Placement agents, in-house marketers, data providers and others interviewed by The Hedge Fund Law Report have identified two salient trends in the current hedge fund capital raising environment: the “race to the top” and the growing importance of ERISA money.  As discussed below, both trends highlight the importance to the hedge fund industry of a provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank or the Act), enacted on July 21, 2010, relating to swaps with “special entities.”  On the first trend: The race to the top refers to the fact – good for larger managers, not so good for smaller and start-up managers – that the lion’s share of recent inflows have gone to the largest hedge funds.  According to data provider Hedge Fund Research, Inc., 93 percent of the $9.5 billion of net inflows into hedge funds in the second quarter of 2010 went to funds managed by managers with more than $5 billion in assets under management (AUM).  And that capital raising advantage is only enhancing the current distribution of assets in favor of larger managers.  According to HFR, as of June 30, 2010, managers with $5 billion or more in AUM managed approximately 60 percent of total industry assets of $1.6 trillion.  Moreover, HFR data as of June 30 showed that while 342 hedge funds with $1 billion or more in AUM comprised just 4.9 percent of the total number of hedge funds globally, they accounted for 76.1 percent of total industry AUM.  While a full analysis of the reasons for this race to the top is beyond the scope of this article, a few of the reasons are discussed herein.  However, investors racing to the top may miss many of the more interesting hedge fund investment opportunities.  According to research published by PerTrac Financial Solutions in February 2007 and updated to incorporate 2009 data, smaller, younger hedge funds appear to perform better, over longer periods, than larger, older funds.  And on the second trend: The Hedge Fund Law Report has and continues to analyze the growing importance of ERISA investors in hedge funds.  See, for example, The Hedge Fund Law Report’s three-part series on ERISA considerations for hedge fund managers and investors.  The story here is essentially as follows: private sector pension funds are the most important category of ERISA investor.  According to data provider Preqin, as of late 2009, private sector pension funds represented 14 percent of institutional investors in hedge funds and constituted the largest group of investors actively considering their first investment in hedge funds in 2010.  Moreover, survey data released by Preqin on August 10, 2010 indicates that 29 percent of institutional investors plan to allocate more capital to hedge funds in the next 12 months while just 15 percent are looking to redeem, meaning the balance of inflows into hedge funds over the next year is expected to be positive.  Preqin also found that 37 percent of institutional investors are planning to invest in new hedge funds in the next 12 months.  Many of those new investments, often with new managers, will come from private sector pension funds and other ERISA investors.  Accordingly, more hedge fund managers (by number and AUM) will become subject to ERISA in the near term.  In anticipation of that trend, we have provided managers with a roadmap for accepting ERISA money without materially undermining their investment and operational discretion.  See “How Can Hedge Fund Managers Accept ERISA Money Above the 25 Percent Threshold While Avoiding ERISA’s More Onerous Prohibited Transaction Provisions? (Part Three of Three),” The Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).  In light of the importance of the race to the top and ERISA money to hedge fund capital raising, any legal provision that directly impacts larger hedge funds and hedge funds subject to ERISA (Plan Asset Hedge Funds) is of central importance to the industry.  Dodd-Frank contains precisely such a provision.  Specifically, Dodd-Frank will require a “swap dealer” or “major swap participant” that enters into a swap with a “special entity” to: (1) have a reasonable basis to believe that the special entity has an independent representative that, among other things, has sufficient knowledge to evaluate the transaction and risks; and (2) comply with certain business conduct standards.  As explained more fully below, the definition of “major swap participant” in Dodd-Frank may include large hedge funds, and the definition of “special entity” in Dodd-Frank may include Plan Asset Hedge Funds.  See “Hedge Fund Industry Practice for Defining ‘Class of Equity Interests’ for Purposes of the 25 Percent Test under ERISA,” The Hedge Fund Law Report, Vol. 3, No. 29 (Jul. 23, 2010).  To help explain the application of this “swaps and special entities” provision of Dodd-Frank to hedge fund managers, swap dealers and others, this article: defines the relevant terms, including a discussion of the extent to which those definitions may include hedge funds and hedge fund managers; offers examples of applications of the special entities provision in the hedge fund context; explains the mechanics of the “reasonable basis test” included in the statute; describes the business conduct standards; then analyzes the elements of the statutory reasonable basis test, including a potential “de facto best execution” standard included in the test.

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  • From Vol. 3 No.30 (Jul. 30, 2010)

    Connecticut Welcomes You!  Federal Financial Regulatory Reform Restores Connecticut’s Authority over Hedge Fund Advisers

    The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203) (the "Dodd-Frank Act") changes the federal framework for regulating investment advisers by amending provisions of the Investment Advisers Act of 1940, as amended (the "Advisers Act") regarding state and federal responsibilities and SEC investment adviser registration requirements.  These changes not only impact the scope of the federal regulation of investment advisers by the Securities and Exchange Commission ("SEC"), but also restore, in part, Connecticut's regulatory authority and enforcement responsibilities with respect to investment advisers previously preempted by the National Securities Markets Improvement Act of 1996 ("NSMIA").  More than 4,000 investment advisers are expected to land within the purview of state securities regulators when the Dodd-Frank Act amendments to the Advisers Act become effective on July 21, 2011.  The Securities Division of the Connecticut Department of Banking (the "Securities Division") is well-known in the securities industry for its aggressive approach to securities enforcement.  With a newly appointed U.S. Attorney whose first announcement was that he is creating a securities fraud task force focused on the financial services industry, it is clear that the stakes are going up significantly for private fund managers and other investment advisers with offices in Connecticut – as well as those out of state fund managers and other investment advisers with Connecticut clients.  Those advisers who have been able to escape the reach of the Securities Division, because they are either registered with the SEC or relying on a soon-to-be-lost exemption from SEC registration, must consider the application of Connecticut law to their advisory businesses.  Significantly, Connecticut, unlike most states, requires registration of investment advisers who have a place of business in Connecticut regardless of the number of Connecticut clients, as well as out-of-state investment advisers with more than five clients who are Connecticut residents.  For those investment advisers who would not otherwise land within the reach of the Securities Division, Connecticut Governor Jodi Rell is rolling out the red carpet in the hope of making Connecticut the haven for New York investment advisers looking to escape the proposed increase to the New York state non-resident income tax proposed by New York Governor David Patterson.  With so many variables now at play as a result of the passage of the Dodd-Frank Act, Genna N. Garver, an Associate at Bracewell & Giuliani LLP, and John A. Brunjes and Cheri L. Hoff, both Partners at Bracewell & Giuliani LLP, take this opportunity to survey, in a guest article, the changing federal framework and the interplay of these requirements with the current Connecticut investment adviser regulatory scheme.

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