Wash. Admin. Code § 460-24A-150 - Performance compensation arrangements

Current through Register Vol. 21-18, September 15, 2021

(1) General. If you are an investment adviser you may, without violating RCW 21.20.030(1), enter into, extend, or renew an investment advisory contract which provides for compensation to you on the basis of a share of capital gains upon or capital appreciation of the funds, or any portion of the funds, of the client if:
(a) You are an investment adviser who is not registered and is not required to be registered under RCW 21.20.040; or
(b) The client is a "qualified client" as defined in subsection (2) of this section and the conditions of subsections (3) through (8) of this section are met.
(2) Definitions. For the purposes of this section:
(a) The term "qualified client" means:
(i) A natural person who, or a company that, immediately after entering into the contract has at least one million dollars under the management of the investment adviser;
(ii) A natural person who, or a company that, the investment adviser entering into the contract (and any person acting on his or her behalf) reasonably believes, immediately prior to entering into the contract, either:
(A) Has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than 2.1 million dollars. For purposes of calculating a natural person's net worth:
(I) The person's primary residence must not be included as an asset;
(II) Indebtedness secured by the person's primary residence, up to the estimated fair market value of the primary residence at the time the investment advisory contract is entered into may not be included as a liability (except that if the amount of such indebtedness outstanding at the time of calculation exceeds the amount outstanding sixty days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess must be included as a liability); and
(III) Indebtedness that is secured by the person's primary residence in excess of the estimated fair market value of the residence must be included as a liability; or
(B) Is a qualified purchaser as defined in section 2 (a)(51)(A) of the Investment Company Act of 1940 ( 15 U.S.C. 80a-2(a)(51)(A) ) at the time the contract is entered into; or
(iii) A natural person who immediately prior to entering into the contract is:
(A) An executive officer, director, trustee, general partner, or person serving in a similar capacity, of the investment adviser; or
(B) An employee of the investment adviser (other than an employee performing solely clerical, secretarial, or administrative functions with regard to the investment adviser) who, in connection with his or her regular functions or duties, participates in the investment activities of such investment adviser, provided that such employee has been performing such functions and duties for or on behalf of the investment adviser, or substantially similar functions or duties for or on behalf of another company for at least twelve months.
(b) The term "company" has the same meaning as in section 202 (a)(5) of the Investment Advisers Act of 1940 ( 15 U.S.C. 80b-2(a)(5) ), but does not include a company that is required to be registered under the Investment Company Act of 1940 but is not registered.
(c) The term "private investment company" means a company that would be defined as an investment company under section 3(a) of the Investment Company Act of 1940 ( 15 U.S.C. 80a-3(a) ) but for the exception provided from that definition by section 3 (c)(1) of such Act ( 15 U.S.C. 80a-3(c)(1) ).
(d) The term "executive officer" means the president, any vice president in charge of a principal business unit, division or function (such as sales, administration, or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions, for the investment adviser.
(3) Compensation formula. The compensation paid to you with respect to the performance of any securities over a given period must be based on a formula with the following characteristics:
(a) In the case of securities for which market quotations are readily available within the meaning of Securities and Exchange Commission Rule 2a-4 (a)(1) under the Investment Company Act of 1940 (Definition of "Current Net Asset Value" for Use in Computing Periodically the Current Price of Redeemable Security), 17 C.F.R. 270.2a-4(a)(1), as amended effective February 7, 2014, the formula must include the realized capital losses and unrealized capital depreciation of the securities over the period;
(b) In the case of securities for which market quotations are not readily available within the meaning of Securities and Exchange Commission Rule 2a-4 (a)(1) under the Investment Company Act of 1940, 17 C.F.R. 270.2a-4(a)(1), as amended effective February 7, 2014, the formula must include:
(i) The realized capital losses of securities over the period;
(ii) If the unrealized capital appreciation of the securities over the period is included, the unrealized capital depreciation of the securities over the period;
(c) The formula must provide that any compensation paid to you under this section is based on the gains less the losses (computed in accordance with (a) and (b) of this subsection) in the client's account over a specified period. The formula must not calculate the compensation more frequently than once per calendar quarter. However, if your client invests mid-period in a private fund that you manage, you may apply the compensation formula to that client for the partial period in order to keep the client on the same schedule as the other clients who invest in the private fund; and
(d) The formula must reflect that you will only receive performance compensation on the client's cumulative net investment gain, and only upon the amount of the client's cumulative net investment gain for which you have not previously received a performance fee.
(4) Client disclosure. To the extent not otherwise disclosed on Form ADV Part 2, you must disclose in writing to the client all material information concerning the proposed advisory arrangement, including the following:
(a) That the fee arrangement may create an incentive for the investment adviser to make investments that are riskier or more speculative than would be the case in the absence of a performance fee;
(b) Where relevant, that the investment adviser may receive increased compensation with regard to unrealized appreciation as well as realized gains in the client's account;
(c) The period which will be used to measure investment performance throughout the contract and their significance in the computation of the fee;
(d) The nature of any index which will be used as a comparative measure of investment performance, the significance of the index, and the reason the investment adviser believes that the index is appropriate; and
(e) Where your compensation is based in part on the unrealized appreciation of securities for which market quotations are not readily available within the meaning of Securities and Exchange Commission Rule 2a-4 (a)(1) under the Investment Company Act of 1940, 17 C.F.R. 270.2a-4(a)(1), as amended effective February 7, 2014, how the securities will be valued and the extent to which the valuation will be independently determined.
(5) Equity owners. In the case of a private investment company, as defined in subsection (2)(c) of this rule, an investment company registered under the Investment Company Act of 1940, or a business development company, as defined in section 202 (a)(22) of the Investment Advisers Act of 1940, each equity owner of any such company (except for the investment adviser entering into the contract and any other equity owners not charged a fee on the basis of a share of capital gains or capital appreciation) will be considered a client for the purposes of subsection (1) of this rule.
(6) Informed consent. You or any of your investment adviser representatives that enter into a contract under this rule, must reasonably believe, immediately before entering into the contract that the contract represents an arm's length arrangement between the parties and that the client, alone or together with the client's independent agent, understands the proposed method of compensation and its risks.
(7) Nonexclusive. Any person entering into or performing an investment advisory contract under this section is not relieved of any obligations under RCW 21.20.020 or any other applicable provision of the Securities Act of Washington, chapter 21.20 RCW, or any rule or order thereunder.
(8) Obligations of independent representative. Nothing in this section relieves a client's independent representative from any obligation to the client under applicable law.
(9) Transition rules.
(a) Registered investment advisers. If you are a registered investment adviser that entered into a contract and satisfied the conditions of this section that were in effect when the contract was entered into, you will be considered to satisfy the conditions of this section. If a natural person or company who was not a party to the contract becomes a party (including an equity owner of a private investment company advised by the adviser), however, the conditions of this section in effect at that time will apply with regard to that person or company.
(b) Registered investment advisers that were previously not registered. This section does not apply to an advisory contract entered into when you were not required to register and were not registered. If a natural person or a company who was not a party to the contract becomes a party (including an equity owner of a private investment company advised by the adviser) when you are registered or required to register, however, the conditions of this section in effect at that time will apply with regard to that person or company.
(c) Certain transfers of interest. Solely for purposes of (a) and (b) of this subsection, a transfer of an equity ownership interest in a private investment company by gift or bequest, or pursuant to an agreement related to a legal separation or divorce, will not cause the transferee to "become a party" to the contract and will not cause this section to apply to such transferee.

Notes

Wash. Admin. Code § 460-24A-150
Amended by WSR 14-13-068, Filed 6/12/2014, effective 7/13/2014 Amended by WSR 19-03-133, Filed 1/18/2019, effective 2/18/2019

Statutory Authority: RCW 21.20.450. 00-01-001, § 460-24A-150, filed 12/1/99, effective 1/1/00. Statutory Authority: RCW 21.20.450 and 1993 c 114. 93-20-012, § 460-24A-150, filed 9/23/93, effective 10/24/93.

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