Tag: investment

SEC Proposes Significant Amendments to Investment Adviser Advertising Rule

The Securities and Exchange Commission (the “Commission” or the “SEC”), on November 4, approved the publication of a substantial release (the “Release” 1 proposing significant amendments to the rules under the Investment Advisers Act of 1940 (the “Advisers Act”) that govern advertising by investment advisers and the solicitation of advisory and fund investments, as well as related recordkeeping and SEC Form ADV disclosure requirements. This memorandum provides a summary of the proposed amendments to the advertising rule and related recordkeeping requirements; a separate memorandum addresses the proposed amendments to the solicitation rule.2

The Advisers Act advertising rule, Rule 206(4)-1, has not been amended significantly since it was first adopted in 1961. 3 The changes now proposed by the SEC are largely motivated by the SEC’s desire to modernize the rule and create a more “principles-based” approach to advertising regulation.

I.  Overview of the Amendments

  • Broadened Definition of “Advertisement”: The proposed amendments to Rule 206(4)-1 would broaden the definition of “advertisement” to cover all communications that promote an investment adviser’s services, even if sent to a single person, subject to specific exemptions.
  • Advertising Standards: The amendments would replace the current list of prohibited forms of advertisement with general prohibitions on misleading advertising practices. The proposed amendments would also adopt new requirements for advertisements that include gross, past, extracted, related or hypothetical performance.
  • Administrative Provisions: Advisers would have to designate specific employees to review and approve advertisements before distribution. Advisers would also be required to report certain of their advertising practices on Form ADV, and would be subject to new recordkeeping obligations under Rule 204-2 intended to require advisers to demonstrate their compliance with the new obligations under Rule 206(4)-1.
  • Comment Period: The comment period will end 60 days after the Release is published in the Federal Register.
  • Compliance Date: Compliance with the amended rules would be required one year after the effective date.

II.  Broadened Definition of “Advertisement”

A.  Overview

Rule 206(4)-1 currently defines “advertisement” to mean “any notice, circular, letter or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television [emphasis added].”

Under Proposed Rule 206(4)-1(e), “advertisement” would be defined to mean “any communication, disseminated by any means, by or on behalf of an investment adviser, that offers or promotes the investment adviser’s investment advisory services or that seeks to obtain or retain one or more investment advisory clients or investors in any pooled investment vehicle advised by the investment adviser [emphasis added].” The proposed rule would expand the definition of “advertisement” to apply to any communication that promotes an investment adviser’s services, regardless of the form of the communication or the manner in which it is distributed (e.g., in writing, electronically, in audio or video files, blogs or social media), and even if sent to a single person.

Certain communications would nonetheless be excluded from the proposed expanded definition of “advertisement”: (i) live oral communications not broadcast on electronic media; 4 (ii) responses to unsolicited requests for information about an adviser’s services, except for (a) communications about performance results to Retail Persons and (b) all communications about Hypothetical Performance; 5 (iii) communications about registered investment companies (“RICs”) or business development companies (“BDCs”);6 and (iv) disclosures required by statute or regulation (e.g., information required by Part 2 of Form ADV or Form CRS).

B.  Key Terms

Certain of the terms used in the proposed definition of “advertisement” are further explained or defined in the Release or in the proposed amendments. The key terms are as follows:

  • Disseminated by any means. This phrase would replace the current limitation to written communications or announcements made over radio or television. The Release emphasized that the focus of the amended rule is “on the goal of the communication, and not its method of delivery.”
  • By or on behalf of an investment adviser. The proposed rule would apply to material disseminated by an adviser’s agents, such as consultants and solicitors, 7 or by an investment adviser’s affiliates, and may apply, depending on the facts and circumstances, to material disseminated by unaffiliated third parties. 8 The determination of whether material distributed by a third party is considered an “advertisement” of the adviser will depend on the adviser’s involvement in the content or production of the material (g., whether the investment adviser assists in preparing the content, influences or controls the substance of the content or pays for the distribution). Advisers should thus implement appropriate procedures to monitor materials distributed on their behalf to assure compliance with the requirement of any newly adopted rules.
  • Offers or promotes the investment adviser’s investment advisory services. Material providing a client with general account information in the regular course of business or disseminating general educational materials about investing and markets would not be considered advertisements. However, the Commission may consider an adviser’s market commentary to be an advertisement if the commentary offers or promotes the adviser’s services. 9
  • Investors in any pooled investment vehicle. This provision treats investors in a pooled investment vehicle, other than investors in a RIC or a BDC,10 as clients of the adviser. This provision would provide additional protections for investors in pooled investment vehicles beyond those already provided under Rule 206(4)-8 (prohibiting fraudulent practices with respect to pooled investment vehicles).

III.  Advertising Standards

A.  General Prohibitions

The current rule contains a general prohibition on false or misleading statements, and additionally prohibits four specific types of communications in advertisements: (i) testimonials; (ii) past specific recommendations; (iii) representations that a chart or graph alone can be relied upon to make investment decisions; and (iv) misrepresentations about the cost of services. The proposed amendments replace these specific prohibitions by instead creating General Prohibitions that largely incorporate principles developed through the Commission’s prior no-action letters and are consistent with other anti-fraud provisions in the Federal securities laws.11

Under Proposed Rule 206(4)-1, advisers would be prohibited from making untrue or misleading statements or omissions, making material claims that are unsubstantiated,12 failing to “clearly and prominently” disclose potential risks, or referencing performance results and specific investment advice in a way that is not fair and balanced.13 A finding of negligence would be sufficient to establish a violation of the General Prohibitions.14

B.  Specific Investment Advice

The SEC proposes to replace the prescriptive requirements currently applicable to advertisements that include discussions of “past specific recommendations” with a principles-based approach that would permit material that discusses “specific investment advice” as long as it is “fair and balanced.”15 The Release notes that the following current guidance may be helpful to advisers in satisfying the “fair and balanced” requirement:

  1. referring to the information that must currently be included when presenting a list of all past specific recommendations made by the adviser within the past year;16
  2. using objective, non-performance based criteria to select the securities discussed in advertisements;17 and
  3. considering “the facts and circumstances of the advertisement, including the nature and sophistication of the audience.”

While reference to current guidance may be useful, the proposed rule would provide advisers with greater flexibility to include discussions of specific investment advice in advertising material, provided that the discussion is fair and reasonable, and includes sufficient information and context to enable recipients to evaluate the discussion.18 Advisers would, however, be subject to the specific requirements applicable to performance information discussed in Section D below.

C.  Testimonials, Endorsements, and Third-Party Ratings

The proposed amendments establish conditions that, if followed, allow for the use of testimonials, endorsements and third-party ratings in advertisements.19

  • Advisers using Testimonials20 or Endorsements21 in advertisements must “clearly and prominently disclose”: (i) that the testimonial was given by a client or investor, and the endorsement was given by a person who is not a client or investor; and (ii) whether the adviser, or anyone acting on its behalf, provided (cash or non-cash) compensation for the testimonial or endorsement.22
  • Third-Party Ratings23 may be used if: (i) the adviser “reasonably believes”24 that the questionnaires used to produce the ratings were designed to produce unbiased results; and (ii) the adviser or third party clearly and prominently discloses information including the rating date, time period on which the rating was based, the identity of the third party that produced the rating and whether the adviser, or anyone acting on its behalf, provided compensation, in the form of cash or otherwise.

D.  Performance Advertising

The current rule does not address the appropriate presentation of an adviser’s performance results. Guidance on performance advertising has been developed through SEC no-action letters.25 The proposed rule would establish explicit requirements as to the use of performance results, setting different standards depending on whether the advertisement is a Retail or Non-Retail Advertisement, as defined below.

  • Non-Retail Advertisements would mean advertisements directed at Non-Retail Persons, defined for this purpose as “qualified purchasers” or “knowledgeable employees,”26 as defined in the Investment Company Act.27 For such advertisements, an adviser would be required to implement “policies and procedures reasonably designed to ensure that the advertisement is disseminated solely to qualified purchasers and knowledgeable employees.”
  • Retail Advertisements would mean advertisements directed at Retail Persons, meaning anyone other than a Non-Retail Person.

Under the SEC proposal, performance information would be subject to the following requirements:

  • All Portfolio28 performance results included in Retail Advertisements must be presented in 1-, 5-, and 10-year periods, “each presented with equal prominence and ending on the most practicable date.”29
  • To use Gross Performance30 in a Retail Advertisement, the advertisement must: (i) present Net Performance31 results “with at least equal prominence,” in a format designed to facilitate comparison with the Gross Performance, using the same calculation methods and calculated over the same prescribed time periods;32 and (ii) provide, or offer to provide promptly, a percentage schedule of the fees and expenses deducted to calculate Net Performance.33
  • To use Gross Performance in a Non-Retail Advertisement, an adviser must provide or offer to provide promptly, a percentage schedule of the fees and expenses deducted to calculate Net Performance. The Non-Retail Advertisement would not, however, be required to include Net Performance results.34
  • An advertisement may include Related Performance35 only if it includes the performance of all Related Portfolios,36 unless (a) the performance results advertised are no higher than they would have been if no Related Portfolios were excluded, and (b) for Retail Advertisements, the performance results must be presented for the required time periods noted above, notwithstanding the exclusion of some Related Portfolios.37
  • Extracted Performance38 may be used only “if the advertisement provides, or offers to provide promptly, the performance results of all investments in the Portfolio from which the performance was extracted.”
  • To use Hypothetical Performance,39 an adviser would be required to:
    1. adopt policies and procedures “reasonably designed to ensure that the Hypothetical Performance is relevant to the financial situation and investment objectives” of the recipient. The purpose of this requirement is to ensure that an adviser only provides hypothetical performance “where the recipient has the financial and analytical resources to assess the hypothetical performance and that the hypothetical performance would be relevant to the recipient’s investment objective”;40
    2. provide, in both Retail and Non-Retail Advertisements, “calculation information” that is tailored to the audience receiving it, to enable recipients to understand the criteria and assumptions used in calculating Hypothetical Performance; and
    3. provide in Retail Advertisements, or offer to provide promptly in Non-Retail Advertisements, “risk information” tailored to the audience receiving it, to enable recipients to understand the risks and limitations of using the Hypothetical Performance in making investment decisions.

All performance advertisements must comply with the General Prohibitions. Though the Commission declined to require specific disclosures, the Release noted that examples of disclosures currently used by advisers in performance advertisements include: “(1) the material conditions, objectives, and investment strategies used to obtain the results portrayed; (2) whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings; (3) the effect of material market or economic conditions on the results portrayed; (4) the possibility of loss; and (5) the material facts relevant to any comparison made to the results of an index or other.”41 In line with its principles-based approach, advisers would be required to include appropriate disclosures to reflect the assumptions and factors relevant to the calculation of performance information.42

E.  Portability

The Commission has issued a number of no-action letters on when investment advisers may advertise performance results from the firm’s predecessor entities or from entities at which the firm’s employees were previously employed.43 Neither the current rule nor the proposed amendments set explicit standards for portability; the determination is subject to analysis under whether the porting of the prior results would be misleading. However, the Release does summarize and discuss the Commission’s considerations as to when portability is appropriate:

“(i) the person responsible for such results is still the adviser;

(ii) the prior account and the present account are similar enough that the performance results would provide relevant information;

(iii) all prior accounts that are being managed in a substantially similar fashion to the present account are being factored into the calculation; and

(iv) the advertisement includes all relevant disclosures.”44

The Release stated that the portability of testimonials, endorsements, and third-party ratings would be governed by the same considerations as predecessor performance results.

IV.  Administrative Provisions

A.  Internal Review and Approval of Advertisements

Proposed Rule 206(4)-1(d) creates a new requirement that investment advisers designate an employee to review and approve all advertisements before they are disseminated. The only exceptions to this rule are for (1) communications to only a single person, household, or investor in a pooled investment vehicle and (2) live oral communications broadcast on electronic media. The SEC did not propose an exemption from pre-distribution reviews for Non-Retail Advertisements.45

B.  Amendments to Form ADV

The proposed rule would amend Item 5 of Part 1A of Form ADV to add a subsection “L. Advertising Activities” to help SEC staff prepare for on-site examinations. This five-question subsection would ask advisers to respond yes or no to the following questions:

(1) Whether any of the adviser’s advertisements contain performance results;

(2) If so, whether all of those performance results were verified or reviewed by a person who is not a “related person” (i.e., an entity unaffiliated with the adviser);

(3) Whether any of the adviser’s advertisements include testimonials, endorsements, or third-party ratings, and if so, whether the adviser provides direct or indirect compensation in connection with their use; and

(4) Whether any of the adviser’s advertisements includes a reference to specific investment advice provided.

C.  Amendments to the Books and Records Rule

First, the recordkeeping requirements of Rule 204-2(a)(11) would be expanded to require advisers to keep copies of all advertisements disseminated, whereas the rule currently requires that advisers only keep records of written communications disseminated to 10 or more people. This provision would require that advisers retain records of the risk and calculation information for Hypothetical Performance that they are required to provide under amended Rule 206(4)-1(c)(1)(v) because the Commission views such additional information as part of the advertisement itself.46

Second, the amended recordkeeping rule would require investment advisers make and keep originals of: (1) written communications sent or received relating to the performance or rate of return of any or all Portfolios and (2) supporting records regarding the calculation of the performance or rate of return of any or all Portfolios.

Third, advisers would be required to retain records of any questionnaires and surveys used to obtain third-party ratings for advertisement purposes.

Finally, advisers would be required to maintain records of the written approvals for all advertisements.

V.  Summary and Policy Considerations

The SEC has issued a thoughtful proposal that would adopt a technology-neutral, principles-based approach to investment adviser advertising. The Release includes extensive questions on all aspects of the proposal, and industry participants should carefully consider whether to submit responses.

One issue that is not specifically addressed in the Release is the degree to which the amended rules should be harmonized more closely with equivalent FINRA standards for broker-dealer communications and NFA standards for promotional material distributed by CFTC-registered firms. These considerations are particularly relevant to SEC-registered investment advisers that are also registered with the CFTC as CPOs or CTAs, which are subject to both SEC and NFA requirements, and advisers who market interests in funds they advise through broker-dealers, in which case the sales material would be subject to both the SEC and FINRA requirements. Finally, we note that the Release contains a wealth of material on current requirements for investment adviser advertising, which firms may consult to confirm that their current advertising practices conform to applicable SEC standards.

1   Commission Release No. IA-5407 (Nov. 4, 2019).

2  See Cadwalader Clients and Friends Memo titled SEC Proposes Significant Amendments to Investment Adviser Solicitation Rule, dated December 3, 2019 (the “Cadwalader Investment Adviser Solicitation Proposal Memo”).

3   Any reference to Rules in this memorandum shall mean rules promulgated under the Advisers Act, unless otherwise specified.

4   The Release differentiates between “live” oral communications, which are not “advertisements” if not broadcast widely on electronic media, and pre-recorded communications, which could be considered advertisements. Additionally, any written materials (e.g., slides, storyboards, or scripts) prepared in advance for use during a live oral communication could be considered advertisements. See Release, pp. 41-42.

5   See Section III.D., infra, for definitions.

6  Specifically, the exclusion would apply to sales material about RICs and BDCs complying with the advertising requirements of rules 156 and 482 under the Securities Act of 1933 (the “Securities Act”).

7   Persons who promote an investment adviser’s services through testimonials or endorsements may be considered solicitors and thus subject to the requirements of both Rule 206(4)-1 (the advertising rule) and Rule 206(4)-3 (the solicitation rule). See Cadwalader Investment Adviser Solicitation Proposal Memo, Section III.A at nn.16-17 and accompanying text.

8  The Release discusses the circumstances in which online material may be deemed to be an investment adviser’s advertising as a result of linkages between the investment adviser’s website or social media site and third-party sites. See Release, pp. 25-28.

9   See Release, p. 33 (citing Investment Counsel Association of America, Inc., SEC Staff No-Action Letter (Mar. 1, 2004)).

10 The Release reasons that investors in RICs and BDCs are adequately protected by provisions of the Securities Act and Investment Company Act of 1940 (the “Investment Company Act”). See Release, pp. 36-40.

11 See, e.g., Release, pp. 67-68 (delineating criteria that would help advisers comply with the proposed rule (citing Franklin Management, Inc., SEC Staff No-Action Letter (Dec. 10, 1998))).

12 Put differently, an adviser would have to be able to substantiate every material claim contained in its advertisements.

13 This would prohibit, for example, cherry-picking favorable results or time periods. The “fair and balanced” standard mirrors FINRA Rule 2210(d)(1)(A), which requires broker-dealer communications to be “fair and balanced.”

14 See Release, p. 54 at n.109 and accompanying text.

15 The SEC proposes to replace the current Rule’s reference to “past specific recommendations” with “specific investment advice” to clarify that the Rule applies to current advice, and investments in a discretionary account. See Release, pp. 68-69.

16 Rule 206(4)-1(a)(2) currently requires that advisers advertising their past specific recommendations disclose a list of all recommendations they made in the last year, including: the name of each security, the date and nature of the recommendation (e.g., buy, sell, hold), the market price of the security at the time of the recommendation and as of the most recent date, the price at which the recommendation was to be acted upon and a warning that “it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.”

17 See the TCW Group, SEC Staff No-Action Letter (Nov. 7, 2008) (declining to recommend enforcement action when a chart contained in an advertisement was clear, consistent, and included both the account’s best and worst performance during the period).

18 See Release, pp. 64-65.

19 FINRA permits broker-dealers to include testimonials in sales material, but requires additional disclosures when they are used in retail communications. See FINRA Rule 2210(d)(6).

20 “Testimonial” would be defined in Proposed Rule 206(4)-1(e) as “any statement of a client’s or investor’s experience with the investment adviser or its advisory affiliates.” The proposed rule defines “advisory affiliate” by reference to the definition in Form ADV, which includes, among others, entities “directly or indirectly controlling or controlled by” the investment adviser. This would thus include entities in the ownership chain of the adviser, but not entities under common control (i.e., sister companies). See Release, pp. 78-79 at n.152 and accompanying text.

21 “Endorsement” would mean “any statement by a person other than a client or investor indicating approval, support, or recommendation of the investment adviser or its advisory affiliates.”

22 Examples of non-cash compensation could include reduced-fee or no-fee advisory services, or the adviser referring its clients or investors to the third-party’s business. See Release, p. 90.

23 “Third-party rating” would mean “a rating or ranking of an investment adviser provided by a person who is not a related person and such person provides such ratings or rankings in the ordinary course of its business.” The proposed rule uses the Form ADV definition of “related person”: “[a]ny advisory affiliate and any person that is under common control with your firm.” A third-party rating is thus a rating produced by an entity that is not a parent, subsidiary, or entity in a common control relationship with the adviser. The Release notes that “The requirement that the provider not be an adviser’s related person would avoid the risk that certain affiliations could result in a biased rating.” See Release, p. 81.

24 The Release provides no definition for “reasonable belief,” and instead suggests that advisers be responsible for creating internal policies and procedures to implement the “reasonable belief” provisions.

25 See, e.g., Clover Capital Mgmt., Inc., SEC Staff No-Action Letter (Oct. 28, 1986) (discussing when an advertisement using Hypothetical Performance might be false or misleading); Anametrics Investment Management, SEC Staff No-Action Letter (Apr. 5, 1977) (stating that advertising account performance without disclosing that the market significantly outperformed the account over the same time period was misleading); Bradford Hall, SEC Staff No-Action Letter (Jul. 19, 1991) (stating that the presentation of gross performance not reflecting a deduction for advisory fees would be misleading).

26 A “knowledgeable employee” would be a Non-Retail Person solely with respect to a fund falling within the exclusion from the definition of an “investment company” in Section 3(c)(7) of the Investment Company Act, advised by the investment adviser. See Release, pp. 114-15.

27 The Commission decided against treating other categories of investors as Non-Retail Persons, such as Regulation D accredited investors, and Rule 205-3(d)(1) qualified clients. See Release, p. 114. We note the following regarding the treatment of retail vs. non-retail advertisements by the National Futures Association (“NFA”) and the Financial Industry Regulatory Authority (“FINRA”):

– The NFA governs communications by firms registered with the Commodity Futures Trading Commission (“CFTC”), including commodity pool operators and commodity trading advisors (“CPOs” and “CTAs”). The NFA imposes somewhat more lenient requirements on promotional material directed at “qualified eligible persons” (“QEPs”) as defined in CFTC Rule 4.7. See, e.g., NFA Compliance Rule 2-29(c). QEPs include, but are not limited to, “qualified purchasers” and “knowledgeable employees.” An SEC-registered investment adviser that is also registered with the CFTC as CPO or CTA would thus have to determine whether it is sending sales material to (i) a Retail or Non-Retail Person under the SEC’s proposed rule, and (ii) a QEP or non-QEP under CFTC Rule 4.7.

– FINRA Rule 2210, governing broker-dealer communications, distinguishes between “retail communications” and “institutional communications.” For this purpose, an “institutional communication” is a communication sent exclusively to “institutional investors,” which are defined as certain categories of regulated entity, and other entities or individuals that have total assets of at least $50 million. See FINRA Rule 2210(a)(4) incorporating the definition of “institutional account” in FINRA Rule 4512(c). This is a higher asset test than that used in the “qualified purchaser” definition, which requires individuals to own at least $5 million in investments, and institutions to own and invest at least $25 million in investments. This means that where an investment adviser directly markets interests in a fund operated under Section 3(c)(7) of the Investment Company Act to “qualified purchasers” and “knowledgeable employees,” it may treat those investors as “Non-Retail Persons,” whereas if interests in the fund are sold through a broker-dealer, the broker-dealer would be required to treat those investors as “retail investors” for purposes of complying with the communications requirements of FINRA Rule 2210.

28 “Portfolio” would mean a group of investments managed by the investment adviser, including an account or a “pooled investment vehicle” as defined in Rule 206(4)-8(b) (i.e., an “investment company” as defined in Section 3(a) of the Investment Company Act, or a fund falling within the exclusion from the definition of an “investment company” in Section 3(c)(1) or 3(c)(7) of the Investment Company Act). Proposed Rule 206(4)-1(e)(10).

29 If the relevant Portfolio did not exist for a particular prescribed period, then the life of the Portfolio must be submitted for that period.

30 “Gross Performance” would mean “the performance results of a Portfolio before the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant Portfolio.” Proposed Rule 206(4)-1(e)(4).

31 “Net Performance” would mean “the performance results of a Portfolio after the deduction of all fees and expenses that a client or investor has paid or would have paid in connection with the investment adviser’s investment advisory services to the relevant Portfolio, including, if applicable, advisory fees, advisory fees paid to underlying investment vehicles, and payments by the investment adviser for which the client or investor reimburses the investment adviser.” Proposed Rule 206(4)-1(e)(6).

32 The Release does not prescribe a specific calculation of Gross and Net Performance; the Commission seeks comment on what additional guidance it should provide for such calculations.

33 See Release, p. 128 (noting that “Where an adviser presents net performance, whether because net performance is required under the proposed rule or because the adviser otherwise chooses to present it, the schedule should show the fees and expenses actually applied in calculating the net performance that is presented.”).

34 We note that the NFA recently amended NFA Compliance Rule 2-29(b)(5) to include a specific requirement that past performance be presented on a net basis, regardless of whether the recipient is a QEP (and thus a Non-Retail Person). See NFA Notice to Members I-19-26 (Nov. 13, 2019). This reflects existing requirements under the CFTC and NFA rules that require CPOs and CTAs to calculate rate of return information on a net basis regardless of whether the investor is a QEP. See NFA Compliance Rule 2-29(b)(5)(ii).

35 “Related Performance” would mean “the performance results of one or more related Portfolios, either on a Portfolio-by-Portfolio basis or as one or more composite aggregations of all Portfolios falling within stated criteria.” Proposed Rule 206(4)-1(e)(11).

36 “Related Portfolio” would mean a “Portfolio with substantially similar investment policies, objectives, and strategies as those of the services being offered or promoted in the advertisement,” including, but not limited to, Portfolios for the account of the investment adviser or its advisory affiliate. Proposed Rule 206(4)-1(e)(12).

37 Under FINRA guidance, a broker-dealer may only include related performance information in sales materials distributed to (i) “institutional investors,” as defined in FINRA Rule 2210(a)(4), or (ii) qualified purchasers with respect to their investment in funds falling within Section 3(c)(7) of the Investment Company Act. See, e.g., FINRA Interpretive Letter to Stradley Ronon Stevens & Young, dated April 16, 2018; see also FINRA Interpretive Letter to Davis Polk & Wardwell, dated Dec. 30, 2003. The Release notes FINRA’s more restrictive approach, and comments that: “We believe that the utility of related performance in demonstrating the adviser’s experience in managing portfolios having specified criteria, together with the provisions designed to prevent cherry-picking and the provisions of paragraph (a) [imposing prohibitions on false or misleading advertisements], support not prohibiting related performance in advisers’ Retail Advertisements.” See Release, p. 151.

38 “Extracted Performance” would mean “the performance results of a subset of investments extracted from a Portfolio.”

39 “Hypothetical Performance” would mean “performance results that were not actually achieved by any Portfolio of any client of the investment adviser.” Under this definition, results achieved by proprietary accounts of the adviser would be “hypothetical” as they would not be achieved by a client of the adviser. Examples of Hypothetical Performance that an adviser may use include Backtested Performance, Representative Performance (including performance of “model” portfolios), and Targets and Projections. See Proposed Rule 206(4)-1(e)(5) and Release, pp. 162-67, for definitions and discussions of these subsets of Hypothetical Performance.

40 See Release, p. 171. The Release further notes that in determining whether hypothetical performance is relevant to a Retail Person, a firm’s policies should include “parameters that address whether the Retail Person has the resources to analyze the underlying assumptions and qualifications of the hypothetical performance to assess the adviser’s investment strategy or processes, as well as the investment objectives for which such performance would be applicable.” In light of this requirement, the Release concludes that investment advisers would not be permitted to include hypothetical performance in advertisements that are distributed generally to Retail Persons regardless of their financial situation or investment objectives. See Release, p. 174.

FINRA and the NFA take differing approaches to hypothetical performance information:

– FINRA only permits broker-dealers to include hypothetical (backtested) performance information in certain communications with “institutional investors” as defined in FINRA Rule 2210(a)(4). See, e.g., FINRA Interpretive Letter to Foreside, dated Jan. 31, 2019.

– The NFA prohibits CFTC-registered firms from including hypothetical performance in promotional material sent to non-QEPs (i.e., Retail Persons) with respect to any trading program for which the firm has three months of actual trading results. Further, to the extent hypothetical performance information is permitted in retail promotional material, NFA requires a CFTC-registered firm to include comparable information regarding actual past performance of all customer accounts directed by the firm for the last five years (or the entire performance history, if less than five years). These restrictions do not, however, apply to hypothetical performance included in promotional material sent exclusively to QEPs (i.e., Non-Retail Persons). See NFA Compliance Rule 2-29(c)(3), (4) and (6).

41 See Release, pp. 103-05.

42 See Release, p. 105

43 The Commission also recently extended these guidelines to a case in which an investment adviser desired to use performance results of its predecessor entity after an internal restructuring. See South State Bank SEC Staff No-Action Letter (May 8, 2018) (not recommending enforcement action when the successor entity would operate in the same manner and under the same brand name as the predecessor).

44 See Horizon Asset Management, LLC, SEC Staff No-Action Letter (Sept. 13, 1996).

45 By contrast, FINRA Rule 2210(b)(3) permits post-distribution reviews of broker-dealer communications to “institutional investors” as defined in FINRA Rule 2210(a)(4) provided the firm trains personnel in the firm’s procedures governing institutional communications, and implements follow-up procedures to confirm that the procedures have been followed.

46 This information includes the criteria, assumptions, and methodology used in calculations, and the risks and limitations of the calculations. See Release, pp. 176-77, 287-88.

© Copyright 2019 Cadwalader, Wickersham & Taft LLP

For more Securities and Exchange Commission regulations, see the National Law Review Securities Law section.

Modernization at Last: Insight to the Newly Published EB-5 Modernization Rules … Now the Race is On …

On July 23, 2019, United States Citizenship and Immigration Services’ (USCIS) regulations to update the Immigrant Investor Program were published in the Federal Register. The new EB-5 Immigrant Investor Program Modernization rules (New Rules) amend the historic Department of Homeland Security (DHS) regulations governing the employment-based, fifth preference (EB-5) immigrant investor classification and associated regional centers to reflect statutory changes and modernize the EB-5 program. The New Rules are creating quite a buzz in the EB-5 community with good reason. Of particular note, the New Rules modify the EB-5 program by:

  • Increasing the required minimum investment amounts;

  • Providing the long-awaited priority date retention to EB-5 investors in certain cases;

  • Amending targeted employment area (TEA) designation criteria;

  • Centralizing TEA determination;

  • Clarifying USCIS procedures for the removal of conditions on permanent residence fulfilment;

  • Providing for periodic minimum investment increases henceforth; and

  • Implementing a myriad other amendments.

The New Rules are effective 120 days from publication, which is November 21, 2019. The effective date of the New Rules presupposes that Congress will extend the EB-5 Program’s current sunset date of September 30, 2019. USCIS clarified that it will adjudicate investors, who file a Form I-526 petition before November 21, 2019, under the current EB-5 program rules. Now the race is on to initiate and complete investments by the effective date.

The “New” EB-5 Program: A Closer Look at Certain Changes.

Increased Minimum Investment. To account for inflation since the commencement of the EB-5 Program, the New Rules increase the minimum investment amount per investor to participate to $900,000 (from $500,000) if the project is located in a TEA or to $1.8 million (from $1 million) if not in a TEA. This increased amount commences on November 21, 2019. For many this is good news as the minimum investment amount increase is substantially lower than DHS’ initial proposal to increase to $1.35 million. To further adjust for inflation, the New Rules provide for periodic increases henceforth to the minimum investment every five years. USCIS proposes that this fixed schedule will create “predictability and consistency” by allowing EB-5 participants to plan accordingly.

TEA Determination. The amendments to TEA’s determination procedures that commence on and after November 21, 2019, are a hot topic. The biggest change in the New Rules is the abolishment of state sovereignty in the TEA determination process. No longer will the state in which the project is located determine TEA qualification. USCIS, which operates under DHS, will review and determine the designation of high-unemployment TEAs. EB-5 program stakeholders believe this change alone will dramatically limit the number of projects that qualify as a TEA, which could lead to an obsolescence of the EB-5 program. Also of note, the New Rules provide that any city or town with a population of 20,000 or more, whether inside or outside of a metropolitan statistical area, may qualify as a TEA henceforth. The New Rule also provides that a TEA may consist of a census tract or contiguous census tracts in which the new commercial enterprise (NCE) is principally doing business if the NCE is located in more than one census tract, and the weighted average of the unemployment rate for the tract or tracts is at least 150% of the national average. The applicability of TEA status to rural areas remains unchanged. Thus, only projects in metropolitan areas are at risk of no longer qualifying as a TEA under the New Rules after November 20, 2019.

DHS supports these steps with the position that the New Rules will ensure consistency in TEA adjudications by directing investment to areas most in need and increase the consistency of how high-unemployment areas are defined in the program. Of note, the New Rules do not include any preference for rural and urban distressed areas, notwithstanding the proposals for visa set-asides for such project. In addition, the New Rules do not integrate TEA determination with the new qualified opportunity zone designations under the 2017 Tax Cuts and Job Creation Act. These provisions might be addressed legislatively by Congress as part of a reauthorization bill this year. Some EB-5 stakeholders believe that Congress might overrule the New Rules in part (i.e., regarding the minimum investment amount and TEA changes) plus enact additional modernization rules such as authorizing additional visas, etc.

Priority Date Retention. For many years, both Congress and USCIS have recognized the value of a modification to the EB-5 Program to permit EB-5 investors to retain their visa priority date if they are required to amend their EB-5 petition for reasons unrelated to their own doing. The New Rules will allow EB-5 investors to use the priority date of a previously approved EB-5 petition. If and when an investor needs to file a new EB-5 petition, they can now retain the priority date of the previously approved petition, subject to certain exceptions.

An EB-5 immigrant petition’s priority date is normally the date on which the petition was properly filed. In general, when demand exceeds supply for a particular visa category, an earlier priority date is more advantageous. DHS will allow an EB-5 immigrant petitioner to use the priority date for a subsequently filed petition for the same classification for which the petitioner qualifies (unless the petition is revoked for material error, fraud or willful misrepresentation). We note that the New Rules allow an EB-5 petitioner to retain the priority date from an approved Form I-526 petition for a subsequently filed Form I-526 on or after November 21, 2019.

Removal of Conditions on Permanent Residence. The New Rules clarify that derivative family members must file their own Form I-829 to remove conditions on their permanent residence if they are not included in the principal petitioner’s I-829 petition. In addition, the New Rules streamline the adjudication process for removing conditions by providing flexibility in interview locations.

What happens next?

Until November 21, 2019, foreign investors, regional centers, developers and job-creating entities can rely on the existing rules. We urge those considering participation in the EB-5 program who desire to be grandfathered under the current law and the minimum investment amount of $500,000 to invest as soon as possible. As discussed above, if a project’s location in the market no longer qualifies as a TEA, then the minimum investment amount increases to $1.8 million, not just to $900,000. Accordingly, we recommend amending offering documents to include a discussion of the additional risks caused by the New Rules; principal among them is the potential inability to raise funds after November 21.

Regarding future viability of the EB-5 program, the increased investment amount may cause foreign investors to look to other United States programs, such as the L-1 and EB-1, as multinational executive or may look to the immigrant investor programs in other countries with a lower investment amount than the United States.[1]

[1] https://www.eb5investors.com/eb5-basics/international-immigrant-investor-programs

© Polsinelli PC, Polsinelli LLP in California
Article by Debbie A. Klis of Polsinelli PC.
For more on EB-5 immigration developments, see the National Law Review Immigration Law page.

As 2019 Approaches, Private Equity Investment in Health Care Shows No Signs of Slowing Down

As the year draws to a close, it’s clear that 2018 was another record year for private equity investment in health care. In its report on the top health industry issues of 2019, PWC’s Healthcare Research Institute recently highlighted the continued prevalence of private equity in health care transactions, and predicted even more private equity investment in the coming year. Below is an overview of the current and expected trends, as well as a few key considerations for private equity deals in the health care space.

Corporate health care buyers are likely to continue seeing steep competition from private equity firms… 

According to the PWC report, since 2009 the number of health care deals involving private equity buyers or sellers has tripled, and the number of deals is projected to increase further in 2019. Private equity investment in health care remains diversified and frequent, with deals ranging from health care technology to the management of physician practices. Because the health care industry is expected to continue to grow — with CMS projecting national health spending to rise to 20 percent of GDP by 2026 — investment in health care is a relatively safe bet for private equity when compared to more volatile fields like technology. Further, private equity firms tend to be more aggressive in the bid process and more willing to move deals ahead quickly.  As such, traditional health care companies seeking to acquire new lines of business face increased competition from private equity.

…but 2019 may bring additional opportunities for traditional health care companies to partner with private equity in acquisitions.

By partnering with private equity firms, health care companies can diversify their businesses while also mitigating some of the financial and operational risks that come with any deal. Partnerships between private equity and health care companies benefit from the strengths of both parties, enabling further growth while capitalizing on the health care companies’ existing expertise. Private equity firms’ willingness to invest in health care could also mean opportunities for health care companies to divest their non-core assets and refocus on their core business.

Regulatory Considerations for PE Health Care Deals

As with any highly-regulated industry, health care deals present regulatory hurdles for any prospective buyer, some of which may provide additional challenges in the private equity context.

Private equity deals often need to be structured to accommodate corporate practice of medicine (CPOM) issues. In states with CPOM prohibitions, private equity buyers cannot directly acquire medical practices. Instead, the prospective buyer would need to invest in or create a management company through which they manage the practice for a fee, which in many states is capped at a certain percentage of the practice’s revenue.

Regulatory filing requirements and the need for review and approval of deals by regulatory bodies often drive transaction timelines much longer than those to which private equity firms are accustomed. Some states can require up to 120 days’ notice prior to a change in ownership in certain health care companies. Involving regulatory counsel at the beginning of deal negotiations can help set reasonable expectations for timing while also letting the parties get a head start on the sometimes cumbersome filing requirements.

State licensing boards also often require disclosure of detailed information about the prospective ownership and management of licensed health care entities. This information can range from basic background checks to detailed financial information. While many states only require information about individuals who will be actively involved in the day-to-day operations of the health care business, some states require information about anyone with a five percent or greater ownership in the business, which sometimes requires an examination of ownership held by controlling entities, including parent, grandparent and great grandparent companies. Private equity firms should take this into consideration and consult with regulatory counsel about potential disclosure requirements and the feasibility of providing the required information when structuring deals.

Private equity activity in the health care industry presents many evolving opportunities and challenges, but one thing remains clear as 2018 winds down: growth in health care investment is full speed ahead.

©1994-2018 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.
This post was written by Cassandra L. Paolillo of Mintz.

New Rules Offer Clarity On China’s Outbound M&A Crackdown

On August 18, 2017, China’s State Council issued guidelines clarifying rules passed a year ago by the State Administration of Foreign Exchange (SAFE) limiting outbound investments as cover-up to move money out of China.

The new guidelines provide different policies for Chinese companies’ investment overseas, broadly dividing overseas investment into three categories:

  • investments in “real estate, hotels, entertainment, sport clubs, [and] outdated industries” are restricted;

  • investments in sectors that could “jeopardize China’s national interest and security, including output of unauthorized core military technology and products” and investments in gambling and pornography are prohibited; and

  • investments in establishing R&D centers abroad and in sectors like high-tech and advanced manufacturing enterprises that could boost China’s Belt and Road Initiative, and investments that would benefit Chinese products and technology will be encouraged by Chinese outbound regulators.

These guidelines are new and we have to wait and see how they will be interpreted and implemented by regulators. Still, there may be reasons to believe they will have a net positive effect on the China-U.S. M&A market. The new guidelines bring about greater certainty to buyers, lenders and targets on whether a deal will get approved by Chinese regulators.

The volume and size of Chinese outbound M&A is already on an upward trajectory in the second quarter of 2017, as buyers are already getting more acclimated to SAFE rules announced at the end of 2016 restricting the outflow of Chinese capital. Chinese buyers completed 94 deals totaling $36 billion in Q2, compared to the 74 deals totaling $12 billion in Q1. The current Chinese outbound M&A trend, coupled with greater certainty under the new guidelines, is likely to result in more Chinese outbound M&A deals during the last quarter of 2017, as well as in 2018.

This post was written by Shang Kong & Zhu Julie Lee of Foley & Lardner LLP © 2017

For more legal analysis go to The National Law Review

The ERISA Fiduciary Advice Rule: What Happens on June 9?

This is an update on the upcoming effective date of the “fiduciary rule” or “fiduciary advice rule” (the “Rule”) that was issued under the US Employee Retirement Income Security Act of 1974 (ERISA). The Rule was published by the US Department of Labor (DOL) in April, 2016. The purpose of the Rule is to cause a person or entity to become a “fiduciary” under ERISA and the US Internal Revenue Code of 1986 (the “Code”) as a result of giving of certain types of advice involving investment of assets of employee benefit plans, such as 401(k) or pension plans, or of individual retirement accounts (IRAs) and receiving compensation for that advice.

calendar hundred daysThe Rule was originally intended to become effective April 10, but in April the DOL extended (the “Extension Notice”) the effective date of the Rule for 60 days (until June 9), and provided for reduced compliance obligations under the Rule from that date through the end of 2017 (the “Transition Period”). The effective date for Prohibited Transaction Exemptions (PTEs), both new and amended, that are related to the Rule also was extended until June 9, and further transitional relief was provided with respect to certain of those PTEs.

In a May 23 Op Ed in the Wall Street Journal, Labor Secretary Acosta announced that the Rule would go into effect on June 9, as provided for in the Extension Notice, and that the DOL would seek additional public comment on possible revisions to the Rule.  He indicated that the DOL “found no principled legal basis to change the June 9 date while we seek public input.”  The DOL also published, on May 23, FAQs on implementation of the Rule and an update of its previously-issued enforcement policy for the Transition Period. Therefore, it is important to review the rules that will go into effect on June 9.

Under the Rule, fiduciary status is triggered by investment “recommendations.” It provides, in general, that if a person (1) provides certain types of recommendations to a plan or its participants and/or beneficiaries, or to an IRA owner (collectively, “Protected Investors”); and (2) as a result, receives a fee or other compensation (direct or indirect), then that person is providing “investment advice for a fee” and therefore, in giving such advice, is a fiduciary to the Protected Investor. Receipt of compensation tied to such recommendations by a person or entity that is a fiduciary could result in prohibited transactions under ERISA and the Code. Under the Extension Notice, the DOL provided simplified compliance requirements under the Rule for the Transition Period.

This post was written by Gary W. Howell, Austin S. Lilling, Gabriel S. Marinaro, Richard D. Marshall, Andrew R. Skowronski, Robert A. Stone of Katten Muchin Rosenman LLP.

New Transportation Investment Center Boosts P3 (Public-Private Partnerships) Projects: “P3 or Not P3?” That is the Question. Obama Says: “P3.”

Beveridge Diamond Logo

 

President Obama last week formally embraced the expansion of Public-Private Partnerships (P3s) as a means to fill the gap in public sector transportation financing. Infrastructure developers and project sponsors should look to a planned September 9 summit on infrastructure investment hosted by the U.S. Treasury Department to learn more about how they may gain access to/benefit from expanded resources for P3s.

In an announcement culminating after a series of events aimed at cajoling Congress into addressing the looming deficit in the Highway Trust Fund, the President established the “Build America Transportation Investment Center,” a new office in the U.S. Department of Transportation (DOT) focused on encouraging P3s. Citing the potential for domestic and foreign investment in American infrastructure, the President moved to create this resource center within DOT to assist states and local governments find ways to expand the use of innovative financing to build needed projects.

For many years, the Office of Innovative Program Delivery Finance was housed within theFederal Highway Administration (FHWA). This latest move will centralize P3 resources at DOT for highway, transit and other crucial projects, particularly those considered to be of regional and national significance and “those that cross state boundaries,” according to the White House statement.

If those sorts of projects are truly the focus of this initiative, perhaps there could be new life (or added momentum) for long-planned, but delayed projects like the Columbia River Crossing in Washington State/Oregon or the New International Trade Crossing between Detroit and Windsor, Ontario or even a variety of high-speed rail proposals that fell victim to budgetary politics during President Obama’s first term.

The President’s announcement offers the promise of additional access to existing DOT credit programs, including the highly successful Transportation Infrastructure Finance and Innovation Act (TIFIA) program. According to government estimates, each dollar of TIFIA loans leverages an additional $10 in private loans, guarantees, and lines of credit. The new Investment Center will also offer technical assistance to states that wish to expand private infrastructure investment and the 20 states that have not yet entered the P3 market at all. The Center may offer case studies of successful projects, examples of deal structures, and analytical toolkits.

The White House also announced that the Treasury Department will host a summit on infrastructure investment in the U.S. on September 9, 2014 for state and local officials to meet with their federal counterparts.

Article By:

James M. Auslander
Brian C. Levey
Fred R. Wagner
Of:
Beveridge & Diamond PC

10 Insights You Want to Gain from Your Social Media Monitoring

The Rainmaker Institute mini logo (1)

If you are participating in social media for your law firm, you should also be monitoring whether or not your time investment is paying dividends.

Social Media Insight

You should be creating Google Alerts or searching on Social Mention for the name of your law firm and the names of your attorneys at least once a month.  Create alerts for the areas of law you practice as well.  The social media blog site Buffer recommends you keep these 10 insights in mind when reviewing your results:

Sentiment — Are mentions generally position, neutral or negative?

Questions — Look for questions people may have that you can provide the answers to in your social media posts or blogs.

Feedback — If you see feedback on Avvo or Yelp or some other site that directly affects your firm, you need to listen and respond appropriately.

Links — keep track of who is retweeting or reposting your content and keep track of who is linking back to you.

Pain points — absorb what people are talking about online that is of concern to them and use that information to inform your future posts.

Content — this is where your alerts for your practice area come in handy.  Use these to mine for topics of interest to your target market.

Trends — recent court decisions or trending news in your practice area should be included in your posts so it is clear you are on top of all the trends.

Media — journalists spend a lot of time online so pay attention to the areas they are covering that might provide you with an opportunity to reach out as a spokesperson on those subjects.

Influencers — are there certain individuals who keep popping up in your feeds?  They may be someone it would be advantageous for you to know as an industry influencer.

Advocates — monitoring is a great way to find and recognize those people who are talking positively about you online.

Article By:

Stephen Fairley
Of:
The Rainmaker Institute

EB-5 Visas: A Source of Funding for US Businesses But Not Without Risk

Poyner Spruill

China’s wealthy investors are known for seeking secure havens for their money overseas.  In addition to being considered a secure environment for their money, the US offers the EB-5 program providing the investor and his or her immediate family with permanent US residence, known as getting “green cards” in return for making an investment.

Basically, in return for an investment of either $500,000 or $1,000,000, which can be shown to the satisfaction of the US Citizenship and Immigration Services to create 10 US jobs per investment over a two year period, the investor and his family get green cards.  Since it started in 1990, the EB-5 visa program has brought approximately $6.7 billion to the US and has created 95,000 jobs.  In fact, the EB-5 visa program was not very popular until the 2008 financial crisis when traditional sources of financing became more difficult to obtain.  Since then, numerous businesses have attempted to use the EB-5 program to raise money.  For example, Vermont’s Trapp Family Lodge of “Sound of Music” fame advertises that it seeks EB-5 investors to open a beer hall and renovate its existing resort facilities.

There are two distinct EB-5 routes — the Basic Program and the Regional Center Pilot Program. Both programs require that the immigrant make a capital investment of either $500,000 or $1,000,000 (depending on whether the investment is in a Targeted Employment Area [TEA]) in a new commercial enterprise located within the United States.  A TEA is defined by law as “a rural area or an area that has experienced high unemployment of at least 150% of the national average.”  The new commercial enterprise must create or preserve 10 full-time jobs for qualifying US workers within two years (or under certain circumstances, within a reasonable time after the two year period) of the immigrant investor’s admission to the US as a Conditional Permanent Resident.

Entrepreneurs across the nation have set up regional centers for foreign investment to market local EB-5 projects to investors.  There are over 230 such regional centers, some of which are state-run  like Vermont’s Jay Peak. The flexibility offered by a regional center is attractive to both the investor and developer since the investor does not have to play a role in the company. With a direct EB-5 investment, the investor must have some sort of “managerial” function.  Seeing a lucrative opportunity when connecting an investor with regional centers, an industry has sprung up, particularly in China, to connect US businesses with potential investors. These go-betweens charge the regional center as much as $175,000 per investor for making the introduction.

Some projects have not produced the requisite number of jobs that would prompt US immigration authorities to withhold green cards – resulting in exposure to lawsuits from the investor against the developer or regional center that has solicited the investment.  Approximately 31 investors, 15 from China, filed a federal lawsuit alleging the only thing they had to show for a $15.5 million investment was an undeveloped plot of land across the Mississippi River from New Orleans.  In San Bruno, California, three Chinese investors alleged in a lawsuit filed last year that they lost $3 million when an EB-5 developer disappeared with his associates concocted a story about his death.

In contrast, the Marriot and Hilton hotel chains have successfully solicited and obtained EB-5 investment funds to build new hotels; Sony Pictures Entertainment and Warner Brothers have used the EB-5 program to raise funds for film projects; and the new home of the NBA’s Brooklyn Nets, Barclay Center, was funded through EB-5 investment.

Even if successful, EB-5 visa approval has become much slower due to suspicion of fraud and developers’ inaccurate estimate of creating 10 jobs per investor.  With the economic downturn, the USCIS has hired economists and securities lawyers to review EB-5 applications. Now showing it that it means business, the Securities Exchange Commission has filed its first lawsuit against an EB-5 project alleging that the promoters of a Chicago hotel and convention center project fraudulently sold more than $145 million in securities and collected $11 million in administrative fees from over 250 Chinese investors.

The Canadian government has decided recently to halt its immigrant investor program due to the number of Chinese applications.  This has left Chinese investors potentially turning their attention to the US equivalent as they seek a financially and politically stable haven for themselves and their families.

Article By:

Jennifer G. Parser
Of:
Poyner Spruill LLP

A Giant Leap: EU-China Bilateral Investment Treaty Negotiations to Be Launched Formally

McDermottLogo_2c_rgb

 

Negotiations for a bilateral investment treaty between the European Union and China are expected to be formally launched during the EU-China Summit next week. Though the launch would be just the first step in a long negotiation process, it would also be a giant leap for upgrading the investment relationship between the EU and China.

On 24 October 2013, the fourth meeting of the EU-China High Level Economic and Trade Dialogue was held in Brussels.  Among other points, the most recent talk between the world’s two biggest traders reaffirmed the willingness to formally launch negotiations for a bilateral investment treaty (BIT) during the EU-China Summit to be held in Beijing later this month.

This move is significant for several reasons.

  • There is huge potential for investment flow between the European Union and China.

According to provisional Eurostat data, in 2012 Chinese investments into the EU(27) amounted to €3.5 billion, and only accounted for 2.2 per cent of total foreign direct investment (FDI) flowing into the EU. By contrast, in the same year EU firms invested €9.9 billion in China, accounting for approximately 11.4 per cent of all China’s inward FDI. It is worth noting that the EU’s outward FDI to China only accounted for 2.4 per cent of total outbound investment flowing from the EU to the rest of world in 2012. By contrast, bilateral trade in goods and services is more than €1 billion per day.

  • The existing BITs between China and EU Member States are to be upgraded.

China signed its first BIT with Sweden in 1982, and currently has similar arrangements with each and every EU Member State (except Ireland).  However, these BITs were negotiated and executed in the past 30 years, during which China went through substantial changes in all aspects of society, including a significant increase in outbound investment.  Some of the BITs were updated to reflect such changes, e.g., the China-Netherlands BIT was amended to include national treatment in 2001.

Overall, the EU-China BIT will not be a simple compilation of the existing BITs between China and EU Member States, but an upgrade of the investment relationship between them.

  • The negotiation of a EU-China BIT is likely to be a long process.

The negotiation of a BIT between two giant economic entities is likely to be a long process.  For example, the China-US BIT negotiation is still in its preliminary stage more than 30 years after both parties opened the dialogue in 1980.  The China-Canada agreement took 18 years and went through 22 rounds of formal negotiations.

The difficulties of these negotiations must not be underestimated.  The EU-China BIT will go further than the existing bilateral agreements with individual Member States.  The EU negotiators are keen to include provisions on market access, including access to services, and on intellectual property.  The negotiation process is likely to be complicated by calls from the European Parliament to include provisions on fundamental rights and values (social, environmental, consumer, etc.).

From a procedural point of view, this will be the first trade agreement negotiated by the EU since the assignment of trade and investment agreements to the exclusive competence of the EU under the Lisbon Treaty.  This gives the European Parliament a key role to play in approving any final agreement.

In sum, if both parties formally launch the negotiations in November, it will be a small step in the negotiation process, but a giant leap for upgrading the investment relationship between EU and China.

If EU industry has concerns about obstacles to FDI in China, including discrimination and absence of mutual treatment, it is not too late to raise them with the Directorate General for Trade of the European Commission.

Article by:

Philip Bentley, QC

Frank Schoneveld

Bryan Fu

Of:

McDermott Will & Emery