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Corporate Alert: SEC Adopts Rule Defining "Family Offices"; Supreme Court Limits Scope of Persons Liable for Securities Fraud; SEC Adopts Rules for Venture Capital Exemption; Delaware Supreme Court Upholds Disgorgement; Enactment of the UK Bribery Act; SEC Amends Political Contribution Rules; Delaware Chancery Court Applies Derivative Requirement
July 2011
Authors: Edward B. Stevenson, Irwin A. Kishner

The Herrick Advantage

Herrick was recently highlighted in Hedge Fund Alert as a top 30 law firm, one of a handful of U.S. firms with significant practices in the industry. The article noted Herrick's broad offering "working with start-ups and mid-sized managers, both onshore and offshore, across all asset classes and strategies". We are especially pleased to be recognized alongside our peers as a major provider of legal services to the industry.

On July 27 Herrick will continue its tradition of informative, business oriented events geared toward the hedge fund industry as we host "Industry Perspectives: Entering the New Hedge Fund Era";  The panel program will address how to strike the right balance in order to meet investor and regulatory demands, while remaining focused on delivering investment results. Herrick reaffirms its commitment to providing a forum for the hedge fund industry to gather in, share best practices and discuss critical operational and legal issues.

Stay tuned! On September 22nd Herrick will host its 5th Annual Symposium on the Capital Markets, featuring thought provoking discussion on key topics affecting the industry.

SEC Adopts Rule Under Dodd-Frank Defining "Family Offices"

The Securities and Exchange Commission (the "SEC") has adopted a new rule to define "family offices" to be exempt from registration under the Investment Advisers Act of 1940 (the "Advisers Act").  "Family offices" are entities established by wealthy families for the purpose of managing their wealth and providing tax and estate planning services to family members. Under the new rule, which stems from the Dodd-Frank Wall Street Reform and Consumer Protection Act, to qualify for the exemption a family office must meet three criteria: (1) it must provide investment advice only to "family clients" (this includes family members, former family members, key employees, former key employees, and other family clients, including certain trusts, estates, and charities); (2) it must be wholly-owned by family clients and exclusively controlled by family members and family entities; and (3) it may not hold itself out to the public as an investment adviser.

Family offices not meeting the exclusion must register with the SEC under the Advisers Act and with applicable state securities authorities by March 30, 2012.  Family offices that obtained exemptive orders from the SEC prior to the enactment of the new rule may continue to operate under their existing exemptive orders or may elect to operate under the new rule. Lastly, the Dodd-Frank Act's grandfathering provision applies to the new rule. As such, the SEC may not preclude certain family offices from meeting the new exclusion solely because they provided investment advice to certain clients prior to January 1, 2010.

SEC Press Rel. No. 2011-134 (June 22, 2011)

Supreme Court Limits Scope of Persons Primarily Liable for Securities Fraud Under Rule 10b-5

On June 13, 2011 the U.S. Supreme Court, by a 5 to 4 vote, narrowed the scope of primary liability under Securities and Exchange Commission Rule 10b-5 by holding that someone who participates in the preparation of a misstatement, but does not utter the misstatement or control the speaker, cannot be liable.  Rule 10b-5, which contains a prohibition against "making any untrue statement of a material fact," is one of the primary provisions under which securities actions by private plaintiffs and enforcement actions by the SEC are brought.  Accordingly, the questions of what it means to "make," and who can be liable for "making," a statement, are of central importance to professionals and others who assist entities that make public securities filings.

The Janus Capital Group, Inc v. First Derivative Traders decision rejected the SEC's view that the term "make" in Rule 10b-5(b) encompassed those who had "intricate involvement," "substantially participated," or otherwise provided behind the scenes assistance in the creation of misstatements voiced by others.   Instead, the Court announced a bright-line rule that the "maker of a statement" for purposes of Rule 10b-5 liability "is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it."  The Janus decision, thus, narrows the scope of liability under Rule 10b-5 for investment bankers, lawyers, accountants, and executives who assist in the preparation of the securities filing.

Janus Capital Group, Inc. v. First Derivative Trader, No. 09-525 (U.S. June 13,2011)

SEC Adopts Final Rules for Venture Capital Exemption to the Investment Advisers Act

The Securities and Exchange Commission (the "SEC") has recently adopted final rules, pursuant to the Investment Advisers Act of 1940, clarifying the venture capital exemption to registration.  Generally, investment advisers to venture capital funds must register with, and submit detailed information to, the SEC.  The new rule however exempts advisers to qualified venture capital funds.  The new rules define a qualified venture capital fund as a private fund that holds no more than 20% of its aggregate capital commitments in "non-qualifying investments."  Qualifying investments are those equity securities issued by a qualifying portfolio, which is a portfolio that is not traded internationally, does not issue debt obligations and is not a pooled investment.

In addition, to qualify for the exemption, the venture capital fund cannot be leveraged, registered as a business development company, or offer redemption rights to investors.  The rules also require that the fund pursue a venture capital strategy. 

Sec. Exch. Press Rel. No. 2011-133 (June 22, 2011)

Delaware Supreme Court Upholds Disgorgement as Insider Trading Remedy - Reaffirms "Brophy" Standard

Reaffirming the standard applied in Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949), the Delaware Supreme Court has upheld disgorgement as an acceptable remedy for a fiduciary's improper use of material, non-public information for insider trading, even where the corporation suffers no actual harm.  The opinion reversed the Chancery Court's dismissal of plaintiff's breach of fiduciary duty claims, finding that it is inequitable for fiduciaries to profit from confidential corporate information. 

In the subject case, plaintiff-shareholders sued Primedia, Inc. ("Primedia"), its directors, Kohlberg Kravis Roberts & Co., L.P. ("KKR"), and Primedia's controlling shareholder, alleging breaches of fiduciary duty relating to KKR's purchase of Primedia preferred stock based on material, nonpublic information.  It was alleged that KKR purchased the shares after learning Primedia intended to sell a materially significant asset.  The Court, in rejecting multiple Chancery Court opinions, held that the corporation need not suffer harm prior to bringing an insider trading claim.  The Court grounded its reasoning in the public policy of preventing unjust enrichment based on the misuse of corporate information and ultimately ordered the disgorgement of defendant's profits gained from the insider trading.  The decision re-affirms Brophy, which held that public policy required an insider to disgorge profits obtained through the use of confidential corporate information, even if the corporation suffered no loss as a result of that insider trading.

Kahn v. Kohlberg Kravis Roberts & Co., Inc., C.A. No. 1808 (Del. June 20, 2011)

Enactment of the UK Bribery Act

On July 1, 2011, the United Kingdom Bribery Act 2010 (the "Act") became effective.  The Act introduces four new categories of offense: (1) offering, promising, or giving a bribe to another person (the active offense); (2) requesting, agreeing to receive, or accepting a bribe from another person (the passive offense); (3) bribing a foreign public official (specific principal offense); and (4) failing to prevent bribery (strict liability corporate offense).  The broad jurisdictional reach of the Act significantly impacts United States companies doing business in the United Kingdom.  For example, a U.S. company that carries on its business in the U.K. may be prosecuted for failing to prevent bribery if any of its employees commit bribery anywhere in the world.  Thus, a U.S. company's global activities, even if they take place in a third country and are unrelated to the company's U.K. operations, may be brought within the jurisdiction of U.K. authorities pursuant to the Act.

The Act imposes potentially harsh penalties, including, for individuals, up to 10 years of imprisonment and/or a fine, and, for corporations, an unlimited fine. Other penalties may include debarment from public contracts, director disqualification in the U.K., and asset confiscation proceedings.

The only defense available to companies charged with failing to prevent bribery is for the organization to show that the company had "adequate procedures" in place to prevent the infractions.  It is therefore prudent for all companies doing business in the U.K. to implement compliance systems that adequately prevent bribery in all locations where they do business.

UK Bribery Act 2010 (available at

SEC Amends Political Contribution Rules to the Investment Advisers Act

On June 22, 2011, the Securities and Exchange Commission (the "SEC") amended the investment advisor "pay-to-play" rule in response to changes made by the Dodd-Frank Act.  The rule is designed to prevent an advisor, either directly or indirectly, from seeking to influence the award of contracts by government officials through political contributions. 

Under the revised rule, investment advisers are prohibited from engaging any third party to solicit government authorities on their behalf unless such third party is a "regulated person" and subject to pay-to-play rules that are at least as stringent as the investment adviser pay-to-play rules.  The definition of "regulated persons" initially was limited to include registered investment advisers and broker-dealers and FINRA-member registered broker-dealers.  Under the expanded definition, however, a "municipal advisor" (defined as a person registered as such pursuant to Section 15B of the Securities Exchange Act of 1934 and subject to the rules of the Municipal Securities Rulemaking Board), is also included in the definition.  The intent of the expansion is to harmonize the rule with Section 975 of the Dodd-Frank Act, which requires persons providing certain advisory services to municipalities or soliciting municipalities for advisory services offered by an unaffiliated third party investment advisor to register as a municipal advisor.  Investment advisors have until June 13, 2012 to comply with the revised prohibitions relating to the use of third party solicitors.

Sec. Exch. Press Rel. No. 2011-133 (June 22, 2011)

Delaware Chancery Court Applies Derivative Requirement in Suit Against Statutory Trust

The Delaware Chancery Court has dismissed with prejudice derivative and direct breach of fiduciary duty claims brought by trust interest-holders against two statutory trust funds within the Vanguard mutual fund complex. In its opinion, the court established two important rules. First, losses from the alleged mismanagement of investments by a mutual fund manager raise a derivative, rather than a direct, claim because the diminution of the value of a plaintiff's shares is "secondary and derivative" to the injury suffered by the funds themselves. Second, in derivative actions involving interest-holders bringing suits against trusts, the normal rules of derivative litigation apply. Applying these rules, the court held that since all of the plaintiffs' claims were derivative in nature rather than direct, the complaint must be dismissed because the plaintiffs failed to make demand upon the Board of Trustees or demonstrate why demand would be futile.

Hartsel v. The Vanguard Group, Inc., C.A. No. 5394-VCP (Del Ch. June 15, 2011)

For more information on the other issues in this alert, or corporate matters generally, please contact:

NY          Irwin Kishner
at 212.592.1435 or
NJ          Edward Stevenson at 973.274.2025 or


Copyright © 2011 Herrick, Feinstein LLP. Corporate Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.