Md. Code Regs. 02.02.05.08

Current through Register Vol. 51, No. 12, June 14, 2024

Section 02.02.05.08 - Exemption from the Maryland Securities Act, Corporations and Associations Article, Section11-302(e)(1)(i) for Performance-Based Compensation

A. Definitions. As used in this regulation:

(1) "Affiliate" has the meaning stated in § 2(a)(3) of the Investment Company Act of 1940.

(2) "Client's independent agent" means a person who agrees to act as an investment advisory client's agent in connection with the contract, but does not include:

(a) The investment adviser relying on this regulation;

(b) An affiliate of the investment adviser or an affiliate of an affiliate of the investment adviser, including an investment adviser representative;

(c) An interested person of the investment adviser;

(d) A person who receives, directly or indirectly, compensation in connection with the contract from the investment adviser, an affiliate of the investment adviser, an affiliate of the affiliate of the investment adviser, or an interested person of the investment adviser; or

(e) A person having the benefit of a material relationship between or among himself (or an affiliate of that person) and the investment adviser (or an affiliate of the investment adviser) that exists, or has existed at any time during the past 2 years.

(3) Company.

(a) Except for the companies listed in §A(3)(b) of this regulation, "company" means a corporation, partnership, association, joint stock company, trust, or any organized group of persons, whether incorporated or not, or a receiver, trustee in a case under Title 11 of the United States Code, or similar official or a liquidating agent for any of the above, in his capacity as such.

(b) Unless each of the equity owners of the companies listed below, other than the investment adviser entering into the contract, is a natural person as described in §B(1) of this regulation or is a company as defined in §A(3)(a) of this regulation, "company" does not include:

(i) A company required to be registered under the Investment Company Act of 1940 but that is not so registered;

(ii) A private investment company that, for purposes of this paragraph, means a company that would be defined as an investment company under § 3(a) of the Investment Company Act of 1940 but for the exception from that definition provided by § 3(c)(1) of that act;

(iii) An investment company registered under the Investment Company Act of 1940; or

(iv) A business development company, as defined in § 202(a)(22) of the Investment Advisers Act of 1940.

(4) "Interested person" means:

(a) A member of the immediate family of a natural person who is an affiliate of the investment adviser;

(b) A person who knowingly has a direct or indirect beneficial interest in, or who is designated as trustee, executor, or guardian of a legal interest in, a security issued by the investment adviser or by a controlling person of the investment adviser if that beneficial or legal interest exceeds:

(i) One-tenth of 1 percent of any class of outstanding securities of the investment adviser or a controlling person of the investment adviser; or

(ii) Five percent of the total assets of the person seeking to act as the client's independent agent; or

(c) A person or partner or employee of a person who, at any time during the past 2 years, has acted as legal counsel for the investment adviser.

B. Exemption from the Maryland Securities Act, Corporations and Associations Article, § 11-302(e)(1)(i). Notwithstanding the prohibitions of the Maryland Securities Act, Corporation and Associations Article, §11-302(e)(1)(i), Annotated Code of Maryland, an investment adviser may enter into, extend, or renew an investment advisory contract that provides for compensation to the investment adviser on the basis of a share of capital gains upon or capital appreciation of the funds or a portion of the funds of the client if the following conditions are met:

(1) The client entering into the contract is a:

(a) Natural person or a company that, immediately after entering into the contract, has at least $500,000 under the management of the investment adviser; or

(b) Person who the investment adviser and its investment adviser representatives reasonably believe, immediately before entering into the contract, is a natural person or a company whose net worth, at the time the contract is entered into, exceeds $1,000,000. The net worth of a natural person may include assets held jointly with that person's spouse.

(2) The compensation paid to the investment adviser with respect to the performance of securities over a given period shall 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 17 CFR § 270.2 a- 4(a)(1) (SEC Rule 2a-4(a)(1), Periodic Calculation of Net Asset Value of Redeemable Security), the formula shall 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 17 CFR § 270.2 a- 4(a)(1) (SEC Rule 2a-4(a)(1), Periodic Calculation of Net Asset Value of Redeemable Security), the formula shall include:

(i) The realized capital losses of securities over the period; and

(ii) If the unrealized capital appreciation of the securities over the period is included, the unrealized capital depreciation of the securities over the period; and

(c) The formula shall provide that compensation paid to the investment adviser under this regulation is based on the gains less the losses (computed in accordance with §B(2)(a) and (b) of this regulation) in the client's account for a period of not less than 1 year.

(3) Before entering into the advisory contract and in addition to the requirements of Form ADV, the investment adviser shall disclose in writing to the client or the client's independent agent 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 involve more risk and are more speculative than would be the case in the absence of a performance-based fee;

(b) When 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 time periods that will be used to measure investment performance throughout the contract and their potential significance in the computation of the fee;

(d) The nature of an index that will be used as a comparative measure of investment performance, the potential significance of the index, and the reasons the investment adviser believes that the index is appropriate; and

(e) When the investment adviser's compensation is based in part on the unrealized appreciation of securities for which market quotations are not readily available within the meaning of 17 CFR § 270.2 a- 4(a)(1) (SEC Rule 2a-4(a)(1), Periodic Calculation of Net Asset Value of Redeemable Security), the method by which the securities will be valued and the extent to which the valuation will be independently determined.

(4) The investment adviser, and any investment adviser representative who enters into the contract, shall reasonably believe, immediately before entering into the contract, that the contract represents an arm's-length arrangement between the parties and that the client (or in the case of a client that is a company as defined in §A(3) of this regulation, the person representing the company), alone or together with the client's independent agent, understands the proposed method of compensation and its risks. The representative of a company may be a partner, director, officer, or an employee of the company or the trustee when the company is a trust, or other person designated by the company or trustee, but shall satisfy the definition of client's independent agent set forth in §A(2) of this regulation.

C. A person entering into or performing an investment advisory contract under this regulation is not relieved of any obligations under the Maryland Securities Act, Corporations and Associations Article, § 11-302(a), Annotated Code of Maryland, or any other applicable provision of the Maryland Securities Act, Corporations and Associations Article, Title 11, Annotated Code of Maryland, or a regulation or order promulgated under it, or any other state or federal law, rule, or regulation.

D. Nothing in this regulation shall relieve a client's independent agent from any obligation to the client under applicable law.

Md. Code Regs. 02.02.05.08

Regulations .08 adopted as an emergency provision effective July 25, 1989 (16:16 Md. R. 1733); emergency status expired December 22, 1989
Regulations .08 adopted as an emergency provision effective December 23, 1989 (17:1 Md. R. 63); adopted permanently effective April 16, 1990 (17:7 Md. R. 845)