In order to qualify for the “foreign private adviser” exemption, an investment adviser must satisfy each of the following criteria: (i) have no “place of business” in the United States; (ii) have, in total, 14 or fewer clients in the United States and investors in the United States in private funds advised by the investment adviser; (iii) have aggregate assets under management attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser of less than US$25 million; (iv) not hold itself out generally to the public in the United States as an investment adviser; and (v) not advise a US-registered fund or business development company.

Given the narrow provisions of this definition, many non-US advisers with even limited US contacts will not qualify for the relief provided by the exemption. In this regard, it is interesting to note that Congress provided the SEC with the authority to increase the US$25 million threshold to “such higher amount as the Commission may, by rule, deem appropriate.” In electing to leave the threshold at only US$25 million, the SEC appears to have displayed a preference to subject non-US advisers to the substantive provisions of the Advisers Act (or at least have them register as exempt reporting advisers). As a result, many non-US advisers will have to quickly familiarize themselves with the new regulatory framework.

A “private fund adviser” will qualify for a partial exemption under the Advisers Act if it (i) advises solely private funds, and (ii) in total, manages less than $150 million of private fund assets in the United States. Notably, the terms of this exemption apply quite differently depending on whether the adviser’s principal place of business is within or outside the United States. For example, in determining whether it qualifies for this exemption, a non-US adviser need only consider those private funds it manages from a place of business within the United States. The corollary is that non-US entities may provide investment advice to an unlimited number of private funds—whether or not US-organized and regardless of the number or value of US investors in them—provided that the investment advice is given from a place of business outside of the United States. Additionally, while a US adviser may only provide advice to clients that are private funds, non-US advisers may render investment advice to clients outside of the United States that are not private funds (subject to certain limitations).

The final exemption adopted by the SEC is available to firms that provide investment advice “solely to venture capital funds.” The definition put forth by the SEC is quite narrow and many advisers to venture capital firms will find that they cannot satisfy the requisite criteria. Moreover, unlike the private adviser exemption discussed above, the provisions of the venture capital exemption apply equally to US and non-US investment advisers. This means that in order to qualify for the exemption, non-US advisers cannot advise any type of client aside from venture capital funds. The venture capital exemption would not be available to a non-US adviser that provides advice to even one private fund, even if outside of the United States, that is not a venture capital fund.

Among the adjustments facing investment advisers as a result of the new rules is significantly increased disclosure requirements regarding their private fund clients. The following list provides a summary of the items that either a registered investment adviser or an exempt reporting adviser must disclose on the SEC website for each one of its private fund clients: the fund’s gross asset value, the minimum subscription amount for non-affiliated entities, the number of beneficial owners, the identities of the fund’s directors, the identities of any other investment advisers to the fund and identifying information about the fund’s service providers.

While publicly disclosing such information presents a marked departure from the current regulatory regime, the SEC has given somewhat of a reprieve to non-US advisers in this regard. Specifically, an investment adviser having its principal office and place of business outside of the United States would not be required to make such disclosures with respect to a private fund that is not a “US person” (which, for the most part, tracks the definition provided under Regulation S of the US Securities Act of 1933), and that is not offered to, or beneficially owned by, US persons.

(For registered investment advisers, this is only the beginning. Far broader and more intensive—albeit confidential—reporting to the SEC regarding private funds is proposed under a new Form-PF to come into effect as soon as 2011 year-end.)

In the face of a looming July 21, 2011 deadline for new investment adviser registrations, the SEC extended the mandatory final registration date to March 30, 2012. Given the SEC is entitled to 45-days when reviewing registration statements, however, firms generally should ensure that their filings are submitted with the SEC by February 14, 2012. In the meantime, it will be prudent to start the process of coming to terms with the new requirements and implementing any related commercial changes—such as revised affiliate, subadvisory or service provider arrangements—as soon as possible. For firms planning to register, it may take at least several months to develop the robust compliance procedures needed to operate under the Advisers Act.

For more information on these as well as other rules adopted under the Advisers Act, see Shearman & Sterling memorandum, Dodd-Frank Act Rulemaking: SEC Finalizes Exemptions and Disclosure Requirements for Investment Advisers and sets Compliance for Early 2012

For more information on the proposed Form-PF, see Shearman & Sterling memorandum, Under Rubric of Systemic Risk, Joint SEC-CFTC Proposal Would Dramatically Expand Reporting by Private Fund Managers.

The action before the Supreme Court is the culmination of a set of lawsuits between Vickie Lynn Marshall (Vickie) and E. Pierce Marshall (Pierce). Vickie (known to the public as Anna Nicole Smith) was Pierce’s father’s third wife. Vickie filed suit in Texas state probate court against Pierce asserting that he fraudulently induced his father to sign a living trust that did not include her. Vickie later filed for bankruptcy protection in the United States Bankruptcy Court for the Central District of California (the Bankruptcy Court). Pierce filed a complaint (and an accompanying proof of claim) in Vickie’s bankruptcy proceeding for defamation. Vickie responded to the action by, among other things, filing a counterclaim for tortious interference (essentially the same action as her Texas suit).

Under 28 U.S.C. § 157(b), bankruptcy judges may hear and enter final judgments “in all core proceedings arising under title 11, or arising in a case under title 11.” Section 157(b)(2)(C) enumerates a non-exclusive list of 16 different types of matters that are considered core proceedings, including “counterclaims by [a debtor’s] estate against persons filing claims against the estate.” When a bankruptcy judge determines that a proceeding is not a core proceeding but “is otherwise related to a case under title 11,” the judge may only “submit proposed findings of fact and conclusions of law to the district court.”

The Bankruptcy Court concluded that Vickie’s counterclaim was a “core proceeding” under 28 U.S.C. § 157(b)(2)(C), and therefore, it had the “power to enter judgment” on it. After reversal on appeal by the United States District Court for the Central District of California, the Court of Appeals held that, in order to constitute a “core proceeding” under § 157, the counterclaim must be so closely related to the creditor’s proof of claim that the resolution of the counterclaim is necessary to resolve the allowance or disallowance of the claim itself. The Supreme Court granted certiorari to determine (i) whether the Bankruptcy Court had statutory authority under 28 U.S.C. § 157(b) to issue a final judgment on Vickie’s counterclaim; and (ii) if so, whether conferring that authority on the Bankruptcy Court is constitutional.

Chief Justice Roberts, writing for the majority, rejected Pierce’s interpretation of § 157(b), and held that Vickie’s counterclaim is a “core” proceeding under the plain text of § 157(b)(2)(C). The majority similarly rejected Pierce’s counsel’s jurisdictional argument, finding that § 157 only addresses where personal injury tort claims “shall be tried,” and does not refer to any court’s jurisdiction or implicate questions of subject matter jurisdiction. Furthermore, Chief Justice Roberts found ample evidence in the record that Pierce consented to the Bankruptcy Court’s resolution of his claim.

While the majority ruled that the Bankruptcy Court had statutory authority to enter a final judgment on Vickie’s counterclaim, it noted that designating all counterclaims as core proceedings “raises serious constitutional concerns.” Chief Justice Roberts, writing for the majority, concluded that while § 157(b)(2)(C) permits the Bankruptcy Court to enter a final judgment on Vickie’s counterclaim, Article III of the Constitution does not.

Article III, § 1, of the Constitution mandates that “[t]he judicial Power of the United States, shall be vested in one supreme Court, and in such inferior Courts as the Congress may from time to time ordain and establish.” The same section provides that the judges of those constitutional courts “shall hold their Offices during good Behaviour” and “receive for their Service[] a Compensation[] [that] shall not be diminished” during their tenure.

Vickie’s counsel argued that the Bankruptcy Court’s final judgment on Vickie’s state common law counterclaim was constitutional under the 1984 amendments to the Bankruptcy Code, or in the alternative, the counterclaim falls into the “public rights” exception. In doing so, Vickie’s counsel distinguished prior Supreme Court precedent in Granfinanciera, S.A. v. Nordberg and Langenkamp v. Culp by arguing that Pierce filed a proof of claim against Vickie’s estate, and therefore, submitted himself to the jurisdiction of the Bankruptcy Court.

The majority found that the Bankruptcy Court lacked constitutional authority to enter a final judgment on a state law counterclaim that is not resolved through the bankruptcy claims process. It found that the Bankruptcy Court was clearly exercising the “judicial Power of the United States” as the counterclaim is a state law claim. The majority further ruled that the counterclaim does not fall within the “public rights” exception as it is a state common law claim between two private parties and the terms of its adjudication do not depend on Congress. In addition, Vickie’s requested relief does not flow from a federal statutory scheme, and is not completely dependent upon adjudication of a claim created by federal law.

Additionally, the Court, in distinguishing Granfinanciera and Langenkamp, held that the adjudication of Pierce’s claim in no way affects the nature of Vickie’s counterclaim. Furthermore, the majority was not convinced by Vickie’s assertion that, as a practical matter, restrictions on the bankruptcy courts’ ability to hear and resolve compulsory counterclaims will create significant delays and impose additional costs on the bankruptcy process.

Justice Scalia, while agreeing with the majority’s opinion, separately wrote a concurring opinion. He noted that the “public rights” exception must be read narrowly, and that unless there is a firmly established historical practice to the contrary, an Article III judge (those appointed by the President and confirmed by the Senate) is required in all federal adjudications.

Justice Breyer, joined by Justice Ginsburg, Justice Sotomayor and Justice Kagan, dissented. Justice Breyer agreed with the majority that § 157(b)(2)(C) authorizes a bankruptcy court to adjudicate Vickie’s counterclaims, but disagreed with the majority about the statute’s constitutionality. The dissent contended that the statute is constitutional because, among other reasons, (i) the resolution of counterclaims often turns on facts identical to, or at least related to, those at issue in a creditor’s claim that is undisputedly proper for the bankruptcy court to decide; (ii) bankruptcy judges are appointed by federal courts of appeal, they can functionally be compared to magistrate judges, law clerks and the Judiciary’s administrative officials; (iii) Article III judges retain control and supervision over the bankruptcy court’s determinations so there are sufficient checks on the bankruptcy court’s judgments; and (iv) the parties consented to the jurisdiction of the Bankruptcy Court. Regarding Vickie’s counsel’s argument of the practical consequences, the dissent agrees and believes that limiting bankruptcy courts’ authority would lead to inefficiency, increased cost, delay and needless additional suffering among those faced with bankruptcy.

As a practical matter, the Supreme Court decision likely does not affect most creditors. Although it discussed both issues briefly, the Court left open the definition of a “personal injury tort” for purposes of § 157(b) and how this decision, when read with Granfinanciera and Langenkamp, impacts avoidance actions against parties who did not submit proofs of claim against the bankruptcy estate. The only direct implication of the decision is in cases where a debtor files a counterclaim that is unrelated to the underlying claim filed against the debtor. In such a scenario, the counterclaim still may be heard by the bankruptcy judge, who will issue proposed findings of fact and conclusions of law to the district court, and then by the district court, who will conduct an independent review of the record before entering a final order. However, to avoid what could be a substantial inefficiency of having only proposed findings being issued by the bankruptcy court, it is more likely that the counterclaim will be “withdrawn” to the district court to allow it to hear the matter directly.

For a complete copy of Shearman & Sterling LLP’s Client Publication covering this topic, please click here.

A secured creditor’s right to bid up to the full amount of its claim in a sale of its collateral (commonly referred to as credit bidding) has long been a fundamental creditor protection under the Bankruptcy Code. Credit bidding enables a creditor to obtain possession of its collateral to satisfy its secured claim in lieu of receiving proceeds from the sale of the collateral which the creditor considers inadequate. The Third Circuit’s decision in Philadelphia Newspapers, and the Fifth Circuit’s decision in Pacific Lumber, created substantial uncertainty for secured creditors. Both courts held that the Bankruptcy Code does not require credit bidding when the collateral is sold pursuant to a chapter 11 plan.

The statutory provision driving this controversy is section 1129(b)(2)(A) of the Bankruptcy Code. This section contains the test for determining whether a proposed chapter 11 plan is “fair and equitable” with respect to a class of secured claims that has voted to reject the plan. If the proposed plan passes this test, and meets all other requirements set forth under the Bankruptcy Code, it may be confirmed (or crammed down) over the dissenting vote of a secured creditor class. Under section 1129(b)(2)(A), a proposed plan is “fair and equitable” to secured creditors if:

Clause (ii) commonly was understood to enable secured creditors to credit bid their claims in any sale involving their collateral conducted pursuant to a chapter 11 plan, but Philadelphia Newspapers and Pacific Lumber adopted an alternative interpretation of section 1129(b)(2)(A). Those courts ruled that a sale of collateral without credit bidding could be “fair and equitable” under the nebulous “indubitable equivalent” prong of clause (iii). Both the Third Circuit and the Fifth Circuit reasoned that the word “or” at the end of clause (ii) rendered the three options set forth in section 1129(b)(2)(A) disjunctive, so the “indubitable equivalent” prong constituted an alternative “fair and equitable” treatment of a secured creditor’s claim distinct from the secured creditors’ entitlement to credit bid contained in clause (ii).

The debtors in River Road sought to sell substantially all of their assets pursuant to plans of reorganization and distribute the sale proceeds to their creditors in accordance with the priority provisions of the Bankruptcy Code. The debtors separately filed motions to approve bid procedures to govern the asset sales. Notably, the proposed procedures did not offer the debtors’ secured lenders the opportunity to credit bid their claims in the auction process. The agent for the secured lenders objected to these procedures on the grounds that they impinged the secured lenders’ right to credit bid under section 1129(b)(2)(A)(ii). The debtors responded that their proposed plans were confirmable under the “indubitable equivalent” test contained in section 1129(b)(2)(A)(iii). The bankruptcy court sided with the secured lenders and denied the debtors’ motions. The debtors appealed directly to the Seventh Circuit Court of Appeals.

The Seventh Circuit affirmed the bankruptcy court’s decision, holding that “the [Bankruptcy Code] requires that cramdown plans that contemplate selling encumbered assets free and clear of liens at an auction satisfy the requirements set forth in [s]ubsection (ii) of [section 1129(b)(2)(A)].” The Court of Appeals concluded that section 1129(b)(2)(A) is vague and subject to two different interpretations. In analyzing the two possible readings, the Court of Appeals reasoned that under a “cardinal rule of statutory construction,” a statute should be construed so that no clause, sentence, or word would be rendered superfluous, void or insignificant. Based on this principle, the Seventh Circuit observed that the debtors’ proposed expansive interpretation of the “indubitable equivalent” prong would render the first two clauses of section 1129(b)(2)(A) superfluous in situations that expressly are contemplated in those provisions. The Court of Appeals concluded that under “[t]he infinitely more plausible interpretation of [s]ection 1129(b)(2)(A),” “plans could only qualify as ‘fair and equitable’ under [s]ubsection (iii) if they proposed disposing of assets in ways that are not described in [s]ubsections (i) and (ii).”

In reaching this decision it appears that the Seventh Circuit was guided by the policy reason for offering secured creditors the right to credit bid. After noting that the ability to credit bid “provides lenders with means to protect themselves from the risk that the winning auction bid will not capture the asset’s actual value,” the Court of Appeals proceeded to list a number of factors that contribute to such a risk – including the “inherent risk of self-dealing on the part of existing management.” The Court of Appeals then concluded: “Because the Debtors’ proposed auctions would deny secured lenders the ability to credit bid, they lack a crucial check against undervaluation. Consequently, there is an increased risk that the winning bids in these auctions would not provide the [secured lenders] with the current market value of the encumbered assets.”

The Seventh Circuit’s decision in River Road departs from the recent trend toward limiting the credit bid option when collateral is sold pursuant to a plan of reorganization. This decision is a positive development for secured creditors, whose leverage over chapter 11 debtors had eroded after Philadelphia Newspapers and Pacific Lumber. In light of River Road, secured creditors can credit bid their claims in any sales of their collateral pursuant to a chapter 11 plan in the Seventh Circuit.

By contrast, courts in the Third and Fifth Circuits will not necessarily permit secured creditors to submit credit bids in sales conducted pursuant to a chapter 11 plan. In Philadelphia Newspapers, however, the Third Circuit left open the possibility that a proposed treatment nevertheless might not constitute an “indubitable equivalent” of the secured claim due to the absence of an opportunity for the secured party to credit bid. In the Third and Fifth Circuits (and in any of the other judicial circuits that have yet to decide this issue), it may be advisable for secured creditors to attempt to negotiate a court-approved agreement from debtors to refrain from pursuing a “cramdown” plan that omits the credit bid option, for example, in the context of a cash collateral order.