1. (a) Performance-based compensation exemption.

   1. (1) Notwithstanding Arkansas Code § 23-42-307(b)(1) of the Arkansas Securities Act, Arkansas Code § 23-42-101 et seq., an investment adviser may enter into, extend, or renew an investment advisory contract which provides for compensation to the investment adviser on the basis of a share of capital gains upon or capital appreciation of the funds, or any portion of the funds, of the client if the following conditions are met:

      1. (A) The client entering into the contract is a “qualified client”, as defined by Rule 205-3 under the Investment Advisers Act of 1940, 17 C.F.R. § 275.205-3; and
      2. (B) To the extent not otherwise disclosed on Form ADV Part 2, the investment adviser must disclose in writing to the client all material information concerning the proposed advisory arrangement, including the following:

2. (i) That the fee arrangement may create an incentive for the investment adviser to make investments that are riskier or more speculative than would be the case in the absence of a performance fee;

   1. (ii) Where relevant, that the investment adviser may receive increased compensation with regard to unrealized appreciation as well as realized gains in the client’s account;

      1. (iii) The periods which will be used to measure investment performance throughout the contract and their significance in the computation of the fee;

         1. (iv) The nature of any index which will be used as a comparative measure of investment performance, the significance of the index, and the reason the investment adviser believes that the index is appropriate; and
         2. (v) Where 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 Rule 2a-4(a)(1) under the Investment Company Act of 1940, 17 C.F.R. § 270.2a-4(a)(1), how the securities will be valued and the extent to which the valuation will be independently determined.
   2. (2) In the case of a private investment company, as defined in subdivision (a)(4)(B) of this section, an investment company registered under the Investment Company Act of 1940, or a business development company, as defined in Section 202(a)(22) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-2(a)(22), each equity owner of any such company (except for the investment adviser entering into the contract and any other equity owners not charged a fee on the basis of a share of capital gains or capital appreciation) will be considered a client for purposes of subdivision (a)(1) of this section.

   3. (3) Transition rules:

      1. (A) If an investment adviser entered into a contract and satisfied the conditions of this section that were in effect when the contract was entered into, the adviser will be considered to satisfy the conditions of this section, provided, however, that if a natural person or company who was not a party to the contract becomes a party (including an equity owner of a private investment company advised by the adviser), the conditions of this section in effect when the person or company becomes a party to the contract will apply with regard to that person or company;
      2. (B) If an investment adviser was not required to register pursuant to Arkansas Code § 23-42-301 of the Arkansas Securities Act and was not registered, Arkansas Code § 23-42-307(b)(1) of the Arkansas Securities Act shall not apply to an advisory contract entered into when the investment adviser was not required to register and was not registered, provided, however, that the investment adviser was in compliance with all rules and regulations regarding performance-based compensation in any jurisdiction in which the investment adviser was registered or required to be registered at the time of entering into the advisory contract; and
      3. (C) Solely for purposes of subdivisions (a)(3)(A) and (B) of this section, a transfer of an equity ownership interest in a private investment company by gift or bequest, or pursuant to an agreement related to a legal separation or divorce, will not cause the transferee to “become a party” to the contract, and will not cause Arkansas Code § 23-42-307(b)(1) of the Arkansas Securities Act to apply to such transferee.

   4. (4) The following definitions apply for purposes of this section:

      1. (A) “Company” shall have the same meaning as in Section 202(a)(5) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-2(a)(5), but does not include a company that is required to be registered under the Investment Company Act of 1940 but is not registered; and
      2. (B) “Private investment company” means a company that would be defined as an investment company under Section 3(a) of the Investment Company Act of 1940, 15 U.S.C. § 80a-3(a), but for the exception provided from that definition by Section 3(c)(1) of the Investment Company Act of 1940, 15 U.S.C. § 80a-3(c)(1).
   5. (5) Independent agent. Nothing in this section shall relieve a client’s independent agent from any obligation to the client under applicable law.

3. (b) Custody of client funds or securities by investment advisers.

   1. (1) Safekeeping required. It is unlawful and deemed to be a fraudulent, deceptive, or manipulative act, practice, or course of business for an investment adviser, registered or required to be registered, to have custody of client funds or securities unless the following occurs:

      1. (A) Notice to commissioner.

         1. (i) The investment adviser notifies the Securities Commissioner promptly in writing that the investment adviser has or may have custody.
         2. (ii) This notification is required to be given on Form ADV;

      2. (B) Qualified custodian. A qualified custodian maintains those funds and securities:

         1. (i) In a separate account for each client under that client’s name; or
         2. (ii) In accounts that contain only the investment adviser’s clients’ funds and securities, under the investment adviser’s name as agent or trustee for the clients or, in the case of a pooled investment vehicle that the investment adviser manages, in the name of the pooled investment vehicle;

      3. (C) Notice to clients.

         1. (i) If an investment adviser opens an account with a qualified custodian on behalf of a client, under the client’s name, under the name of the investment adviser as agent, or under the name of a pooled investment vehicle, the investment adviser must notify the client in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, promptly when the account is opened and following any changes to this information.
         2. (ii) If the investment adviser sends account statements to a client to which the investment adviser is required to provide this notice, the investment adviser must include in the notification provided to that client and in any subsequent account statement the investment adviser sends that client a statement urging the client to compare the account statements from the custodian with those from the investment adviser;
      4. (D) Account statements. The investment adviser has a reasonable basis, after due inquiry, for believing that the qualified custodian sends an account statement, at least quarterly, to each client for which it maintains funds or securities, identifying the amount of funds and of each security in the account at the end of the period and setting forth all transactions in the account during that period;
      5. (E) Special rule for limited partnerships and limited liability companies. If the investment adviser or a related person is a general partner of a limited partnership (or managing member of a limited liability company, or holds a comparable position for another type of pooled investment vehicle), the account statements required under subdivision (b)(1)(D) of this section must be sent to each limited partner (or member or other beneficial owner);

      6. (F) Independent verification.

         1. (i) The client funds and securities of which the investment adviser has custody are verified by actual examination at least once during each calendar year by an independent certified public accountant pursuant to a written agreement between the investment adviser and the independent certified public accountant, at a time that is chosen by the independent certified public accountant without prior notice or announcement to the investment adviser and that is irregular from year to year.
         2. (ii) The written agreement must provide for the first examination to occur within six (6) months of becoming subject to this subdivision (b)(1)(F) except that, if the investment adviser maintains client funds or securities pursuant to this section as a qualified custodian, the agreement must provide for the first examination to occur no later than six (6) months after obtaining the internal control report.
         3. (iii) The written agreement must require the independent certified public accountant to do the following:
4. (a) (a) File a certificate on Form ADV-E with the commissioner within one hundred twenty (120) days of the time chosen by the independent certified public accountant in this subdivision (b)(1)(F), stating that it has examined the funds and securities and describing the nature and extent of the examination;

5. (b) (b) Upon finding any material discrepancies during the course of the examination, notify the commissioner within one (1) business day of the finding by means of a facsimile transmission or electronic mail followed by first-class mail directed to the attention of the commissioner; and

   1. (c) (c) Upon resignation or dismissal from, or other termination of, the engagement, or upon removing itself or being removed from consideration for being reappointed, file within four (4) business days Form ADV-E accompanied by a statement that includes the following:
   2. (1) (1) The date of the resignation, dismissal, removal, or other termination, and the name, address, and contact information of the independent certified public accountant; and

   3. (2) (2) An explanation of any problems relating to examination scope or procedure that contributed to:

      1. (A) (A) The resignation;
      2. (B) (B) The dismissal;
      3. (C) (C) The removal; or
      4. (D) (D) Other termination;

      5. (G) Investment advisers acting as qualified custodians. If the investment adviser maintains, or if the investment adviser has custody because a related person maintains, client funds or securities pursuant to this section as a qualified custodian in connection with advisory services, the investment adviser provides to clients:

         1. (i) The independent certified public accountant the investment adviser retains to perform the independent verification required by subdivision (b)(1)(F) of this section must be registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by the Public Company Accounting Oversight Board in accordance with its rules; and
         2. (ii)
6. (a) (a) The investment adviser must obtain, or receive from its related person, within six (6) months of becoming subject to this subdivision (b)(1)(G) and thereafter no less frequently than once each calendar year, a written internal control report prepared by an independent certified public accountant.

7. (b) (b) The internal control report must include an opinion of an independent certified public accountant as to whether controls have been placed in operation as of a specific date and are suitably designed and are operating effectively to meet control objectives relating to custodial services, including the safeguarding of funds and securities held by either the investment adviser or a related person on behalf of the investment adviser’s clients during the year.

   1. (c) (c) The independent certified public accountant must verify that the funds and securities are reconciled to a custodian other than the investment adviser or the investment adviser’s related person.

      1. (d) (d) The independent certified public accountant must be registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by the Public Company Accounting Oversight Board in accordance with its rules; and
      2. (H) Independent representatives. A client may designate an independent representative to receive on his or her behalf notices and account statements as required under subdivisions (b)(1)(C) and (D) of this section.

   2. (2) Exceptions.

      1. (A) Shares of mutual funds. With respect to shares of an open-end company as defined in Section 5(a)(1) of the Investment Company Act of 1940 (“mutual fund”), the investment adviser may use the mutual fund’s transfer agent in lieu of a qualified custodian for purposes of complying with subdivision (b)(1) of this section.

      2. (B) Certain privately offered securities.

         1. (i) The investment adviser is not required to comply with subdivision (b)(1)(B) of this section with respect to securities that are the following:
8. (a) (a) Acquired from the issuer in a transaction or chain of transactions not involving any public offering;

9. (b) (b) Uncertificated and ownership thereof is recorded only on the books of the issuer or its transfer agent in the name of the client; and

   1. (c) (c) Transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer.

      1. (ii)
10. (a) (a) Notwithstanding subdivision (b)(2)(B)(i) of this section, the provisions of this subdivision (b)(2)(B) are available with respect to securities held for the account of a limited partnership (or limited liability company or other type of pooled investment vehicle) only if the limited partnership is audited, and the audited financial statements are distributed as described in subdivision (b)(2)(D) of this section and the investment adviser notifies the commissioner in writing that the investment adviser intends to provide audited financial statements, as described above.

11. (b) (b) The notification is required to be provided on Form ADV.

    1. (C) Fee deduction. Notwithstanding subdivision (b)(1)(F) of this section, an investment adviser is not required to obtain an independent verification of client funds and securities maintained by a qualified custodian if all of the following are met:

       1. (i) The investment adviser has custody of the funds and securities solely as a consequence of its authority to make withdrawals from client accounts to pay its advisory fee;

          1. (ii) The investment adviser has written authorization from the client to deduct advisory fees from the account held with the qualified custodian;
          2. (iii) Each time a fee is directly deducted from a client account, the investment adviser concurrently:
12. (a) (a) Sends the qualified custodian an invoice or statement of the amount of the fee to be deducted from the client’s account; and

13. (b)

    1. (1) (b)(1) Sends the client an invoice or statement itemizing the fee.

    2. (2) (2) Itemization includes the formula used to calculate the fee, the amount of assets under management the fee is based on, and the time period covered by the fee; and

       1. (iv)
14. (a) (a) The investment adviser notifies the commissioner in writing that the investment adviser intends to use the safeguards provided above.

15. (b) (b) The notification is required to be given on Form ADV.

    1. (D) Limited partnerships subject to annual audit. An investment adviser is not required to comply with subdivisions (b)(1)(C) and (D) of this section and shall be deemed to have complied with subdivision (b)(1)(F) of this section with respect to the account of a limited partnership (or limited liability company or another type of pooled investment vehicle) if each of the following conditions are met:

       1. (i) At least annually, the fund is subject to an audit and distributes its audited financial statements prepared in accordance with generally accepted accounting principles to all limited partners (or members or other beneficial owners) and the commissioner within one hundred twenty (120) days of the end of its fiscal year;

          1. (ii) The audit is performed by an independent certified public accountant that is registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by the Public Company Accounting Oversight Board in accordance with its rules;
          2. (iii)
16. (a) (a) Upon liquidation, the adviser distributes the fund’s final audited financial statements prepared in accordance with generally accepted accounting principles to all limited partners (or members or other beneficial owners) and the commissioner promptly after the completion of the audit.

17. (b) (b) If liquidation occurs within six (6) months of the previous fiscal year-end, the limited partnership (or like entity) may incorporate the previous year annual audit into the final audit;

    1. (iv) The written agreement with the independent certified public accountant must require the independent certified public accountant to, upon resignation or dismissal from, or other termination of, the engagement, or upon removing itself or being removed from consideration for being reappointed, notify the commissioner within four (4) business days accompanied by a statement that includes the following:
18. (a) (a) The date of the resignation, dismissal, removal, or other termination, and the name, address, and contact information of the independent certified public accountant; and

19. (b) (b) An explanation of any problems relating to audit scope or procedure that contributed to:

    1. (1) (1) The resignation;
    2. (2) (2) The dismissal;
    3. (3) (3) The removal; or

    4. (4) (4) Other termination; and

       1. (v)
20. (a) (a) The investment adviser must also notify the commissioner in writing that the investment adviser intends to employ the use of the statement delivery and audit safeguards described above.

21. (b) (b) Such notification is required to be given on Form ADV.

    1. (E) Registered investment companies. The investment adviser is not required to comply with this section with respect to the account of an investment company registered under the Investment Company Act of 1940.
    2. (3) Delivery to related persons. Sending an account statement under subdivision (b)(1)(E) of this section or distributing audited financial statements under subdivision (b)(2)(D) of this section shall not satisfy the requirements of this section if the account statements or financial statements are sent solely to limited partners (or members or other beneficial owners) that themselves are limited partnerships (or limited liability companies or another type of pooled investment vehicle) and are related persons of the investment adviser.

    3. (4) Definitions. For purposes of this section:

       1. (A) “Qualified custodian” means:

          1. (i) A bank or savings association that has deposits insured by the Federal Deposit Insurance Corporation under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, 12 U.S.C. § 1811 et seq.;
          2. (ii) A broker-dealer registered in this jurisdiction and with the United States Securities and Exchange Commission holding the client assets in customer accounts;
          3. (iii) A registered futures commission merchant registered under Section 4f(a) of the Commodity Exchange Act, holding the client assets in customer accounts, but only with respect to clients’ funds and security futures or other securities incidental to transactions in contracts for the purchase or sale of a commodity for future delivery and options thereon; and
          4. (iv) A foreign financial institution that customarily holds financial assets for its customers, provided that the foreign financial institution keeps the advisory clients’ assets in customer accounts segregated from its proprietary assets; and

       2. (B) “Related person” means:

          1. (i) Individual control. The person is controlled or significantly influenced by a member of key management personnel or by a person who controls the entity;
          2. (ii) Common control. The person is, directly or indirectly, either under common control with the entity or has significant or joint control over the entity;
          3. (iii) Associate. The person is an associate of the entity; or
          4. (iv) Family member.
22. (a) (a) The person is a close family member of a person who is part of key management personnel or who controls the entity.

23. (b) (b) A close family member is:

    1. (1) (1) An individual's domestic partner and children;
    2. (2) (2) Children of the domestic partner; and
    3. (3) (3) Dependents of the individual or the individual's domestic partner.

    4. (5) This subsection shall not apply to an investment adviser also registered as a broker-dealer in Arkansas who is the following:

       1. (A) Subject to and in compliance with United States Securities and Exchange Commission rule 17 C.F.R. § 240.15c3-1, promulgated under the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq.; or
       2. (B) A member of an exchange whose members are exempt from United States Securities and Exchange Commission rule 17 C.F.R. § 240.15c3-1, under subdivision (b)(2)(B) of this section, and the broker-dealer is in compliance with all rules and settled practices of the exchange imposing requirements with respect to financial responsibility and the segregation of funds or securities carried for the account of customers.

Codification Notes: The Investment Company Act of 1940 is codified at 15 U.S.C. § 80a-1 et seq. The Investment Advisers Act of 1940 is codified at 15 U.S.C. § 80b-1 et seq. The Securities Act of 1933 is codified at 15 U.S.C. § 77a et seq. The Commodity Exchange Act is codified at 7 U.S.C. § 1 et seq.