Last week, Sen. Christopher Dodd (D-CT), Chairman of the Banking, Housing, and Urban Affairs Committee, introduced a discussion draft of the Restoring American Financial Stability Act of 2009 (the “Dodd Bill”) that comprehensively addresses financial regulatory reform. The Dodd Bill includes a modified version of the Private Fund Investment Advisers Registration Act of 2009 (the “Registration Act”) that was initially introduced by the Obama Administration in July and was subsequently presented in the U.S. House of Representatives and approved by the House Financial Services Committee last month. In addition to the exemption for “venture capital fund” advisers first proposed in the House version of the Registration Act and included in the Dodd Bill, most notably, the Dodd Bill would also exempt any adviser to a “private equity fund” from the registration requirements of the bill.
The Obama Administration Version of the Registration Act
The Registration Act was first introduced by the Obama Administration in July 2009 (see Goodwin Procter’s July 21, 2009 Financial Services Alert), and the Obama Administration’s version would (i) effectively eliminate the “private adviser” exemption,1 (ii) require every adviser to “private funds” (including hedge funds, private equity funds and venture capital funds) with at least $30 million in assets under management to register with the Securities and Exchange Commission (the “SEC”) under the Investment Advisers Act of 1940 (the “Advisers Act”) and (iii) impose upon advisers enhanced recordkeeping and reporting obligations designed to help the SEC and other government agencies identify and monitor threats to the stability of the economy.
The House Version of the Registration Act and the “Venture Capital Fund” Adviser Exemption
On October 1, 2009, Rep. Paul Kanjorski (D-PA), Chairman of the U.S. House of Representatives Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, released a modified version of the Registration Act (“H.R. 3818”) modeled on the version of the Registration Act released by the Obama Administration in July, which provided an exemption from the registration requirements for advisers to a “venture capital fund” (see Goodwin Procter’s October 15, 2009 Client Alert for a more detailed description of the “venture capital fund” exemption under the H.R. 3818). As noted above, H.R. 3818, as amended, was approved by the House Financial Services Committee on October 27, 2009.
The Senate Version of the Registration Act and the “Private Equity Fund” Adviser Exemption
Like the Obama Administration’s version of the Registration Act and H.R. 3818, the Dodd Bill proposes to eliminate the “private adviser” exemption from registration under the Advisers Act. The Dodd Bill includes the exemptions that were included in H.R. 3818 for (i) advisers to “venture capital funds” (to be defined by the SEC within six months of enactment of the legislation) and (ii) “foreign private advisers” (generally, advisers who are not holding themselves out to the public or advising registered funds, have no place of business in the United States, have fewer than 15 U.S. domiciled or U.S. resident clients and manage assets from such clients totaling less than $25 million),2 but also includes new proposed exemptions for (a) “family offices” (to be defined by the SEC) and (b) advisers to “private equity funds” (also to be defined by the SEC within six months of enactment of the legislation). While these proposed exemptions appear to hold promise, the Dodd Bill does not define “private equity fund,” “venture capital fund” or “family office,” but instead directs the SEC to define such terms, and therefore it is not clear how broadly or narrowly these terms will be defined and to what extent venture capital and private equity fund managers may be able to rely on them.
The Dodd Bill does not include the exemption in H.R. 3818 that would apply to advisers whose clients are exclusively (i) small business investment companies or (ii) private funds each with less than $150 million in assets; however, the Dodd Bill does provide that advisers with less than $100 million under management in the aggregate not be subject to federal registration (representing an increase in the minimum for federal registration from the current threshold of $25 million), presumably subjecting them to the potential for substantive state registration requirements.
Recordkeeping and Reporting Requirements for Exempt “Private Equity Fund” Advisers
While advisers to “private equity funds” may be exempt from registration under the Dodd Bill, the legislation does require the SEC to promulgate recordkeeping and reporting rules (that the SEC determines are necessary or appropriate in the public interest and for the protection of investors) for private equity fund advisers relying on such an exemption. Notably, while H.R. 3818 contains a similar requirement for advisers relying on the “venture capital fund” exemption, the Dodd Bill proposes eliminating the recordkeeping and reporting requirements for advisers relying on such an exemption. As a result, it is possible that advisers to private equity funds, though exempt from registration, may be required to report to the SEC some or all of the information referred to below related to the private funds that they advise (in addition to any other reporting requirements established by the SEC for such exempt advisers, whether relating to the advisers themselves or the private funds that they manage).
Dodd Bill Recordkeeping and Reporting Requirements for Registered Advisers
In addition to the broadened list of possible exemptions from registration described above, the Dodd Bill would specifically provide the SEC with recordkeeping, reporting and inspection authority so that it can gather and share information, e.g., about “private funds” managed by registered advisers. These new recordkeeping and reporting requirements, relating both to the advisers and to the private funds that they manage, would be in addition to the current recordkeeping and reporting requirements under the Advisers Act. As in H.R. 3818 and the Obama Administration’s version of the Registration Act, the Dodd Bill defines “private funds” by reference to the exceptions from the definition of “investment company” under Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, although the Dodd Bill (like the Obama Administration version of the Registration Act) also limits the definition to those funds either organized under U.S. law or having 10% or more of its outstanding securities owned by U.S. persons.
While the Dodd Bill’s recordkeeping and reporting requirements are similar to H.R. 3818’s, the Dodd Bill does not give the SEC rulemaking power to require specific disclosures by registered advisers to a private fund’s investors, prospective investors, counterparties and creditors. The Dodd Bill also includes additional, subtle differences when compared to H.R. 3818 and the Obama Administration’s version of the Registration Act. For example, the Dodd Bill details a longer list of records and reports required to be filed with the SEC by registered advisers with respect to each private fund advised by such adviser, including (i) valuation methodologies, (ii) types of asset held and (iii) side arrangements or side letters.3 The Dodd Bill, like the Obama Administration’s version of the Registration Act, suggests this information must be “filed” with the SEC, whereas H.R. 3818 suggests the records would be “maintained or filed” with the SEC. The Dodd Bill also would give the SEC authority to promulgate additional regulations on a variety of related topics.
General Requirements of a Registered Adviser under the Advisers Act
If the proposed exemptions referred to above do not survive the legislative process, or the final rules adopted by the SEC limit the number and/or types of advisers permitted to rely on them, and these advisers are required to register with the SEC as investment advisers, in general terms such advisers would be required to (i) file an annual Form ADV that would be publicly available and provided to clients, (ii) appoint a chief compliance officer and (iii) establish, implement and monitor written compliance policies and procedures reasonably designed to prevent violation of the Advisers Act and related regulations (including a code of ethics, insider trading policies, disaster recovery policies, etc.). In addition, SEC registered investment advisers should expect to be subject to periodic examinations by the SEC staff.
Additional Dodd Bill Proposals of Interest to Advisers of Private Funds
Apart from regulation of advisers of private funds, the Dodd Bill suggests adjusting (for inflation) the “accredited investor” standard under the Securities Act of 1933. Finally, the Dodd Bill suggests studies to examine (i) the appropriate criteria for accredited investors status for hedge funds, (ii) feasibility of a self-regulatory organization to oversee hedge funds, private equity funds and venture capital funds, and (iii) the state of short selling in the stock market.
*****Although it is unclear precisely what scope any final legislation might have, it is increasingly likely that there will be legislation in the near future. We will continue to monitor the progress of the proposals now pending in Congress and any other related proposals and will advise on material developments.