The Obama administration has provided Congress with draft legislation entitled the Private Fund Investment Advisers Registration Act of 2009 (the “Proposed Legislation”). The Proposed Legislation is designed to implement the recommendations regarding hedge fund oversight made in the U.S. Treasury Department’s (“Treasury”) white paper, “Financial Regulatory Reform - A New Foundation: Rebuilding Financial Supervision and Regulation,” which outlined the Obama administration’s plans to reform the U.S. financial regulatory system. (For a more detailed summary of the Treasury white paper, please see the June 23, 2009 Alert).
The Proposed Legislation has two principal elements. First, it would effectively eliminate the registration exemption under the Investment Advisers Act of 1940 (the “Advisers Act”) currently available to advisers that do not hold themselves out to the public as investment advisers and who have fewer than 15 clients (the “private adviser exemption”) by making the exemption available only to non-U.S. based advisers with fewer than 15 U.S. clients and very limited U.S. sourced assets under management. This element of the Proposed Legislation would cause advisers that have heretofore relied on the private adviser exemption, including advisers to many types of private investment pools, such as hedge funds, private equity funds and venture capital funds, to register with the SEC. The second principal element of the Proposed Legislation involves giving the SEC recordkeeping, reporting and inspection authority so that it can gather and share information about “private funds” managed by all registered advisers. Under the Proposed Legislation, a private fund is any fund that (a) relies on the exceptions from the definition of “investment company” under the Investment Company Act of 1940 (the “1940 Act”) contained in Sections 3(c)(1) or 3(c)(7) of the 1940 Act and (b) is either organized under U.S. law or has 10 percent or more of its outstanding securities owned by U.S. persons.
I. SEC Oversight of Private Funds
The Proposed Legislation would give the SEC authority to (a) require recordkeeping and reporting by all registered investment advisers regarding their private funds, (b) inspect private fund records maintained by all registered investment advisers, (c) require registered advisers to private funds to make disclosures to private fund investors, prospective investors, counterparties and creditors, and (d) require the SEC to share information about private funds with other federal regulatory bodies for risk assessment purposes. Regulatory reporting would be on a confidential basis and would, at a minimum, encompass (1) assets under management, (2) leverage (including off-balance sheet leverage), (3) credit risk exposures, (4) trading and investment positions, (5) trading practices and (6) other information that the SEC and the Board of Governors of the Federal Reserve System (the “Federal Reserve”) consider necessary or appropriate. The Proposed Legislation would require the SEC to provide systemic risk data and reports on private funds to the Federal Reserve and to the Financial Services Oversight Council proposed in the Treasury white paper. The Proposed Legislation includes a provision expressly allowing the SEC to adopt rules assigning different meanings to definitions, including the definition of “client,” used in different sections of the Advisers Act. This provision is designed to address any limits on SEC rulemaking under the Advisers Act that might exist because of a decision in which the U.S. Court of Appeals for the D.C. Circuit vacated 2004 SEC rulemaking seeking to require registration of hedge fund advisers (see the June 27, 2006 Alert for a discussion of that decision).
II. Other Legislative Proposals Addressing Hedge Fund Oversight
The Proposed Legislation joins three other legislative proposals currently pending in Congress that address the issue of “hedge fund” oversight. S. 344 is the only proposal that focuses on private fund, as opposed to adviser, registration. It would effectively require any private fund with more than $50 million to register with the SEC as an investment company. HR. 711 is similar to the Proposed Legislation in that it seeks greater transparency regarding private investment pools by eliminating the private adviser exemption. H.R. 711 does not, however, seek to supplement SEC rulemaking authority. S.1276, which was introduced days before the Treasury white paper was issued, is the most similar to the Proposed Legislation. S.1276 would narrow the private adviser exemption to apply only to non-U.S. advisers with fewer that 15 clients representing less than $25 million in assets. The bill would also broaden SEC authority regarding registered adviser reporting and recordkeeping, particularly with respect to private funds, but not to the extent contemplated under the Proposed Legislation.
III. Congressional Testimony and Industry Reactions
At a July 17, 2009 hearing before the House Committee on Financial Services, industry participants provided detailed reactions to the Obama administration’s proposal to regulate private fund advisers. Of particular note, Richard Baker of the Managed Funds Association voiced support for the registration of unregistered advisers, stating that “smart regulation” supports proper market functioning and indicating a strong desire to interact with regulators as specific regulatory reforms are implemented. Mr. Baker’s testimony also advocated that the registration requirements apply to advisers to “all private pools of capital.” In addition to the reactions from the Managed Funds Association, the regulatory goals articulated in the Proposed Legislation have received industry support from the Private Equity Council and the Securities Industry and Financial Markets Association.At a July 15, 2009 hearing before the Subcommittee on Securities, Insurance and Investment of the U.S. Senate Committee on Banking, Housing and Urban Affairs, Andrew Donohue, Director of the SEC’s Division of Investment Management, discussed the SEC’s support for requiring private advisers to register under the Advisers Act. In addition to discussing the potential regulation of trading activities of private advisers, Mr. Donohue also discussed the possibility that the SEC may seek to directly regulate private funds, although the Proposed Legislation, as drafted, focuses on adviser registration, not registration of private funds. In other testimony at the July 15, 2009 hearing, the National Venture Capital Association reiterated its opposition to the application of any private fund adviser registration and reporting initiative to the venture capital industry.