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The Treasury Department has proposed legislation that would require all advisers to hedge funds and other private pools of capital, including private equity funds and venture capital funds, to register with the Securities and Exchange Commission and be subject to certain reporting and recordkeeping requirements. The proposal is part of the Obama administration's effort to overhaul the regulation of capital markets and would amend the Investment Advisers Act of 1940.

If enacted, the new law would:

• Eliminate the private adviser exemption from registration in Section 203(b) of the Act and require hedge fund managers and other investment advisers to private investment pools with at least $30 million in assets under management to register with the SEC.  This would essentially transform a heretofore voluntary registration regime into a mandatory one for most U.S.-based fund managers. Registered fund managers would be subject to a host of compliance infrastructure requirements and other regulations and periodic SEC examinations.  The Act goes further than the 2004 SEC rule overturned by the courts which excluded most private equity and venture capital funds from having to register. We note that the Act focuses on registration of fund advisers rather than the funds themselves, contrary to the approach taken by the recently proposed Hedge Fund Transparency Act in the Senate.
  
  

• Authorize the SEC to require investment advisers to maintain certain records and submit them to the SEC.  Each private fund would have to file records showing: (a) the amount of assets under management, use of leverage (including off-balance sheet leverage), counterparty credit risk exposures, trading and investment positions, and trading practices; and (b) such other information as the SEC, in consultation with the Board of Governors of the Federal Reserve System, determines appropriate in the public interest and for the protection of investors or for the assessment of systemic risk. The funds must maintain these records for as long as the SEC deems necessary, and the records may be subject to periodic or special examinations by the SEC. All record submissions will be kept confidential (except with respect to disclosures to other government agencies or pursuant to court order).  The Act attempts to strike a balance between regulators' need to assess systemic risk and fund advisers' need to keep their proprietary trading activities confidential.  Moreover, likely as a result of recent frauds and scandals in the industry, the Act also authorizes the SEC to mandate specific disclosure requirements for private fund advisers to investors, counterparties and creditors.
  
  

• Create a new exemption from registration for a "foreign private adviser." This exemption would apply to any investment adviser with (a) no place of business in the United States, who (b) during the previous 12 months has had fewer than 15 clients in the United States and assets attributable to those clients of less than $25 million (or such higher amount as the SEC may deem appropriate), and (c) neither holds itself out generally to the public in the United States as an investment adviser nor acts as an investment adviser to any registered investment company or business development company.  This exemption would transform the existing private adviser exemption into a relatively narrow exemption for qualifying foreign advisers.  The narrowness of the exemption is reflected in the $25 million asset threshold, which would seem to exclude most foreign advisers from being eligible for the exemption. It also goes further than the 2004 SEC rule which did not contain any such asset threshold and applied a "registration light" scheme to those foreign advisers that were required to register.  This provision of the Act has significant extraterritorial implications with respect to the SEC's jurisdiction and will likely receive significant commentary from the foreign advisory community.  Although not entirely clear from the text, the Act appears designed to limit the registration requirement to foreign advisers to private funds that have 10% or more of their outstanding interests owned by U.S. persons. 
  
  

• Eliminate the exemption from registration under the Advisers Act for any investment adviser registered with the Commodity Futures Trading as a commodity trading advisor to the extent that the advisor acts as an advisor to a private fund. This provision has been criticized as creating a burdensome and duplicative regulatory framework because those advisers that rely on this exemption primarily manage commodity trading funds which do not normally engage in significant securities trading activities. The Act directs the SEC and the CFTC to jointly promulgate rules implementing the reporting requirements of the Act with respect to such dually registered advisers.
  
  

Given the current climate, we believe the chances of the Act's passage are high, though the time frame is uncertain and it will likely be subject to amendment as it moves through Congress and the industry has a chance to provide feedback.

If you have any questions about the Act, please do not hesitate to contact Irwin Latner at (212) 592-1558 or ilatner@herrick.com or Pat Sweeney at (212) 592-1547 or psweeney@herrick.com.

Copyright © 2009 Herrick, Feinstein LLP. Investment Advisor Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.