On July 15, 2009, the Treasury Department released the proposed Private Fund Investment Advisers Registration Act of 2009 (the “Act”), which would implement portions of the financial reform proposals contained in the Administration’s recent White Paper. The Act would amend the Investment Advisers Act of 1940 (the “Advisers Act”) to require nearly all advisers to hedge funds and other private pools of capital to register with the SEC. The Act would not require funds themselves to register, but it would require advisers to private funds to report to the SEC, on a confidential basis, information about the funds they advise to permit an assessment of systemic risk posed by the funds. This newsflash summarizes the main provisions of the Act.
Registration of Private Fund Advisers
The Advisers Act currently provides an exemption from registration with the SEC for any investment adviser who during the course of the preceding 12 months has had fewer than 15 clients and who neither holds itself out generally to the public as an investment adviser nor acts as an investment adviser to any registered investment company or business development company. As a fund is generally counted as one “client,” most advisers to private funds currently rely on this so-called “private investment adviser” exemption and are not required to register. The Act would eliminate the private investment adviser exemption and require all advisers to “private funds” to register with the SEC if their assets under management exceed $30 million. A “private fund” is defined under the Act as any investment fund that would be an “investment company” as defined under the Investment Company Act of 1940 but for the exemptions under Sections 3(c)(1) or 3(c)(7) thereunder and either (i) is organized under the laws of the United States or any state or (ii) has 10% or more of its outstanding securities owned by U.S. persons. The definition of “private fund” does not distinguish between hedge funds and other private funds, such as venture capital and private equity funds.
The registration requirement would also apply to a private fund adviser all of whose clients are residents within the state in which it maintains its principal office and who does not give advice about securities listed on any national exchange, as well as to a private fund adviser who is registered with the Commodity Futures Trading Commission as a commodity trading advisor, thereby eliminating for private fund advisers two current exemptions from registration. Thus, the Act would require nearly all advisers to private funds with over $30 million in assets under management to register with the SEC.
Registered investment advisers are subject to provisions of the Advisers Act requiring them to, inter alia, implement a comprehensive compliance program, adopt a code of ethics and an insider trading policy, comply with certain custody procedures, advertising restrictions and document retention obligations, disclose and report specified information on Form ADV and be subject to SEC examinations.
Registration of Foreign Private Advisers
The Act creates a new exemption for a “foreign private adviser,” defined as an investment adviser who (A) has no place of business in the United States, (B) during the preceding 12 months has had fewer than 15 clients in the United States and assets under management attributable to clients in the United States of less than $25 million (or such higher amount as the SEC may set by rulemaking); and (C) neither holds itself out generally to the public as an investment adviser nor acts as an investment adviser to any registered investment company or business development company. The newly created exemption is narrower than previous guidance by the SEC staff, which indicated that an offshore adviser with a principal place of business outside the United States and fewer than 15 U.S. clients was not required to register. The Act would require that an offshore adviser have no place of business in the United States in order to satisfy the exemption. Furthermore, the exemption would require not only that the foreign adviser’s U.S. clients number less than 15 but also that the adviser manage less than $25 million attributable to U.S. clients.
Collection of Systemic Risk Data
The Act would authorize the SEC to require registered investment advisers to provide reports regarding private funds they advise “as are necessary or appropriate in the public interest and for the assessment of systemic risk” and to provide such reports to the Federal Reserve as well as to the Financial Services Oversight Council, the advisory council proposed in the Administration’s White Paper that would be served by members from each federal financial regulatory agency and chaired by the Treasury Secretary. The Fact Sheet included with the Treasury Department’s release of the Act states the Administration’s view that during the financial crisis the government lacked the data necessary to monitor private fund activity. Accordingly, the Fact Sheet states that the Act would require advisers to private funds to report information necessary to assess “whether risks in the aggregate or risks in any particular fund pose a threat to our overall financial stability.” The reports required by the Act would include assets under management, use of leverage (including off-balance sheet leverage), counterparty credit risk exposure, trading and investment positions, trading practices and other information as determined by the SEC. The Act provides that the reports will be kept confidential by the SEC, the Federal Reserve and the Council (although, as provided elsewhere in the Advisers Act, the SEC is not authorized to withhold information from Congress or to not comply with a request from another Federal department or agency requesting the information for purposes within the scope of its jurisdiction or a court order).
The Act would also authorize the SEC to promulgate rules requiring disclosures by registered investment advisers to investors, prospective investors, counterparties and creditors of any private fund advised by the registered investment adviser. No detail is provided about the nature of any such disclosures.
SEC Rulemaking Authority
Finally, the Act would provide the SEC with enhanced rulemaking authority to define terms used in the Advisers Act, including to classify persons or matters and prescribe different requirements for different classes, as well as to “ascribe different meanings to terms (including the term “client”) used in different sections [of the Advisers Act].” This is likely an attempt to reverse the 2006 decision by the Court of Appeals for the District of Columbia Circuit in Goldstein v. SEC, which vacated a rule adopted by the SEC that interpreted the term “client” for purposes of investment adviser registration in such a way that would have required most hedge fund advisers to register with the SEC.
The Act is the third piece of draft legislation released by the Administration to implement the White Paper. For further information on the White Paper, see the Davis Polk memorandum entitled “A New Foundation for Financial Regulation?” dated June 22, 2009. For further information on the first two legislative proposals implementing the White Paper, see the Davis Polk newsflash entitled “Consumer Financial Protection Agency Act of 2009” dated July 1, 2009 and the Davis Polk newsflash entitled “Investor Protection Act of 2009” dated July 13, 2009.
It is difficult to predict with any certainty the exact form of any final legislation. Davis Polk is monitoring developments with respect to proposed legislation and will issue additional newsflashes and memoranda from time to time.