The Senate has passed the Private Fund Investment Advisers Registration Act of 2010, which, if enacted in its present form,1 would significantly affect hedge fund advisers, hedge fund products, and federal and state regulatory resources.
The Act seeks to eliminate the private investment adviser exemption from registration under the U.S. Investment Advisers Act of 1940, as amended (the "Advisers Act").2 It would require all investment advisers to register with the SEC or in most cases with a state securities regulator,3 unless another exemption from registration were available. In fact, the Senate bill would exempt foreign private advisers who qualify for a modified version of the former private investment adviser exemption,4 advisers to small business investment companies,5 and advisers to venture capital funds, private equity funds6 and "family offices,"7 under definitions the SEC will determine. As a result, the Senate bill as a whole is squarely focused on the registration of investment advisers to hedge funds.8
The Act would also revamp hedge fund advisers' record-keeping and reporting requirements. The SEC would consider all records and reports of private funds that a registered investment adviser managed to be the investment adviser's and thus subject to examination by the SEC. In addition, the SEC would require hedge fund advisers to participate in reporting required as part of the overall systemic risk assessments contemplated by the Senate legislation.9 Specifically, hedge fund advisers would have to provide the SEC with reports concerning assets under management and the use of leverage, counterparty credit risk exposure, trading and investment positions, valuation policies and practices, types of assets held, side letters with certain fund investors, trading practices and other information necessary for an assessment of systemic risk.
The Senate bill would also adjust the jurisdictional boundaries between federal and state regulation of investment advisers. The current threshold for federal registration—$25 million assets under management—would be increased to $100 million. Investment advisers subject to state regulation could not opt for federal registration unless they met this threshold.10 The change in threshold would raise issues about the capacity and resources of the states to regulate what might be a significantly increased number of hedge fund advisers. Published estimates state that approximately 4,000 federally registered advisers would be required to switch to state registration, representing an approximately 28% increase in the number of state registered advisers. This might provide some relief to smaller fund managers that are not able to bear the costs of formalized Advisers Act compliance requirements.11
The Senate bill would also adjust the "accredited investor" standard12 for individual investors in private placements, including private placements of hedge funds, by excluding from the alternative "net worth test" the value of the primary residence of a natural person. The SEC would also periodically adjust the current net worth test of $1 million beginning four years after enactment. These changes would exclude certain currently qualified individual investors from investing in hedge funds and other private placements. The House bill would not modify the accredited investor tests but would subject the current qualified client threshold of $1.5 million net worth to inflation adjustments. As a result, the availability of hedge fund products with carried interests or other performance fees would be curtailed with respect to investors who did not meet the adjusted qualified client threshold.
Despite their nuances, the Senate and House bills are very close in the scope and emphasis of changes to the Advisers Act, which suggests a shortened reconciliation process. We understand that the Obama Administration would like to complete the reconciliation by July 4, 2010. A one-year transition period for mandatory registration requirements is contemplated.
Copyright © 2010 Herrick, Feinstein LLP. Hedge Fund 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.
1 The Senate bill must first be reconciled with the comparable House bill passed in December 2009. The process of reconciling the two bills is now underway.
2Section 203(b)(3) of the Advisers Act currently exempts investment advisers with fewer than 15 clients over the past 12 months, who do not hold themselves out generally to the public as investment advisers and who do not advise registered funds or business development companies subject to the U.S. Investment Company Act of 1940, as amended (the "Investment Company Act").
3 Currently no investment adviser who is regulated or required to be regulated by a state regulator may register with the SEC unless it has assets under management of not less than $25 million, or advises a registered fund. Section 203A(a)(1).
4 A "foreign private adviser" is defined as an investment adviser with no place of business in the U.S., with fewer than 15 U.S. clients, with assets under management attributable to U.S. clients and to U.S investors in private funds of less than $25 million and which neither holds itself out to the public in the U.S. as an investment adviser nor advises registered funds or business development companies subject to the Investment Company Act.
5 Small business investment companies would be defined as licensees under the Small Business Investment Act of 1958, as well as certain applicants for such licenses.
6 Advisers to private equity funds, while exempt from registration, would nonetheless be subject to certain record keeping and reporting requirements that the SEC deemed necessary for the public interest and the investors' protection.
7 The Act would instruct the SEC to define "family offices" consistently with past family offices' exemptive orders and take into account the family offices' organizational, management and employment structures.
8 By contrast, the House bill would not exempt advisers to private equity funds or family offices.
9 The SEC would obtain reports on behalf of the Financial Stability Oversight Council to be established to assess and monitor systemic risk in the financial markets.
10 By contrast, the House bill creates a separate $150 million registration threshold just for private fund managers, resulting in a two-tier registration threshold for investment advisers.
11 The House bill would require "mid-sized investment advisers"—advisers which are not exempt from registration and with assets under management between $25 million and $100 million—to register with the SEC if they are not regulated and examined, or required to be regulated and examined, by a state regulator.
12 Currently individuals qualify as "accredited investors" if they meet either the income test ($200,000 annual income or $300,000 jointly with spouse, earned in the last two years with a reasonable expectation of earning the same in current year) or the net worth test of $1 million (individually or jointly with spouse). Rule 501(a), Securities Act of 1933, as amended.