The Obama Administration has proposed sweeping new regulations that would overhaul the U.S. financial regulatory system, including a proposal published June 17, 2009 that would require investment advisers of hedge funds and other private pools of capital whose assets under management exceed some unspecified, but modest, threshold to register with the Securities and Exchange Commission under the Investment Advisers Act of 1940.  The regulations, as proposed, would also require advisers of private equity funds and venture capital funds that exceed the yet-to-be-determined threshold to register with the SEC.  The proposal is designed to provide federal regulators with tools to gather information to assess potential systemic implications of activity by hedge funds and other capital pools.  The Obama Administration believes there is a compelling rationale for protecting investors by filling perceived gaps in the regulation of investment advisors and the funds that they manage. 

This Update summarizes key issues regarding:

• the Obama Administration’s proposal,
• the current U.S. regulatory regime and legislation pending before Congress,
• efforts by the G-20 leaders regarding the regulation of hedge funds, and
•  the European Commission's proposed directive on alternative investment fund managers.

The Obama Administration’s Proposal Expands Upon Other
Proposed Regulation

The Obama Administration's proposal is part of, and expands upon, a concerted global effort to regulate private pools of capital that may pose systemic risk to the global financial system on either an individual or collective basis.  The United States will be hosting a G-20 leaders summit in September 2009, and the Obama Administration’s proposal allows it to demonstrate its commitment to implementing in the United States the G-20's Declaration of Strengthening the Financial System.  The proposal also complements the European Commission's draft directive on alternative investment fund managers.  Pursuant to the proposal:

• Investment Adviser Registration Would Be Required.  All advisers to hedge funds and other private pools of capital, including private equity funds and venture capital funds, whose assets under management exceed a de minimis threshold (not yet established) will be required to register with the SEC under the Investment Advisers Act.
• Investment Adviser and Fund Reporting Would Be Required.  All investment funds advised by an SEC-registered investment adviser will be subject to recordkeeping, disclosure and reporting requirements.  The requirements may vary across the different types of private pools of capital.  Regulatory reporting would be done on a confidential basis and would include information such as the amount of assets under management, the amount of leverage in the fund, off-balance sheet exposures, and other information necessary to assess whether the fund poses a systemic threat to financial stability.

If the proposal is adopted as currently drafted with its application to private pools of capital and de minimis thresholds, managers of middle-market private equity funds that have never been subject to regulation as investment advisers would be subject to registration and other requirements under the Investment Advisers Act.  The application of the proposal to private equity funds and venture capital funds will be a significant source of debate in Congress over the coming months.

Pending Legislation Contemplates Increased Hedge Fund and Investment
Adviser Regulation

Current U.S. Regulatory Regime Does Not Require Adviser Registration.  Currently, virtually all investment advisers to hedge funds and other private pools of capital do not register with the SEC under the Investment Advisers Act.  They rely instead on the exemption under Section 203(b) of the Investment Advisers Act for an investment adviser that has had fewer than 15 clients in the last 12 months and that neither holds itself out to the public as an investment adviser nor acts as an adviser to any investment company, such as a mutual fund, registered with the SEC under the Investment Company Act of 1940.  Hedge funds and other private pools of capital commonly avoid registration with the SEC under the Investment Company Act by relying upon the exemptions under Section 3(c)(1) for funds with fewer than 100 beneficial owners that have not made a public offering or under Section 3(c)(7) for funds made up exclusively of "qualified purchasers" that have not made a public offering.

Three Related Legislative Proposals Pending.  Three separate pieces of legislation that aim to regulate hedge funds have lain dormant in committees:  the Hedge Fund Transparency Act of 2009, the Hedge Fund Adviser Registration Act of 2009 and the Private Fund Transparency Act of 2009.  The Obama Administration’s proposal joins these three pieces of pending legislation.

• The Hedge Fund Transparency Act Would Require Hedge Fund Registration and Reporting.  The Hedge Fund Transparency Act of 2009, introduced January 29, 2009, is currently before the Senate Committee on Banking, Housing and Urban Affairs.  It proposes to replace the current exemptions to the Investment Company Act commonly relied upon by hedge funds and other private pools of capital with a new array of exemptions.  Among other things, the Hedge Fund Transparency Act would require funds with assets or assets under management of $50 million or more:
• to register and cooperate with the SEC,
• to maintain books and records as required by the SEC, and
• to file annual disclosure statements that would be made available to the public.  The required annual disclosure statement would include, among other things:
•  information regarding the identities of investors in the fund,
• information regarding the current value of assets or assets under management by the fund, and
• a statement of any minimum investment commitment required by an investor in the fund.
• The Hedge Fund Adviser Registration Act Would Eliminate Exemptions to Investment Adviser Registration.  The Hedge Fund Adviser Registration Act of 2009, introduced January 27, 2009, is currently before the House Committee on Financial Services.  It would delete the current exemptions to registration under the Investment Advisers Act relied upon by virtually all investment advisers to hedge funds and other private pools of capital.
• The Private Fund Transparency Act Would Require Investment Adviser Registration and Reporting.  The Private Fund Transparency Act of 2009, introduced June 16, 2009, is currently before the Senate Committee on Banking, Housing and Urban Affairs.  It would:
• amend the Investment Advisers Act to require all hedge fund and other investment pool advisers that manage more than $30 million in assets to register with the SEC under the Investment Advisers Act, and
• provide the SEC with the authority to collect information from the funds regarding the risks they may pose to the financial system.

Recent Declaration by the G-20 Highlights Increased Global Interest in
Hedge Fund Regulation

On April 2, 2009, the G-20 leaders, representing the world’s 19 largest economies and the European Union, adopted a Declaration of Strengthening the Financial System.  The Declaration calls upon member countries to implement requirements for:

• registration of hedge funds or their managers subject to threshold limits, and
• disclosure by hedge funds of appropriate information on an ongoing basis to allow supervisors to assess the systemic risk these funds pose either individually or collectively.

Regulatory reform efforts by the members of the G-20, once implemented, should limit the ability of investment advisers to hedge funds and other private pools of capital to engage in jurisdiction shopping in order to avoid registration with regulatory authorities.

The European Commission Also Proposes to Regulate Alternative
Investment Fund Managers

On April 29, 2009, the European Commission published a draft directive targeted to regulate alternative investment fund managers.  The draft directive has been passed to the European Parliament and European Council for further debate and negotiation.  Pursuant to the draft directive:

• Alternative investment fund managers will be regulated if they either have total assets under management that are acquired through the use of leverage equal to or above €100 million, or total assets under management acquired without the use of leverage equal to or above €500 million.
• Regulated alternative investment fund managers must meet governance standards, have a robust risk management system, provide enhanced disclosure and market in the European Union only to professional investors.
• Alternative investment fund managers based outside the European Union will likely not be able to market their services to professional investors within the European Union for three years after the implementation of the legislation.

Additional Information

This Update provides only a summary of the proposed regulation.  You can find a copy of the full text of the Obama Administration’s proposal here.  You can find discussions of other recent cases, laws, regulations and rule proposals of interest to public companies on our website.