Regulation of Advisers to Hedge Funds and Others

Private Fund Investment Adviser Registration and Disclosure

Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act, referred to as the Private Fund Investment Advisers Registration Act of 2010, requires certain private fund advisers previously exempt from SEC registration to register as investment advisers under the Investment Advisers Act of 1940. The Act defines "private funds" as those funds relying on Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 to avoid registration and as such generally encompasses hedge funds, private equity funds and venture capital funds. The Act eliminates the previous private adviser exemption, which generally exempted from SEC registration advisers with fewer than 15 clients and which did not hold themselves out publicly as advisers. The Act also eliminates a private fund adviser's ability to avoid registration under the "intrastate adviser" exemption found in Section 203(b)1 of the IAA. It should be noted that most of the Act's provisions will not become effective until a year after enactment, giving private fund advisers time to prepare for the new regulatory framework.

Exemptions from Registration. The Act contains a number of exemptions for various types of private fund advisers.

• Advisers solely to one or more venture capital funds are exempt from SEC registration. The phrase "venture capital fund" is not defined in the Act, however it directs the SEC to adopt a definition within one year of enactment. Such advisers, however, will be required to maintain such records and provide such annual or other reports as the SEC deems necessary or appropriate in the public interest or for the protection of investors.
• Advisers solely to private funds with less that $150 million in assets under management in the U.S. will not have to register with the SEC, although they will be required to maintain such records and provide such annual or other reports as the SEC deems necessary or appropriate in the public interest or for the protection of investors. Advisers to private funds with less than $150 million in assets in such funds that also advise separately managed accounts will not qualify for this exemption and would have to find another basis for avoiding SEC registration (e.g., if the adviser qualifies as a "mid-sized investment adviser" as discussed below).
• Foreign private advisers with no place of business in the U.S., fewer than 15 total U.S clients and investors, and less than $25 million in assets attributable to U.S. clients and investors do not have to register with the SEC.
• CFTC-registered commodity trading advisers to private funds do not have to register with the SEC, unless the business of the adviser becomes predominately the provision of securities-related advice.
• Advisers solely to Small Business Investment Companies are exempt from SEC registration.

Private Fund Disclosure and Examination. The Act inserts a new Section 204(b) into the IAA, pursuant to which the SEC must establish record maintenance, disclosure, and inspection requirements, all subject to a confidentiality regime designed to protect private funds' proprietary information.

• For private fund advisers required to register with SEC, records and reports such advisers must maintain include the amount of assets under management, use of leverage (including off balance sheet leverage), counterparty credit risk exposure, valuation methodologies, types of assets held, trading practices, and any side arrangements or side letters that treat certain investors more favorably than others.
• The SEC shall also issue rules requiring each investment adviser to a private fund to file reports containing such information as the SEC deems necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.
• With respect to private fund advisers required to register, the SEC must conduct periodic inspections in accordance with an established schedule. However, the SEC may conduct any additional, special and other examinations of any private adviser that it deems appropriate.

Registration and Examination of "Mid-Sized Private Fund Advisers"

The Act also creates new Section 203(m), which requires the SEC, when adopting regulations to carry out the registration and examination requirements with respect to advisers that manage "mid-sized private funds," to consider the size, governance and strategy of such funds. Any such registration and examination requirements are supposed to reflect the level of systemic risk presented by such funds. This would seem to create the possibility of some form of "registration lite" for these funds; however, the Act does not define "mid-sized private funds" and the impact of this provision remains unclear.

Revised Investment Adviser Registration Threshold

Historically, investment advisers with less than $25 million in assets under management were generally prohibited from registering with the SEC. Advisers with between $25 and $30 million in assets under management could generally be either state or SEC-registered, and advisers with more than $30 million under management were required to register with the SEC. The Act has now created an additional prohibition on SEC registration for any investment adviser that has between $25 and $100 million in assets under management, is required to be registered as an investment adviser in the state in which it maintains its principal office and place of business, and is subject to examination by the state ("mid-sized investment advisers"). Exceptions to this prohibition include advisers to mutual funds and business development companies. Mid-sized investment advisers that would have to register with 15 or more states may register with the SEC. These provisions are effective one year after enactment.

Family Offices

The Act also codifies the historical exemption from registration granted to family offices pursuant to no-action requests by specifically defining "investment adviser" to not include family offices and directing the SEC to adopt rules consistent with past relief.

Study of Possible Broker-Dealer Fiduciary Duty

The SEC must conduct a study to evaluate the effectiveness of existing legal and regulatory standards of care for broker-dealers when providing personalized investment advice and recommendations to retail customers. The study will also examine the effectiveness of enforcement and compliance mechanisms. Within six months of enactment, the SEC is to submit its report on the study to the relevant congressional committees. Following its study, the SEC is expressly authorized to implement regulations, without further Congressional action, as necessary to address the standard of conduct for broker-dealers and certain related disclosures.