The Bill described in the prior article contains a number of provisions specifically directed at private fund managers. Title IV of the Bill deals with advisers to hedge funds and other private funds and is titled The Private Fund Investment Advisers Registration Act of 2009 (the Act). The Act, in a substantially similar form, was initially presented by the Obama Administration in July and was subsequently introduced in the U.S. House of Representatives.

New Concept of Private Funds

In lieu of defining “hedge fund,” the Bill expands the definitions section of the Advisers Act to include the term “private fund.” A private fund is defined as any investment fund that (1) would be an investment company under the 1940 Act but for sections 3(c)1 or 3(c)7 thereof and (2) is either organized under U.S. law or has 10 percent or more of its outstanding securities owned by U.S. persons.

Registration Under the Advisers Act

Removal of de minimis and Intrastate Exemptions. The Bill would remove from the Advisers Act the exemptions from registration for: (1) investment advisers who give advice to fewer than 15 clients (the de minimis exemption) and (2) investment advisers whose clients are all residents of the adviser’s home state if those advisers provide advice to private funds.

The de minimis exemption currently is available to an adviser with fewer than 15 clients that does not hold itself out generally to the public as an investment adviser and does not advise registered funds and exempts the adviser from registration. This exemption also is available currently to private fund managers advising fewer than 15 funds because each fund is generally treated as a single client of the manager without regard to the number of underlying investors in the fund under Rule 203(b)(3)-1 of the Advisers Act.

Adjustment of Federal Registration Eligibility. The Bill would raise the minimum amount of assets under management for registration with the SEC from $25 million to $100 million (investment advisers not meeting the minimum register with the states).

Applicability of Advisers Act to Commodity Pool Operators (CPOs). The Bill would also remove an exemption from registration under the Advisers Act for investment advisers registered with the Commodity Futures Trading Commission if they provide advice to private funds. This provision would impact only CPOs whose pools trade some securities and therefore must be exempt under 3(c)1 or 3(c)7 of the 1940 Act; pure commodity pools would not be affected.

New Exemptions for Foreign Private Advisers, Family Offices, Venture Capital and Private Equity

A new de minimis exemption would be created for newly defined “foreign private advisers” so long as the foreign private adviser: (1) has no place of business in the United States, (2) during the preceding 12 months it had (a) fewer than 15 clients in the United States, and (b) assets under management attributable to clients in the United States of less than $25 million (or a higher amount that the SEC may prescribe), and (3) it does not generally hold itself out in the United States as an investment adviser and is not an investment adviser to a registered investment company or business development company.

The Bill also would change the definition of investment adviser to exclude family offices and add exclusions from registration for advisers to venture capital funds and private equity funds. The Bill directs the SEC to define the terms “private equity fund,” “venture capital fund” and “family office,” within six months of the Bill’s enactment. Private equity fund advisers relying on the exemption would be subject to those recordkeeping and reporting rules that the SEC determines are necessary or appropriate in the public interest and for the protection of investors. The Bill imposes no recordkeeping or reporting obligations for family offices or advisers to venture capital funds.

Recordkeeping and Reporting Requirements

In addition to the existing regulatory and reporting obligations of registered investment advisers, the Bill would require investment advisers to private funds to provide the SEC and a newly created Agency for Financial Stability with additional information about each private fund. The Bill would also direct the SEC to conduct periodic inspections of all records of private funds. These records would generally be treated as confidential and not subject to public disclosure. The records would need to include a description of:

  • assets under management and use of leverage;
  • counterparty credit risk exposure;
  • trading and investment positions;
  • valuation methodologies;
  • types of assets held;
  • side agreements or side letters;
  • trading practices; and
  • ther information that the SEC, in consultation with the Agency for Financial Stability, deems necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.

Other Provisions of Interest to Advisers to Private Funds

Independent custody of client assets. The Bill would require the SEC to prescribe rules requiring registered investment advisers to use an independent custodian to hold client assets where necessary and appropriate in the public interest and for the protection of investors.

Adjustment of Accredited Investor Standard. The Bill would require the SEC to increase the financial thresholds for accredited investors as set forth in the rules of the Securities Act of 1933 to account for inflation.

Authority to Ascribe Different Meanings to “Client.” The Bill would give the SEC authority to ascribe different meanings to terms (specifically including the term “client”) used in different sections of the Act. This would allow the SEC to overturn by rule the holding of the DC Court of Appeals in Goldstein v. Securities and Exchange Commission that found that investment funds, rather than the investors in these funds, are the advisory clients in the adviser-client relationship. 1

Authority to Restrict Mandatory Arbitration Clauses. The Bill would amend the Advisers Act to give the SEC authority to conduct rulemaking to prohibit or limit mandatory predispute arbitration agreements by clients of investment advisers for disputes arising under the securities laws. The Bill directs the SEC to conduct this rulemaking within 180 days of the Bill’s enactment and to prohibit or limit arbitration clauses if it finds that such prohibition or limitation is in the public interest and for the protection of investors.

A similar amendment to the 1934 Act requires the SEC to conduct the same rulemaking process to arbitration agreements by clients of brokers, dealers or municipal securities dealers.

Studies and Reports. The Bill would require the Comptroller General to conduct studies and submit reports to Congress within one year on (1) the appropriate criteria for accredited investor status for private funds, (2) the feasibility of a self-regulatory organization to oversee hedge funds, private equity funds and venture capital funds, and (3) the state of short selling in the stock market.

A copy of the Bill is available at: