The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act), enacted on 21 July 2010 and effective with regard to investment advisory registration matters as of 21 July 2011, mandates significant changes to the regulation of offshore (from the United States) investment managers. The Act deletes the existing “private adviser” exemption from required registration with the US Securities and Exchange Commission (SEC). In its place, the Act adds a set of exemptions for investment advisers to “private funds” and “foreign private advisers”.

Managers that advise only private investment funds will be exempt from SEC registration, but subject to SEC-specified record-keeping and reporting obligations, if they have “assets under management in the United States” of less than US$150 million. Virtually all hedge and private equity funds will be “private funds”, which are investment funds that rely on either section 3(c)(1) of the Investment Company Act of 1940 (no more than 100 US person beneficial owners permitted in an offshore fund) or section 3(c)(7) of that Act (all US person beneficial owners in an offshore fund must be “qualified purchasers”). Advisers that solely advise venture capital funds (to be defined by the SEC) will be exempt from registration but also will be required to retain records and file reports with the SEC.

“Foreign private adviser” means an adviser that:

  • Has no place of business in the United States
  • Has fewer than 15 US direct account clients and investors in the private funds it advises
  • Manages less than US$25 million (or an SEC-determined higher amount) of aggregate assets “attributable to clients in the United States” and to US investors in private funds it advises
  • Does not hold itself out in the United States as an investment adviser
  • Does not advise a US-registered investment company or business development company.

Matters Requiring SEC Clarification

What are “assets under management in the United States” for purposes of the private fund exemption as it will apply to offshore managers? The term will probably be defined to relate to assets attributable to US investors rather than the locus of the managed assets but could take into account management by an offshore adviser’s US personnel (if any).

Will an offshore manager be considered to exclusively advise private funds for purposes of the private fund exemption so long as the manager has no US direct account management clients (as opposed to non-US direct account management clients)? Who will be considered a US client or investor? The SEC’s current position is that if an offshore adviser’s direct account client moves to the United States, that client becomes a US person for purposes of the expiring private adviser’s 15-client exemption. However, if an investor in an offshore adviser’s private fund moves to the United States or transfers his investment to a US resident, that relocation or transfer does not affect qualification for the expiring exemption because the fund, not its investors, is considered to be the client. The SEC may not continue to take the latter position with regard to fund investors, especially because the foreign private advisers exemption requires the joint counting of direct account management clients and fund investors in “counting to 15” and the aggregation of amounts under management in determining qualification for the US$25 million limit on assets under management.

If offshore advisers will be required to track the location of their fund investors and of secondary market transferees in order to avoid US investment adviser registration, significant issues will arise as to how that tracking can be accomplished and whether the adviser can require the redemption or transfer of fund interests in order to avoid US registration. The SEC might take a bifurcated position to the effect that tracking fund investments initially purchased by non- US persons offshore will be required only if an adviser has direct US person investment management clients (who may have moved to the United States) or manages funds that have made direct placements to investors in the United States.