On January 29, 2009, the “Hedge Fund Transparency Act” (the “Bill”)* was introduced by Senators Chuck Grassley (R-Iowa) and Carl Levin (D-Mich.). The Bill sets forth a potential approach to hedge fund oversight and increased regulation of the financial system.
The Bill would require all private investment funds (including hedge funds, private equity funds and venture capital funds) with assets of $50 million or more to register with the Securities and Exchange Commission (the “SEC”) under the Investment Company Act of 1940 (the “Investment Company Act”). In addition, such funds would be required to file an annual information form (“Information Form”) with the SEC which would include among other things:
- The name and current address of each individual that is a beneficial owner of the fund and each company with an ownership interest in the fund
- The name and current address of the fund’s primary accountant and primary broker
- An explanation of the structure of the ownership interests in the fund
- Information on any affiliation that the fund has with another financial institution
- A statement of any minimum investment commitment required of a limited partner, member or other investor
- The total number of limited partners, members or other investors in the fund
- The current value of the fund’s assets and any assets under management by the fund
This Information Form would be made available by the SEC to the public at no cost and in an electronic, searchable format. Private investment funds with less than $50 million in assets will be treated as investment companies for purposes of the Investment Company Act but would remain unregistered and largely unregulated.
Under the Bill, private investment funds that generally rely on the exceptions from the Investment Company Act regulation contained in either Section 3(c)(1) (for vehicles held by no more than 100 beneficial owners and that are not offered publicly) and Section 3(c)(7) (for vehicles held exclusively by “qualified purchasers” and that are not offered publicly) would now be considered “investment companies” for purposes of the Investment Company Act and subject to the SEC’s regulatory authority. Registered private investment funds would be exempt from most provisions of the Investment Company Act, but would have to maintain certain books and records, file an annual Information Form, cooperate with any SEC requests for information and inspection and establish anti-money laundering programs as further discussed below.
Among the Bill’s provisions, the annual reporting requirements may see the most intensive debate. The policy rationale for providing the names and addresses of investors in a publicly available document is unclear. This raises important privacy concerns and disclosing valuation information could be particularly problematic for venture capital and private equity funds, where valuations of portfolio companies are treated as proprietary information. As a result, the Bill could discourage many traditional hedge fund investors, such as wealthy individuals, retirement funds, and endowments, that want to keep their investments private from investing in this asset class.
Furthermore, if the private investment funds were required to register with the SEC under the Investment Company Act, then absent further clarification, the Bill would have the effect of requiring the investment advisers of such private investment funds to register with the SEC under the Investment Advisers Act of 1940 (the “Advisers Act”). Private investment fund advisers typically rely on Section 203(b)(3) of the Advisers Act, which, broadly stated, exempts an adviser with fewer than 15 clients from registering under the Advisers Act, so long as the adviser does not hold itself out to the public as an investment adviser and does not advise an investment company registered under the Investment Company Act.
In addition, the text of the Bill, as submitted, is vague or silent regarding the following points: (1) the effect of the Bill on offshore investment funds; (2) what constitutes “assets” or “assets under management”; and (3) whether an investment fund counts investments of non-US investors in determining the amount of its “assets.”
Anti-Money Laundering Obligations
The Bill would require private investment funds to (i) establish anti-money laundering programs; (ii) ascertain the identity of, and evaluate foreign investors; and (iii) monitor and report to the U.S. government regarding suspicious transactions. All private investment funds would be subject to these rules without regard to whether such private investment funds hold assets of $50 million or more.