The Obama administration has issued its latest salvo in a series of financial reform proposals, the "Private Fund Advisers Registration Act of 2009". If adopted into law, the proposed amendments to the Investment Advisers Act of 1940 (the "Advisers Act") would cover private funds such as hedge funds, private equity funds and venture capital funds and their advisers. US advisers to such private funds in nearly all instances would be required to register with the Securities and Exchange Commission ("SEC") under the Advisers Act and be subject to substantial new public reporting and disclosure requirements. In the United States, these funds are typically formed as limited partnerships or limited liability companies. They rely on exclusions from the Investment Company Act of 1940 (the "Investment Company Act") to avoid registering with the SEC as investment companies, and on private offering exemptions under the Securities Act of 1933 to avoid registering the offerings of their limited partnership or limited liability company interests. Many non-US ("off-shore") funds are also formed and sold to US investors on the basis of these exemptions.

Deceptively simple, the legislation would remove the most common and useful exemption from registration under the Advisers Act for advisers with fewer than 15 clients (the "private adviser exemption"). It also would narrow the "intrastate exemption" by making that exemption unavailable to "private funds", defined as US funds relying on either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act, or non-US funds relying on either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act where US persons own 10% or more of the fund.

There is a new exemption for "foreign private advisers". However, to satisfy that definition and to be eligible for the exemption, the adviser would need to be organized outside the United States, have no place of business in the United States and have fewer than 15 clients in the United States with less than $25 million of assets under management attributable to those US clients. A foreign adviser with only a few clients but more than $25 million under management seemingly would have to register. The SEC is authorized to establish by rule a higher threshold than the $25 million, “if appropriate”, but any rule likely will be conditioned on the foreign adviser meeting certain requirements, such as demonstrating an adequate regulatory regime in the adviser’s home jurisdiction and reporting to the SEC on private funds managed by the adviser.

Note that the SEC is given the authority to establish definitions to implement the legislation, and it could easily define the term "client" to include an individual investor who is an investor in a private fund that the foreign adviser manages. In 2004, the SEC attempted to adopt a rule redefining the term client in this way, for hedge funds, however the rule was challenged and successfully overturned in court on the grounds that, under the law as existed at that time, the SEC lacked authority to make such a change in the definition. Therefore, currently the term "client" means the fund itself and not the underlying individual fund investors. Any change in the definition to mean individual investors in a fund would have an additional immediate impact on non-US advisers.

The new foreign private adviser exemption, in reality, is likely to force the registration of many non-US advisers which currently are not obligated to register with the SEC. Many foreign advisers are financial institutions subject to significant regulation in their home jurisdiction, operating with their own business models and rules. One questions whether the rationale for registering advisers to private funds owned by US investors extends to these foreign institutions.

Overall, the proposals will have the effect of subjecting advisers to private funds, and the funds themselves, to a new and more rigorous regime of new rules, ongoing reporting to the SEC and public disclosure to fund investors under the Advisers Act. The changes are likely to cause funds to need to disclose publicly, for the first time, information like amounts of assets under management, use of leverage, counterparty credit risk exposures, trading and investment positions, trading practices, governance structures, and any additional information that the SEC or the Board of Governors of the Federal Reserve System (the "Board") considers necessary to "protect investors or for the assessment of systematic risk". The law also includes new record keeping requirements with respect to the private funds and subjects such records to periodic and special SEC examinations.

Private funds potentially could become subject to an ongoing reporting and disclosure regime much like that currently applicable to investment companies (i.e., "mutual funds") fully registered under the Investment Company Act. This new reporting and disclosure regime would be a radical change of the regulatory structure applicable to private funds, including hedge funds, private equity and venture capital funds. The new legislation would also provide the SEC with sweeping discretion in its review and oversight of eligible funds. The SEC would have the ability to define different classes of people and matters under the legislation and apply different requirements to these classes.

The new law also would require the SEC to make available to the Board and the Financial Oversight Council (the “Council”) copies of all reports and other information that the Board and Council deem necessary. Although these reports would be confidential, the SEC may provide such information to Congress, other agencies or courts. The law also gives the SEC leeway to require the adviser to a private fund to provide virtually any type of reports or records to investors, prospective investors counterparties or creditors of any such fund.

Finally, the proposed legislation would call for the creation of new rules coordinated by the SEC and the Commodities Futures Trading Commission for investment advisers that are registered under both the Act and the Commodity Exchange Act.