On July 15, 2009, the Treasury Department proposed new legislation entitled the Private Fund Investment Advisers Registration Act of 2009 (the “Act”). If enacted, the Act will require many presently-exempted advisers to private investment funds (such as hedge funds, private equity funds, and venture capital funds) to register as investment advisers with the Securities and Exchange Commission (the “SEC”) under the Investment Advisers Act of 1940 (the “Advisers Act”).
Elimination of Private Adviser Exemption
Currently, Section 203(b)(3) of the Advisers Act exempts from registration any investment adviser who during the course of the preceding twelve months has had fewer than fifteen clients and who neither holds himself out generally to the public as an investment adviser nor acts as an investment adviser to any investment company registered under the Advisers Act. For purposes of this so-called “Private Adviser Exemption”, a private investment fund would be counted as a single client of its investment adviser, and the investment adviser would not be required to register under the Advisers Act.
The Act would effectively remove the Private Adviser Exemption, requiring every investment adviser with more than $30 million in assets under management to register with the SEC, a potentially burdensome and time-consuming process. The Act defines a “private fund” as an investment fund that is excluded from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940 (the “Investment Company Act”) and either: (i) is organized or otherwise created under U.S. federal or state law; or (ii) has ten percent or more of its outstanding securities owned by U.S. persons. Generally, any adviser to a private fund with assets under management of more than $30 million would be required to register under the Advisers Act. The breadth of the definition of “private fund” could encompass types of investment vehicles that are not typically thought of as hedge funds, private equity funds, or venture capital funds, such as structured finance vehicles that rely on section 3(c)(7) of the Investment Company Act. The new “private fund” definition would not apply to funds that invest exclusively in real estate. However, funds that invest in real estate related securities such as mortgage-backed debt would fall under the “private fund” definition.
Potential for Expanded Regulation Including Disclosure and Reporting Obligations
While the most far-reaching aspect of the Act is the elimination of the Private Adviser Exemption, other elements of the Act could have a significant impact. The Act empowers the SEC to require any investment adviser registered under this Act to maintain and submit for inspection records and reports regarding private funds advised by the investment adviser. The SEC is authorized to share this information with the Board of Governors of the Federal Reserve System and a proposed new “Financial Services Oversight Council” for the purpose of “the assessment of systemic risk” (“systemic risk” is not defined but presumably means a risk to the broader financial system posed by a fund’s activities, potential illiquidity or failure, etc.). The Act would require registered investment advisers to report, at a minimum, each private fund’s amount of assets under management, use of leverage, counterparty risk exposures, trading and investment positions, and trading practices. Additionally, the SEC would have authority to conduct regular and periodic examinations of the adviser to monitor compliance with these requirements and to assess the systematic risk of private funds. The Act also enables the SEC to adopt different definitions of the same terms for different sections of the Advisers Act, which would enable the SEC to selectively expand the coverage of the Advisers Act through administrative rulemaking in ways that are currently limited by court rulings.
No Current Private Advisor Exemption Equivalent in Washington
Under current law, even investment advisers that are exempt from federal registration by virtue of the Private Adviser Exemption or another exemption, may be required to register with state regulators in the states where they do business. Regulatory regimes differ from state to state, and some states have no private investment adviser exemption or one that is more restrictive than the federal equivalent. Washington State does not have a private investment adviser exemption, meaning that many investment advisers currently covered by the Private Adviser Exemption are already required to register in Washington. Under Washington law, an investment adviser is only exempt from registration with the state if they have no place of business in Washington and “during the preceding twelve month period the person has had fewer than six clients who are residents of the state.”
Although the Act will affect Washington investment advisers, it will not have as great an impact on investment advisers of Washington State as it will on investment advisers in other states who are currently free of all registration requirements. In Washington, nearly all investment advisers are required to register with the state, therefore, the current legislation will only affect those investment advisers who manage funds with a total asset value greater than $30 million. Those who fall below the $30 million mark will be unaffected by the Act.
It is uncertain whether the Act will be enacted in its present form or at all, and how the changed regulatory regime resulting from enactment will affect investment funds and their advisers. Given the current composition of Congress, it is reasonable to expect the Act to be adopted in some form or another by the end of this year. With this in mind investment advisers to hedge funds, private equity funds, and venture capital funds should anticipate the need for new and enhanced reporting requirements about their funds. And investment advisers that have relied on the Private Adviser Exemption in the past should anticipate that they may be required to register under the Advisers Act.