New York Business Lawyers

By: Simon Riveles

Introduction

Previous blog entries have focused on how sweeping financial reform’s impact on New York businesses and others in terms of raising capital.  But what about the funds that provide the capital? This three part analysis lays out the major pillars of the reform and how private funds will accordingly need to adapt.

Background

On May 20, 2010, the Senate passed a comprehensive set of financial regulatory reforms representing the most sweeping set of changes to the U.S. financial system since the Great Depression. These reforms contain a number of provisions relating to private funds and their advisers. In its treatment of private funds the Senate Bill adopted many of the provisions contained in the Wall Street Reform and Consumer Protection Act, passed by the House on December 11, 2009. Despite their similarities, the House and Senate Bills contain significant discrepancies, however, that are currently in the process of being reconciled. The following are the principal provisions of the Senate and House Bills relating to private funds:

ITEM I

Registration and Reporting Requirements:

The Senate bill requires investment advisers that manage $100 million or more in assets to register with the Securities and Exchange Commission (“SEC”). The House bill requires registration of investment advisers who manage assets of $150 million or more. Reconciliation will determine the final threshold amount. Advisers who manage assets below the final threshold level will be subject to state registration requirements.

The Senate bill exempts from registration investment advisers to venture capital and private equity funds but requires hedge funds to register. Under current law, investment advisers to funds, including venture capital, private equity and hedge funds, are generally exempt from registration as investment advisers under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) because of a provision known as the “private adviser exemption”, which applies to advisers with fewer than 15 clients.[1] The Senate bill would eliminate this exemption, but would create a new exemption for venture capital advisers, private equity advisers, and certain foreign private advisers.[2] The House bill includes the exemption for venture capital advisers but not for private equity advisers. The Senate bill does not define the terms “venture capital” or “private equity,” and instead leaves the task of defining these terms to the SEC. If the exemptions in the Senate bill survive the reconciliation process, the effect would be to subject most hedge fund managers to the registration requirements of the Advisers Act, while continuing to exclude venture capital and private equity managers from the registration requirements.

Advisers of private funds that are required to register with the SEC would be subject, under both the Senate and House Bills, to reporting and record-keeping requirements that are substantially similar. The Senate and House Bills authorize the SEC to require registered investment advisers to maintain records (for such periods as the SEC prescribes) and file such reports with the SEC as deemed necessary or appropriate in the public interest or for purposes of “systemic risk” assessments made by other governmental bodies, such as the Board of Governors of the Federal Reserve System (the “Federal Reserve”) or the Financial Stability Oversight Council (the “Council”), an inter-agency body that would be created by the legislation to monitor and address systemic risk. All such records would also be subject to periodic and special examination by the SEC. The records required to be kept (and made available for SEC inspection and, possibly, subject to SEC filing requirements to be prescribed) by each private fund advised by an investment adviser would include information on the following:

?     amount of assets under management;

?     use of leverage;

?     counter-party credit risk exposure;

?     trading and investment positions;

?     trading practices;

?     valuation policies and practices of the fund (Senate Bill only);

?     types of assets held (Senate Bill only);

?     side arrangements or side letters whereby certain investors in a fund obtain more favorable rights or entitlements than other investors (Senate Bill only); and

?     other information that the SEC, in consultation with the Federal Reserve (House Bill) or the Council (Senate Bill), determines is necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.

To the extent that any “proprietary information” of a private fund is contained in reports required to be filed with the SEC, both bills provide for protections from public disclosure under the Freedom of Information Act. The term “proprietary information” is defined to include sensitive, non-public information regarding the investment or trading strategies of the investment adviser; analytical or research methodologies; trading data; computer hardware or software containing intellectual property; and any additional information that the SEC determines to be proprietary.

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Section 203(b)(3) of the Advisers Act provides an exemption for a private investment that has had fewer than fifteen clients during the preceding twelve months, (ii) does not hold itself out generally to the public as an investment adviser and (iii) does not act as an investment adviser to any registered investment company or business development company.

The foreign private adviser exemption would be available to any adviser that (i) has no place of business in the U.S., (ii) has fewer than 15 clients who are domiciled in or residents of the U.S., (iii) has assets under management attributable to clients in the U.S. and investors in the U.S. in private funds advised by the investment adviser of less than $25 million (such amount may be increased by the SEC), and (iv) neither holds itself out generally to the public in the U.S. as an investment adviser nor acts as an investment adviser to any registered investment company or business development company.