Hedge funds were a key subject of debate during the
passage of Dodd-Frank. While the funds were not tied to the causes of the
market crisis, they do represent large pools of assets which can impact the
market. Regulators frequently note that they have inadequate information about
the funds. Accordingly, the financial reform bill contains provisions focused
on registration of the funds and record keeping.
For registration, the legislation sets a minimum asset
threshold for state regulated investment advisers is $100 million. If however,
the adviser is not subject to registration and examination in their home state,
or would be otherwise required to register with fifteen or more states, the
minimum is $25 million. The Act eliminates the private investment adviser
exemption. It also eliminates the intrastate exemption for advisers with any
private fund client.
All registered investment advisers will be required to
appoint a chief compliance officer and establish compliance programs. In
addition, they must adopt a code of ethics.
The burdens of registration and inspection may be eased
for mid-sized registrants. The legislation requires the SEC to issue
regulations to take into account the size, governance and investment strategy
of these funds. The assessment is to focus on whether these funds pose a
systemic risk. The registration and examination procedures are to be designed to
reflect the results of the risk assessment. Mid-sized private funds is not a
defined term.
The new legislation contains a number of exemptions from
registration. These include:
- Venture capital funds. The SEC has one year to define
this term. These advisers will be subject to the record keeping requirements.
- Small business. Small business investment companies are
exempt from registration.
- Private fund advisers. The SEC is to provide an
exemption from registration for an investment adviser that serves solely
private funds and has assets under management in the U.S. of less than $150
million. Private fund is defined to be any fund that would be an investment
company except for the exemptions contained in Sections 3(c)(1) or 3(c)(7) of
the Investment Company Act.
- Family offices. Generally family offices are placed
outside the Investment Advisers Act. The SEC is required to define the term
taking into account several factors stated in the Act.
- Foreign private adviser. The legislation exempts from
registration an investment adviser who: 1) has no place of business in the
U.S.; 2) has fewer than fifteen clients and investors in the U.S. in private
funds; and 3) has aggregate assets under management attributable to clients and
investors in the U.S. in private funds of less than $25 million. The SEC is
given authority to the dollar amount in the last requirement.
- CFTC registration. Generally, investment advisers
registered with the CFTC as commodity trading advisers that advise private
funds are exempt.
The legislation gives the SEC authority to conduct
periodic inspections of private funds and review all of their records. The
Commission is also authorized to conduct special examinations as it deems
necessary. In addition, advisers are required to maintain specific records
including those regarding: 1) the amount of assets under management, 2) the
type of assets held; 3) the use of leverage; 4) counterparty exposure; 5)
trading and investment positions; 6) valuation policies and practices; and 7) those
deemed necessary by the SEC in consultation with the Counsel created by the
Act. The Act requires certain information to be shared with the Council,
although proprietary information is subject to enhanced confidentiality
measures.
The SEC is required to report to Congress annually on the
uses made of the data collected from registered advisers to monitor the markets
for the protection of investors and the markets. The SEC and CFTC are also
required, within one year, to have consulted with the Council and jointly issue
rules regarding the form and content of reports to be filed with each agency by
advisers registered with each. The provisions of this section of the Act are
generally effective within one year.
Finally, as in other sections of the legislation, it
directs that four studies be undertaken:
- Within one year the SEC must submit a study on the
feasibility, benefits and costs of requiring the reporting of short sale
positions in real time to the public or, alternatively only to the SEC and
FINRA. The study is also to include a voluntary pilot program in which
companies agree to have trades in their shares marked "short," "market maker
short," "buy," "buy-to-cover" or "long" and reported in real time through the
consolidated tape.
- Within two years the SEC is to submit a study on the
state of short selling after recent rule changes.
- Within three years the GAO is to furnish a study on the
criteria for determining who is an accredited investor and the eligibility to
invest in private funds. (The Act also requires the SEC to review the
definition of accredited investor as it applies to individuals and four years
after enactment make appropriate adjustments to the net worth requirements in
view of economic conditions).
- Within three years the GAO is to complete a study
regarding certain aspects of the custody rules and their impact.
Additional note:
Yesterday's article on the latest Dell settlements states that neither settling
defendant relinquished his right to appear and practice before the Commission.
Yesterday, the Commission posted the litigation release related to the two settlements (dated
last Friday) which notes that Messrs. Davis and Imhoff agreed to be prohibited
from practicing before the Commission as accountants in related administrative
proceedings which will be filed. Mr. Davis has a right to apply for
reinstatement after five years while Mr. Imhoff will have that right after
three years. An
addendum was added to yesterday's article noting this important part of the
settlement after I was notified about it by the staff. Thank you to the staff
for the notification.
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.