Editor: Tim, can you describe your practice and the types of clients you advise?
Clark: I am in Proskauer's private funds group where we help managers form hedge funds and private equity funds. In addition to formations, we help start-up managers negotiate with seed capital investors and provide compliance advice including advice related to registration under the Investment Advisers Act. We also have a large practice representing endowments and pension plans that are investing in these private funds. Our group numbers close to 100 people in New York, Boston, London, and Paris.
Editor: Has the credit crisis and recession had an impact on your practice and your clients, i.e., are you seeing the same types of projects that you were seeing before the crisis and doing the same volume of business?
Clark: It has had a profound impact. This time last year and into the early fall we started to see a significant number of funds having severe liquidity issues. A large portion of our work until recently has been restructuring funds to deal with those issues as well as issues with limited partners.
Over the past four to six weeks the market has clearly turned around for new hedge fund formations. We are forming new funds and also representing new managers that are negotiating with seed capital providers. Most of these deals have had traditional fee structures although we have done a number of formations for hedge fund managers where they opted to use a private equity fund structure instead of a hedge fund structure. We are also seeing renewed interest from our pension and endowment fund clients in making new investments into both hedge and private equity funds.
Something your readers may find interesting is that my corporate colleagues also tell me that there has been a strong up tick in our general corporate group where we do M&A deals and corporate financing transactions including high-yield work.
Editor: I understand that there are a number of proposals coming out of Washington for the mandatory registration of hedge fund and private equity managers. Can you describe some of these proposals?
Clark: There are a number of proposals from the House, the Senate and the White House that will significantly change the landscape for quite a few investment advisors. Around 2004 the SEC required hedge fund managers to register while PE managers were in general excluded from those registration requirements. The Goldstein decision overthrew these rules although most managers who were registered under the Investment Advisers Act stayed registered. Given all the issues of the past year, the proposal requiring registration has resurfaced requiring not only advisers to hedge funds but private equity and venture capital advisers to register as well. The impetus for this legislation came from Congress being driven by concerns about disclosure issues and systemic risk.
Editor: What kind of reception are the funds giving these proposals?
Clark: The venture capital folks in particular are trying to fight registration because these firms are often quite small, and the requirements to get registered plus the ongoing compliance will require a fair amount of effort and cost, depending upon the size of the organization. Like many hedge funds a few years ago they may need to hire a new person to cover these kinds of issues. My understanding is that a significant number of PE firms are already engaging headhunters, like others in the industry, seeing it as a forgone conclusion that there will be not only registration but ongoing compliance, ongoing SEC examinations, and ongoing prohibitions against certain activities once a firm is registered.
Editor: Are there some exemptions from registration still remaining?
Clark: The proposals generally eliminate the exemptions from registration for advisers who have 14 or fewer clients. The new proposal applies to investment advisers who manage $30,000,000 of funds. The "private adviser" exemption would remain available for non-U.S. managers provided they have no place of business in the U.S., fewer than 15 clients in the U.S. over the last 12 months, and assets under management attributable to clients in the U.S. of less than $25,000,000.
Editor: The SEC now has the power to define the meaning of "client." How is that expected to change?
Clark: The issue has always been murky. In terms of determining who are clients, it has generally been considered that each fund is a client, not each investor in a fund. There is some thought being given to counting each investor in a fund as a client.
Editor: What new record-keeping requirements are imposed on registered investment advisors?
Clark: There are substantial changes. The requirements in the Advisers Act call for books and records, including emails, to be kept for five years, and that each adviser keep full backup of actual trades that make up the firm's track record. The SEC when they conduct an exam will ask for this information.
Editor: Are there any similar proposals outside the U.S. that could affect U.S.-based managers?
Clark: There is currently a proposal in Europe to require U.S. managers who sell in European countries to register as an investment adviser and comply with capital requirements. Currently, there is no registration requirement provided that they comply with various laws.
Editor: What is the process for getting registered in the U.S.?
Clark: You are required to file what is called Part I of Form ADV with the SEC, which has some basic background information. This form is generally declared effective within a few weeks after filing. At the time your registration is declared effective, you are expected to be in full compliance with the rules including all the books and records rules described previously. There are no test requirements for investment advisers, unlike broker-dealers, unless the manager is also operating as a broker-dealer.
Editor: Are the costs significant for Investment advisers?
Clark: It will depend. There are some costs with the initial registration and then on-going costs. There are also costs when you go through an SEC exam. The costs become much more substantial if the organization is more complex because there are more issues that come up under the Investment Advisers Act that have to be dealt with. For our clients who run only one hedge fund or one private equity fund the compliance issues will generally be fairly straightforward, but for other clients who run multiple funds, the Investment Advisers Act analysis may get significantly more complex.
Editor: Do you think that the registration of advisers will materially impact the way hedge fund and private equity managers do business?
Clark: No, I don't. The only exception might be that if some of the proposals to regulate more strictly those managers posing systemic risk pass. In addition, your readers should note that there are proposals which could allow for the regulation of compensation of people in some of the large organizations.
Editor: Will the increased costs associated with registration mean fewer fund start-ups in the future?
Clark: That is a most interesting question. Over the last four or five years we have seen fewer and fewer start-ups. Eight to ten years ago it was common for some folks to leave investment banks and start small funds, often with friends and family money. We were seeing much less of that, even before the economic crisis. Remember that all of these fund managers are essentially small business men or women. It is very difficult to get a small business started, especially in the face of added costs for registration and compliance and the like.
Editor: Could you give me some kind of range of what registration would be, for example, for a very small venture fund?
Clark: Depending upon the organization, the initial costs of registration are somewhere between $30,000 and $50,000. The greater cost is the on-going compliance costs because of the need for professional help. You will have ongoing updates of all your compliance materials. Then you will have issues when the SEC does come in to look at your compliance program.
Editor: How will the quant funds, which are trading constantly, be affected?
Clark: There is no difference for a quant fund than for any other fund. Every fund that is registered becomes subject to SEC review, including examining their books and records and inquiring about the fund's trades. The SEC always is looking for information regarding insider trading or any collusion.
Editor: When do you expect new legislation regarding registration of fund advisers to be passed and what will be the effective date?
Clark: I think that it will be somewhere around the beginning of next year that it will be passed. There should be a lag time before it goes effective.
Editor: Is there anything more that you would like to add?
Clark: This is a very interesting time to be a fund lawyer. I think that these registration requirements will present firms like ours that have extensive experience dealing with Investment Advisers Act issues with new opportunities. Firms that haven't had to deal with registration and ongoing regulatory compliance requirements because their clients (e.g., private equity funds) haven't been registered may find it very difficult to play catch-up and compete.