Financial Regulatory Reform Update: Which Private Fund Managers Should Anticipate Registration With The SEC?

Tuesday, December 1, 2009 - 01:00
Adrienne L. Atkinson
David W. Blass

The U.S. Congress is preparing to consider far-reaching legislation that would expand the powers of the federal government over financial institutions operating in the United States, dramatically alter the role and authority of many federal regulatory agencies, and require many financial industry participants to be subject to closer oversight by federal regulators. One group of financial industry participants - managers of privately offered investment funds, such as hedge funds, private equity funds and venture capital funds - has been the target of a number of bills introduced this year in both the Senate and the House of Representatives.1One bill, introduced by Congressman Paul Kanjorski (D-PA), has passed the House Financial Services Committee and is expected to be considered soon by the full House of Representatives.2Another is scheduled to be considered by the Senate Banking Committee in the upcoming weeks and is sponsored by Committee Chairman Christopher Dodd (D-CT).3If enacted, those bills, while differing in some respects, would require certain U.S. and non-U.S. managers of privately offered funds to register as investment advisers with the Securities and Exchange Commission under the Investment Advisers Act of 1940. This article examines the Kanjorski House bill and the Dodd Senate bill treatment of registration of managers of privately offered funds. As with any pending legislation, the bills are subject to modification during the legislative process. This article is based on the drafts of the bills available as of November 20, 2009.

Narrowing Of The Existing Exemptions

Today, many managers of privately offered funds rely on the "private adviser exemption" from registration under the Advisers Act. This exemption allows the manager to avoid registration with the SEC as an investment adviser if the manager advises fewer than 15 clients in any rolling 12-month period and does not hold itself out generally to the public as an investment adviser.4Moreover, under current Advisers Act rules, managers of privately offered funds have generally been able to count the funds they manage, rather than the investors in the funds, as the clients for purposes of the exemption.5A 2004 Advisers Act rule intended to oblige hedge fund advisers to register by requiring them to look through the fund to count the investors as clients, was struck down by the courts.6Non-U.S. privately offered fund managers are currently required to count only their U.S. funds toward the 14-client limitation.7

The Senate and the House bills would largely eliminate the private adviser exemption, and, as a result, subject to new exemptions discussed below, the bills, if enacted in their current form, would generally require a manager of a privately offered fund with more than $100 million in assets under management to register as an investment adviser under the Advisers Act, regardless of the number of clients the manager has.8

In addition to eliminating the private adviser exemption, both bills would restrict the ability of a privately offered fund manager to rely on two other current exemptions from registration: (1) the exemption for an adviser registered as a commodity trading adviser with the Commodity Futures Trading Commission and whose primary business does not involve acting as a securities investment adviser; and (2) the exemption for an adviser that does not provide advice regarding securities listed on a national securities exchange and whose clients are all residents of the same state in which the manager has its principal office and place of business.9Under the bills, a manager would not be able to rely on the commodity trading advisor exemption or the intrastate exemption if the manager advises a fund that is not an investment company based on the exemption provided by Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940.10

New Exemptions Introduced

Both House and Senate bills would provide new exemptions from registration under the Advisers Act.

Exemption for Managers of Venture Capital Funds. Each bill would exempt managers from registration with respect to their provision of investment advice relating to a "venture capital fund" and would direct the SEC to define the term "venture capital fund" for purposes of the exemption. The House bill, while exempting managers of venture capital funds from registration, would nonetheless require the SEC to specify such records a manager of a venture capital fund must maintain and require the manager to file such annual and other reports with the SEC as the SEC determines is necessary or appropriate in the public interest or for the protection of investors. The Senate bill contains no such recordkeeping or reporting requirements for managers of venture capital funds.

Exemption For Managers Of Private Equity Funds

The Senate bill, unlike the House bill, adds an exemption from registration for managers with respect to their provision of investment advice relating to a "private equity fund." The bill would direct the SEC to define the term "private equity fund" for purposes of the exemption. The Senate bill would apply recordkeeping and reporting requirements to managers of private equity funds substantially the same way as the House bill applies them to venture capital fund advisers. Although dependent on how the SEC would define private equity, the addition of an exemption for managers of private equity funds would likely result in a significant expansion of the number of advisers that would be exempt from registration compared to the House bill. Neither bill would limit the number of venture capital or private equity funds that a manager could advise, with the result that managers of such funds which would be required to register today if they exceeded 14 clients would no longer be required to register. In effect, the Senate bill shifts the focus of registration to hedge funds.

Exemption for Foreign Private Advisers. Both Senate and House bills, while differing in certain terminology, would create a new exemption from registration for a foreign private adviser, defined as an adviser that:

• has no place of business in the United States; and

• during the preceding 12 months has had fewer than 15 clients in the United States and has had assets under management attributable to clients in the United States of less than $25 million (subject to increase by the SEC)11 ; and

• does not hold itself out generally to the public in the United States as an investment adviser or act as an investment adviser to a registered investment company.

Applying the current law, under which the fund could generally be viewed as the "client," it appears that a non-U.S. privately offered fund manager that manages just one U.S. fund with $25 million or more in assets would be required to register as an investment adviser with the SEC. Applying the same law, however, it would seem that neither bill would require a non-U.S. private fund manager to count toward the $25 million threshold the assets of a fund it advises that is organized outside the United States, or to look through that fund to its investors to determine whether assets were attributable to persons in the United States. However, the Senate bill would permit the SEC to define the term "client" to mean an investor in the fund for different purposes of the Advisers Act, which would permit the SEC to change the scope of the foreign private adviser exemption included in the bills.

Exemptions For Family Offices And Advisers To Small Business Investment Companies

The Senate bill exempts "family offices," as defined by the SEC, from the definition of investment adviser under the Advisers Act. The SEC has issued several orders in recent years granting exemptions to individual family offices and the Senate bill would clarify the SEC's authority to adopt a rule with broader applicability. Finally, the House bill would exempt from the registration requirements advisers to small business investment companies licensed under the Small Business Investment Act of 1958.

Next Steps

Both bills are expected to be debated in the coming weeks and changes to the registration requirements and exemptions should be anticipated. The stakes are high for fund managers because the bills would add potentially substantial new obligations for managers of privately offered funds who are required to register as investment advisers. For example, the bills would require a registered investment adviser that manages a private fund to file with the SEC reports for the fund, including information about counterparty exposure, valuation methodologies, types of assets held, side letters, trading and investment positions, trading practices, use of leverage, and other information that the SEC deems necessary for investor protection or for an assessment of systemic risk.

1 The interests in a hedge fund, private equity fund and venture capital fund generally are offered in a private placement for purposes of the Securities Act of 1933, and such a fund generally is not an investment company for purposes of the Investment Company Act of 1940 in reliance on the exclusions from the definition of investment company under Section 3(c)(1) or 3(c)(7) of that Act.

2 The Private Fund Investment Advisers Registration Act, H.R. 3818, available at: http://thomas. Amendments adopted by the House Financial Services Committee are available at: /apps/list/speech/financialsvcs_dem/markup_102109.shtml The bill modifies earlier proposals by President Obama's administration and Senator Jack Reed (D-RI) relating to the regulation and oversight of privately offered fund managers.

3 Title IV, Regulation of Advisers to Hedge Funds and Others, is contained within a larger bill introducing wide-ranging changes to the regulation of financial institutions in the United States.The full text of a discussion draft of the bill (current as of Nov. 16, 2009) is available at:

4 Section 203(b)(3) of the Advisers Act.Section 203(b)(3) is not the exclusive means for a money manager to avoid registration as an investment adviser with the SEC.

5 See Rule 203(b)(3)-1(a)(2)(i) under the Advisers Act.

6 Goldstein v. SEC, 451 F.3d 873, 877 (D.C. Cir. 2006) (vacating an SEC rule that would have required, under certain circumstances, privately offered fund managers to count fund investors as clients for purposes of Section 203(b)(3) of the Advisers Act). The interpretation of the term "client" to mean a fund investor was struck down in Goldstein as unreasonable and thus outside the SEC's authority .Id.

7 Rule 203(b)(3)-1(b)(5) under the Advisers Act.

8 Today, registration with the SEC as an investment adviser generally is triggered by having assets under management of $25 million or more. The Senate bill would increase this amount to $100 million and investment advisers with less than $100 million in assets under management would generally be subject to applicable state regulation.The House bill includes an additional exemption from SEC registration for advisers to certain privately offered funds that have $150 million or less in assets under management in each fund.

9 See Advisers Act Sections 203(b)(1) (intrastate exemption) and 203(b)(6) (commodity trading advisor exemption).

10 Under the Senate provision, a U.S.-based investment adviser that manages only non-U.S. funds that have 10% or less (by value) of their securities held by U.S. persons could continue to rely on the exemptions provided in Sections 203(b)(1) and 203(b)(6).

11 The Senate bill does not include the words "duringthe preceding 12 months."

Adrienne Atkinson is a Partner and David Blass is Special Counsel in the Asset Management Group of Willkie Farr & Gallagher LLP in New York City and Washington D.C. respectively.

Please email the authors at or with questions about this article.