Chris Salter,
Peter M. Vaglio
With the recent passage of comprehensive health care legislation, Congress has refocused its attention on the regulation of the United States financial markets. On March 22, 2010, the Senate Banking Committee approved the Restoring American Financial Stability Act of 2010 (the “
RAFSA”), which was originally introduced by Senate Banking Committee Chairman Christopher Dodd (D-CT) on March 15, 2010. Included within the RAFSA is the Private Fund Investment Advisers Registration Act of 2010 (the “
Senate Bill”), which is the latest in a series of legislation introduced by the Senate and the House of Representatives (the “
House”) targeting the regulation of private investment funds, including hedge funds and private equity funds. We previously analyzed an earlier version of the Senate Bill in an O’Melveny & Myers Client Alert dated November 12, 2009 (Click to read “
Private Fund Investment Adviser Registration Act of 2009,” a November 2009 O’Melveny Client Alert).
The approval of the Senate Bill by the Senate Banking Committee comes just months after the House approved the Wall Street Reform and Consumer Protection Act of 2009 (the “
Wall Street Reform Act”) on December 11, 2009. The Wall Street Reform Act, which was introduced by House Financial Services Committee Chairman Barney Frank (D-MA), includes the Private Fund Investment Advisers Registration Act of 2009 (the “
House Bill”), which is the House’s counterpart to the Senate Bill. We previously analyzed the House Bill in an O’Melveny & Myers Client Alert dated December 14, 2009 (Click to read “
Private Fund Investment Adviser Registration Act of 2009,” a December 2010 O’Melveny Client Alert).
The Senate Bill will now proceed from the Senate Banking Committee to the full Senate for a vote, where it will be subject to further review and amendment. If approval is granted by the Senate, the House and the Senate would begin the process of reconciling the House Bill and the Senate Bill to provide for a uniform, comprehensive bill. Recent press reports indicate that financial reform legislation is a top priority for both Congress and the Obama administration. As a result, barring a Republican-led filibuster (which many observers regard as unlikely to be successful), we expect Congress to finalize legislation to further regulate the financial markets during 2010, and possibly as early as Memorial Day.
While the House Bill and Senate Bill contain certain conflicting provisions that must be reconciled, the consistent provisions suggest that the final legislation, if adopted, would have a significant impact on domestic and foreign advisers to private investment funds by (i) requiring certain unregistered advisers to register with the Securities and Exchange Commission (“
SEC”) under the Investment Advisers Act of 1940, as amended (the “
Advisers Act”), and (ii) imposing certain reporting, disclosure and record-keeping obligations on registered investment advisers (and potentially unregistered advisers). Most notably, each of the House Bill and the Senate Bill eliminates the “private adviser exemption,” which is the exemption from registration for advisers to private investment funds who have less than 15 clients during the preceding 12 months and do not hold themselves out to the public as an investment adviser. Many domestic and foreign advisers to private investment funds rely on the private adviser exemption to avoid registering under the Advisers Act.
Advisers to private funds should take note of the following conflicting provisions between the House Bill and the Senate Bill, as the reconciliation of these provisions will have a significant impact on whether certain advisers are required to register with the SEC:
1. Exemption for Private Equity Funds and Venture Capital Funds:
The House Bill and the Senate Bill each provide for an exemption from registration for advisers to “venture capital funds.” However, only the Senate Bill provides an exemption from registration for advisers to “private equity funds,” although such private equity funds would be required to retain certain records and be subject to certain reporting obligations prescribed by the Senate Bill. Under each bill, the SEC would be tasked with defining the term “venture capital fund” and “private equity fund” and crafting the relevant exemption.
2. Exemption for Foreign Private Advisers:
The Senate Bill provides an exemption from registration for “foreign private advisers” that (i) have no place of business in the U.S., (ii) do not generally hold themselves out to the public in the U.S., (iii) have fewer than 15
clients[1] in the U.S., and (iv) have less than $25 million in assets under management that are attributable to clients in the U.S. and investors in the U.S in private funds advised by the investment adviser. Consequently, a foreign investment adviser would not be required to register under the Senate Bill if (x) it advised less than a combined 15 private investment funds in the U.S. (regardless of whether the investment funds managed by the adviser include U.S. investors) and natural persons or entities in the U.S. who have a direct advisory relationship (e.g., through a managed account) with the adviser, and (y) less than $25 million of assets under management were contributed by U.S. investors.
The House Bill slightly narrows the “foreign private adviser” exemption by requiring the adviser to have fewer than 15 clients
and investors in the U.S. As a result, a foreign investment adviser would not be required to register under the Advisers Act if (i) it has less than a combined 15 U.S. investors in private investments funds and U.S. managed account clients, and (ii) less than $25 million of assets under management were contributed by U.S. investors.
3. Definition of “Client”: The House Bill formally adopts the interpretation that the term “client” includes only persons or entities that have a direct advisory relationship with the adviser and prohibits the SEC from including the underlying investors of a private investment fund in the definition of “client” so long as such fund has entered into an advisory agreement with the adviser. Conversely, the Senate Bill provides the SEC with statutory authority to define the term client. If the Senate Bill is adopted in its current form, the SEC could potentially define “client” to include the underlying investors in a private investment fund, which would have a significant impact on a registered adviser with respect to, among other things, its fiduciary duties to clients, the cash solicitation rule (Rule 206(4)-3), and the custody rule (Rule 206(4)-2).
Please click here for a summary of select provisions of the House Bill and the Senate Bill and for highlights of the similarities and differences between the bills.
[1] Under the current interpretation of the Advisers Act, the term “client” includes only persons or entities that have a direct advisory relationship with the adviser. In the case of a private investment fund, the fund itself would be considered to be the client of the adviser, but the underlying investors in the fund would not be clients.