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Senate Bill Proposes Registration, Public Disclosure and Additional Compliance Obligations for Most Private Investment FundsJanuary 1, 0001
On January 29, 2009, Senators Chuck Grassley (R-Iowa) and Carl Levin (D-Michigan) introduced in the United States Senate S. 344, the “Hedge Fund Transparency Act” (“S. 344”). S. 344 would amend the Investment Company Act of 1940 (the “Investment Company Act”) to require a variety of private investment funds and similar vehicles (“Private Funds”) to be registered as a special class of investment company with the U.S. Securities and Exchange Commission (the “SEC”). Although these Private Funds would generally be exempt from most of the provisions of the Investment Company Act, the new law would require Private Funds with more than $50 million of assets and/or assets under management, to make significant and ongoing public disclosures and adopt and maintain anti-money laundering programs.
Despite the title, S. 344’s coverage is not limited to hedge funds. If enacted, S. 344 would apply to any new or existing Private Fund that is now excluded from the definition of “investment company” under Section 3(c)(1) or 3(c)(7) of the Investment Company Act. This would include hedge, private equity, venture capital and infrastructure funds as well as a wide range of special purpose vehicles (including those used in many collateralized debt obligation and collateralized loan obligation transactions). Under S. 344, each of these Private Funds would be required to register with the SEC. S. 344 does not contain any transition or grandfathering provisions. Certain types of funds that rely on other provisions of Section 3(c) of the Investment Company Act, such as funds that invest solely in real estate and mortgages or funds that invest in oil, gas or mineral royalties or leases, would be unaffected.
CONDITIONS FOR EXEMPTION FROM REGISTRATION UNDER THE INVESTMENT COMPANY ACT.
Under S. 344, a Private Fund that has $50 million or more of assets under management (“Subject Private Funds”)  would be deemed an “investment company” exempted from registration under Section 8 of the Investment Company Act only if the Subject Private Fund:
(1) Registers with the SEC under a newly enacted provision of Section 6 of the Investment Company Act;
(2) Maintains such books and records as may be required by the SEC;
(3) Cooperates with any requests made by the SEC for information or examination;
(4) Files a searchable information form with the SEC at least once per year; and
(5) Adopts, implements and maintains an anti-money laundering program.
Subject Private Funds that fail to meet any of the above requirements would be required to register under Section 8 of the Investment Company Act and to comply with the substantive requirements of the Investment Company Act. These regulations include ongoing disclosure obligations, internal governance and management requirements, limitations on the use of leverage and restrictions on transactions among affiliates. Given the serious consequences of full compliance with the Investment Company Act, the penalty for failing to meet any of the requirements described above seems disproportionately punitive.
Some Subject Private Funds—including many securitization and other structured finance vehicles—could be contractually obligated to liquidate upon becoming an investment company subject to registration under the Investment Company Act; others could find it difficult (such as foreign companies or those that are heavily leveraged) or extremely burdensome to comply. As a result, S. 344 as proposed may increase systemic risks to investors and counterparties by placing in jeopardy the very contracts upon which their transactions are based. S. 344 does not include any form of safe harbor or savings clause and thus non-compliance would cause such Subject Private Funds to be classified as investment companies. Those unable to function or register as nonexempt investment companies would be subject to a range of civil and criminal penalties and face major questions about the enforceability of their contracts.
MANDATORY REGISTRATION FOR ANY INVESTMENT ADVISER UNDER THE INVESTMENT ADVISERS ACT.
Because a Subject Private Fund would be required to be registered as a result of enactment of S. 344, the argument that it is an “investment company” required to be registered under the Investment Company Act would be compelling. As a result, any investment adviser of such Subject Private Fund (including any subadviser) would be required to register as an investment adviser under the Investment Advisers Act of 1940 (the “Investment Advisers Act”). The exception to registration for investment advisers who advise fewer than fifteen clients and do not hold themselves out to the public as investment advisers is not available for investment advisers who advise investment companies registered under the Investment Company Act.
In a related development, on January 27, 2009, Representatives Michael E. Capuano (D-Massachusetts) and Michael N. Castle (R-Delaware) introduced in the United States House of Representatives H.R. 711, the “Hedge Fund Adviser Registration Act of 2009” (“H.R. 711”). If adopted, this bill would effectively overturn the decision in Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006), by removing Section 203(b)(3) of the Investment Advisers Act, which section currently exempts advisers with fewer than fifteen clients from registration (typically, each investment vehicle managed by an adviser is a client, not the underlying investors). We note that many larger advisers of Private Funds are already registered advisers and believe that H.R. 711 will be adopted in some form in the near future. However, H.R. 711 does not provide any exemption for advisers with smaller assets under management, and the cost of compliance with the Investment Advisers Act can be significant. H.R. 711 might also prevent Private Funds currently relying on Section 3(c)(1) from continuing to charge performance based carry to investors who are not “qualified clients” (a qualified client usually must have a net worth of $1.5 million or assets under management with the adviser of at least $750,000).
DISCLOSURES BY REGISTERED PRIVATE INVESTMENT COMPANIES.
S. 344 would require managers of Private Funds to file with the SEC a form providing certain information regarding the Private Fund at least once per year. The SEC would make such information publicly available. The required information would include:
(1) The name and current address of each natural person who is a beneficial owner of the Subject Private Fund;
(2) The name and current address of any company with an ownership interest in the Subject Private Fund; 
(3) An explanation of the structure of the ownership interests in the Subject Private Fund;
(4) Information about financial institution affiliates of the Subject Private Fund;
(5) Statement of any minimum investment commitment required of investors;
(6) The total number of investors in the Subject Private Fund; and
(7) The current value of assets held by the Subject Private Fund and any assets under management.
We also note that Private Funds relying on the new exemptions are still subject to the provisions of Section 9 of the Investment Company Act, which prohibits certain persons and related entities that have been found to have committed certain types of misconduct from being involved in the management of a Private Fund or its affiliated advisers.
ANTI-MONEY LAUNDERING PROGRAM.
Each Private Fund would be required to establish and implement a written anti-money laundering program and report suspicious transactions under 31 USC 5318(g) and (h). S. 344 would require that the program “use risk-based due diligence policies, procedures, and controls that are reasonably designed to ascertain the identity of and evaluate any foreign person that supplies funds or plans to supply funds to be invested.” Because most Subject Private Funds are passive investment vehicles and act exclusively through their investment advisers (who are not otherwise subject to such requirements) or the broker-dealers (who are subject to anti-money laundering program requirements) who place interests in the Subject Private Fund, it is reasonable to expect that such compliance programs would principally be implemented by the investment adviser or broker-dealer. More important is the question of whether the activities of Subject Private Funds result in an exposure to money laundering risk sufficient to warrant the expense of requiring an anti-money laundering program. FinCEN, the bureau of the Department of Treasury responsible for administration of the money laundering laws, has considered whether to apply the programmatic requirements of anti-money laundering laws to investment advisers and Private Funds but has not yet acted.
S. 344 requires that the Secretary of the Treasury, in consultation with the Chairman of the SEC, issue forms and guidance within 180 days after its enactment, and provides the SEC with authority to make any rule to carry out S. 344 if adopted.
Although there are a number of questions raised by S. 344, its fate is likely to be decided with relative swiftness and it could come before the Senate sometime this year depending on the financial reform goals of the Obama Administration and the preferences of Senate Banking Committee Chairman Christopher Dodd (D-Connecticut). S. 344 raises serious issues for all Subject Private Funds including the requirement that the names of beneficial owners be disclosed and the draconian penalties associated with non-compliance with the exemption. We urge all of our clients to focus carefully on the possible implications to their activities and to work through trade associations or directly with their legislators to either oppose its enactment or seek substantial changes. O’Melveny & Myers LLP will continue to monitor the progress of S. 344 and any other proposed regulatory changes and keep you informed as developments arise.
 A Private Fund with less than $50 million of assets under management would still be obligated to notify the SEC that it is relying on one of the new exemptions.
 We note that advisers with smaller assets under management (which will include many SBICs) manage Private Funds that provide capital to small businesses and the burdens and costs for these advisers caused by this compliance could adversely affect the availability of capital to many small businesses.
 Requiring disclosure of the identity of all limited partners is a radical departure from current laws and apparently does not have any stated purpose. It will likely have a chilling affect on foreign investment in U.S. Subject Private Funds.
If you would like to discuss this matter further, please contact the following lawyers or your primary contact at O’Melveny & Myers LLP.
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