President Signs Financial Reform Legislation Requiring Registration of Hedge Fund and Private Fund Advisers

On July 21, 2010, President Obama signed the Senate the Dodd-Frank Wall Street Reform and Consumer Protection Act mandating the registration of private advisers to hedge funds and other private pools of capital so that regulators can better understand exactly how those entities operate and whether their actions pose a threat to the financial system as a whole. The Act requires investment advisers to hedge funds and other private investment funds to register with the SEC if they have assets under management of at least $150 million and subjects them to significant recordkeeping and disclosure requirements. Current law generally does not require hedge fund and other private fund advisers to register with any federal financial regulator.

While advisers to private funds with assets under management of $150 million in the U.S. are exempt from SEC registration, such advisers must maintain such records and provide to the SEC such annual or other reports as the Commission determines necessary or appropriate in the public interest or for the protection of investors.

The legislation accomplishes the registration of hedge fund advisers by eliminating the Investment Adviser Act’s private adviser exemption, which exempts from registration investment advisers that have fewer than 15 clients, do not hold themselves out to the public as investment advisers, and do not act as investment advisers to registered investment companies or business development companies. This was the legislative fix heralded by the Second Circuit opinion in Goldstein.

The legislation creates a registration exemption for foreign private fund advisers. There is also a registration exemption for investment advisers that solely advise small business investment companies under the Small Business Investment Act and entities that have received from the Small Business Administration notice to proceed to qualify for a license. Moreover, there is an exemption for any investment adviser that is registered with the Commodity Futures Trading Commission as a commodity trading advisor and advises a private fund. However, if the business of the advisor should become predominately the provision of securities-related advice, then the commodity trading advisor must register with the SEC. The legislation also exempts advisers to venture capital funds. However, the Commission must require advisers to venture capital funds to maintain records and provide annual or other reports as the Commission determines necessary or appropriate in the public interest or for the protection of investors.

The provisions are effective one year after enactment.

The legislation erects a confidentiality regime by providing that any proprietary information of an investment adviser ascertained by the SEC from any report required to be filed with the Commission under the new disclosure rubric is subject to limitations on public disclosure. For purposes of this confidentiality regime, proprietary information includes sensitive, non-public information regarding the investment adviser’s investment or trading strategies, analytical or research methodologies, trading data, computer hardware or software containing intellectual property, and any additional information that the Commission determines to be proprietary.

However, the confidentiality provisions do not authorize the SEC to withhold information from Congress or prevent the Commission from complying with a request for information from any other federal regulators or any self-regulatory organization requesting the report or information for purposes within the scope of their jurisdiction, or complying with a federal court order in an action brought by the United States or the SEC.

Family offices provide investment advice in the course of managing the investments and financial affairs of one or more generations of a single family. Since the enactment of the Investment Advisers Act, the SEC has issued orders to family offices declaring that those family offices are not investment advisers within the intent of the Act and thus not subject to registration. The legislation essentially codifies the SEC position by excluding family offices from the definition of investment adviser under Section 202(a)(11) of the Advisers Act. The SEC must adopt rules of general applicability defining family offices for purposes of the exemption. The rules must provide for an exemption that is consistent with the SEC‘s previous exemptive policy and that takes into account the range of organizational and employment structures employed by family offices.

This provision is based on a congressional belief that family offices are not investment advisers intended to be subject to registration under the Advisers Act, which is not designed to regulate the interactions of family members. Registration would unnecessarily intrude on the privacy of the family involved. (S. Rep. No. 111-176, pp. 75-76).

Congress recognizes that many family offices have become professional in nature and may have officers, directors, and employees who are not family members, and who may be employed by the family office itself or by an affiliated entity. Such persons may co-invest with family members, enabling them to share in the profits of investments they oversee, and better aligning the interests of such persons with those of the family members served by the family office. Congress expects that such arrangements would not automatically exclude a family office from the definition. (S. Rep. No. 111-176, pp. 75-76).