November 16, 2009
Previously published on November 13, 2009
On the heels of the U.S. House of Representatives Committee on Financial Services approval of the Private Fund Investment Advisers Registration Act of 2009 (H.R. 3818) (the "House Bill"), Senator Dodd has introduced in the U.S. Senate his own Private Fund Investment Advisers Registration Act of 2009 ("Senator Dodd's Bill"). The material provisions of Senator Dodd's Bill are discussed below.
Private Fund Adviser Registration and Reporting Requirements
Similar to the House Bill, Senator Dodd's Bill, if enacted as proposed, would eliminate the "private adviser exemption" from SEC registration under the Investment Advisers Act of 1940, as amended ("Advisers Act"). The "private adviser exemption" currently exempts from registration advisers who during the course of the preceding 12 months have had fewer than 15 clients. Most private fund advisers rely on the "private adviser exemption" with each fund counting as one client. As would the House Bill, Senator Dodd's Bill would also authorize the SEC to require advisers to "private funds" to maintain records and submit reports with respect to the funds they manage. Although the House Bill would define the term "private funds" to include both domestic and offshore funds relying on section 3(c)(1) or section 3(c)(7) of the Investment Company Act, Senator Dodd's Bill would define the term to include only domestic funds and offshore funds with 10% or more of their securities owned by U.S. persons relying on section 3(c)(1) or section 3(c)(7) of the Investment Company Act. The private fund records and reports would require the following information:
- assets under management ("AUM");
- use of leverage;
- counterparty credit risk exposures; and
- trading positions and practices.
Unlike the House Bill, Senator Dodd's Bill would require the following additional information in the private fund records and reports:
- valuation methodologies;
- investment positions;
- types of assets held;
- side arrangements or letters, whereby certain investors in a fund obtain more favorable rights or entitlements than other investors; and
- such additional information as the SEC, in consultation with the Agency for Financial Stability (the systemic risk regulator that would be created under Dodd's proposed Financial Stability Act of 2009), deems necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk.
Not only would these private fund records and reports be subject to SEC exams prescribed by the SEC as provided in the House Bill, they would also be subject to required, periodic SEC inspections in accordance with a schedule established by the SEC.
Exemptions
Indeed, the most material differences between Senator Dodd's Bill and the House Bill are the exceptions to, and exemptions from, registration and reporting. While the House Bill would exempt from both registration and reporting advisers to small business investment companies licensed under the Small Business Investment Act of 1958, Senator Dodd's Bill would exempt from both registration and reporting advisers to "venture capital funds" (as such term is to be defined by the SEC). In addition, Senator Dodd's Bill would except from the definition of "investment adviser" any "family office" (as such term is to be defined by the SEC), which would alleviate family offices from registration and reporting as well as federal investment adviser regulation generally.
Both proposals provide exemptions from registration for certain advisers that would not be exempt from reporting. The House Bill would exempt from registration, but not reporting, advisers to "venture capital funds" (as such term is to be defined by the SEC) as well as advisers to private funds with AUM in the U.S. of less than $150 million. Senator Dodd's Bill would exempt from registration, but not reporting, advisers to "private equity funds" (as such term is to be defined by the SEC within 6 months after enactment).
State and Federal Responsibilities of Investment Adviser Regulation
Going beyond the Advisers Act amendments included to date in the House Bill, Senator Dodd's Bill would amend the Advisers Act threshold for federal responsibility of investment adviser regulation. The Advisers Act currently reserves for the states the responsibility of regulating investment advisers with AUM of $25 million. Investment advisers with AUM between $25 million and $30 million may choose to be regulated either at the federal level by the SEC or at the state level by their home state regulator. Senator Dodd's Bill would raise the current $25 million threshold for federal responsibility of investment adviser regulation to $100 million--which we assume would be supplemented with a conforming amendment to the current $30 million threshold for required SEC registration. Rep. Paul Kanjorski (D-Pa.), Chairman of the House Financial Services Committee’s Capital Markets Subcommittee, is expecting a similar proposal in the House to raise the $25 million threshold for federal responsibility of investment adviser regulation to $100 million.
Third Party Disclosures
Under the House Bill, private fund advisers would also be required to disclose such reports, records or other information to investors, prospective investors, counterparties, and creditors, as the SEC deems necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk. Senator Dodd's Bill to date does not include these third party disclosure obligations. However, like the House Bill, Senator Dodd's Bill would eliminate Section 210(c) of the Advisers Act, which currently restricts the SEC's ability to require advisers to disclose the identity, investments, or affairs of any client. We can only assume Senator Dodd's Bill intends to authorize the SEC to require disclosure of that type of information.
Information Sharing
Similar to the House Bill, Senator Dodd's Bill would authorize the SEC to share the records and reports of registered private fund advisers for the purpose of assessing systemic risk. However, proposals assume different systemic risk regulators as the recipients of the shared information. The House Bill authorizes the SEC to share information with the Board of Governors of the Federal Reserve System and any entity that the SEC identifies as having systemic risk responsibility. Senator Dodd's Bill would authorize the SEC to share information with the would-be-created Agency for Financial Stability. Senator Dodd's Bill would also require an agreement of confidentiality for such information to be provided to Congress. The SEC would also have to report annually to Congress on how the SEC has used the data collected to monitor the markets for the protection of investors and the integrity of the markets.
Senator Dodd's Bill will likely be amended in the Senate Committee on Banking, Housing and Urban Affairs before moving to the Senate floor for consideration. Ultimately, the Senate and the House will have to reconcile their final versions of private adviser registration to enact a bill into law.
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