THOUGHT LEADERSHIP/ALERTS

On May 20, 2010, the United States Senate adopted S. 3217, the Restoring American Financial Stability Act of 2010, a bill sponsored by Senator Christopher Dodd (D-Connecticut) to enact sweeping reforms in federal regulation of the financial industry. Among the provisions of the Senate bill are several that would affect private investment funds and their advisers.

Registration of fund managers under the Investment Advisers Act

Title IV of the Senate bill, entitled the Private Fund Investment Advisers Registration Act of 2010  would amend the Investment Advisers Act of 1940 (the “Advisers Act”) to make unavailable to advisers to “private funds” the exemption from the requirement to register as an investment adviser, contained in Section 203(b) of the Advisers Act (the so-called “fewer than 15 clients exemption”). The definition of “private funds” in the Senate bill covers all entities that would be deemed to be investment companies under the Investment Company Act of 1940, (the “Investment Company Act”) but for Sections 3(c)(1) and 3(c)(7) of the Investment Company Act, the provisions most private investment funds rely upon to avoid registration under the Investment Company Act. 

Exemption of advisers to venture capital and private equity funds

Because the stated purpose of this portion of the Senate bill is to subject hedge fund managers to the registration requirements of the Advisers Act, the legislation further amends Section 203 of the Advisers Act to exempt an adviser to a “venture capital fund” or a “private equity fund” from the registration requirements. The Senate bill does not define the terms “venture capital fund” and “private equity fund,” but requires the Securities Exchange Commission to issue final rules defining such terms within six months after enactment of the legislation.. There is no specific exemption in the legislation applicable to managers of other types of private investment funds, such as funds of funds, although the discretion granted to the SEC to define the terms “venture capital fund” and “private equity fund” may be broad enough to permit some other types of funds to fall within the definitions.

Record-keeping and reporting obligations of private equity fund advisers

Further, although the Senate bill would exempt advisers to private equity funds from the registration requirements of the Advisers Act, it would impose on advisers to such funds (but not on advisers to venture capital funds) an obligation to maintain such records and to file with the SEC such reports as the SEC determines necessary and appropriate in the public interest and for the protection of investors, taking into account fund size, governance, investment strategy, risk, and other factors. As with the rules defining “venture capital fund” and “private equity fund” the Senate bill would require the SEC to issue, within six months after enactment of the legislation,  final rules regarding record maintenance and reports by advisers to private equity funds.

The Senate bill also includes several other provisions affecting private investment funds and their advisers. 

State jurisdiction over smaller registered investment advisers

The Senate bill would amend the Advisers Act to change the threshold at which exclusive jurisdiction over registered investment advisers (including advisers who have registered voluntarily) shifts from state securities regulators to the SEC. Under current law, registered advisers with less than $25 million in assets under management are subject to the exclusive jurisdiction of the state securities administrators in the jurisdictions in which they conduct business, and such advisers are prohibited from registering with the SEC. The Senate bill would raise this threshold to $100 million in assets under management, thereby subjecting advisers with less than $100 million under management to the exclusive jurisdiction of the state securities regulators. 

Regulation D offerings and state blue sky laws

In addition, the Senate bill would modify the preemption of state securities registration laws applicable to private placements conducted under Rule 506 of Regulation D. The National Securities Market Improvement Act of 1996 (NSMIA) automatically exempts from state registration requirements private placements of securities made in compliance with the SEC’s Rule 506. The Senate bill would provide that such exemption would not apply to any such offering if the SEC has not reviewed the Form D Notice of such offering within 120 days after filing. The SEC’s current practice is not to review or comment on Form D filings, except in unusual circumstances. As adopted, the Senate bill would subject issuers of securities in private placements (including private investment funds and the entities in which they invest) to the risk of retroactive application of state securities registration laws, requiring such issuers either to pre-clear their offerings in advance with the SEC by filing Form D well in advance of an offering or to comply with separate blue sky exemptions in each state in which an offering will be made (with offerings being prohibited in those states where an applicable exemption is not available).

Accredited investors

The Senate bill would also require the SEC to revise Regulation D to change the definition of the term “accredited investor” by indexing the minimum annual income and minimum net worth thresholds  (currently $200,000 of annual income and $1 million in assets) to adjust for inflation since their adoption in 1982.

Differences between Senate bill and House bill

Although the provisions of the Senate bill,  as far as they relate to private investment funds and their managers, are similar to those of H.R. 4173, the Wall Street Reform and Consumer Protection Act of 2009, which was adopted by the United States House of Representatives on December 12, 2009, the bills differ in certain ways. For example, the Senate bill exempts from the registration requirements of the Advisers Act advisers to both venture capital funds and private equity funds, while the House bill exempts only advisers to venture capital funds and would, therefore, require private equity fund managers to register as advisers under the Advisers Act. On the other hand, the House bill excludes advisers to any type of private investment fund with less than $150 million under management from the registration requirements of the Advisers Act, while the Senate bill has no minimum asset value below which advisers who otherwise would be required to register would be exempt. The House bill does not have any provisions relating to the “accredited investor” definition or NSMIA’s preemptive provisions.

The Senate and House bills will now be referred to a joint Conference Committee of members of the Senate and the House of Representatives, to be chaired by Congressman Barney Frank (D-Massachusetts). The Conference Committee will be charged with resolving the differences between the two bills and returning the legislation to both chambers for final consideration. Congressman Frank indicated on May 24, 2010, that he expects the Conference Committee to take about one month to complete its work.