SEC Adopts Hedge Fund Registration Rules
Monday, June 27, 2011

The United States Securities and Exchange Commission (SEC) has adopted rules that impose new registration requirements on advisers to hedge funds and other private funds, while establishing new exemptions from such registration and reporting requirements for certain advisers.

The rules adopted by the SEC implement core provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) regarding investment advisers, including those that advise hedge funds.

It was pointed out that a large number of individuals and institutions invest a significant amount of assets in private funds, such as hedge funds and private equity funds. However, until the passage of the Dodd-Frank Act, advisers managing those assets were subject to little regulatory oversight.

“These rules will fill a key gap in the regulatory landscape,” said SEC Chairman Mary L. Schapiro. “In particular, our proposal will give the SEC, and the public, insight into hedge fund and other private fund managers who previously conducted their work under the radar and outside the vision of regulators.”

Advisers to private funds have previously been able to avoid registering with the SEC because of an exemption that applies to advisers with fewer than 15 clients – an exemption that counted each fund as a client, as opposed to each investor in a fund. As a result, some advisers to hedge funds and other private funds have remained outside of the SEC's regulatory oversight even though those advisers could be managing large sums of money for the benefit of hundreds of investors.

The Dodd-Frank Act eliminated this private adviser exemption. Consequently, many previously unregistered advisers will have to register with the SEC, and be subject to the same registration requirements, regulatory oversight, and other requirements that apply to other SEC-registered investment advisers. To provide these advisers with a window to meet their new obligations, the transition provisions the SEC adopted on June 22 will require these advisers to be registered with the Commission by March 30, 2012.

In addition, the SEC amended rules to expand disclosure by investment advisers, particularly about the private funds they manage. For example, advisers to private funds will have to provide basic organizational and operational information about each fund they manage, such as the type of private fund that it is (e.g., hedge fund, private equity fund, or liquidity fund), general information about the size and ownership of the fund, general fund data, and the adviser's services to the fund.

The SEC said that these reporting requirements are designed to help identify practices that may harm investors, deter advisers' fraud, and facilitate earlier discovery of potential misconduct. The information, it added, will provide for the first time a census of this important area of the asset management industry.

Furthermore, while many private fund advisers will be required to register, the SEC disclosed that some of those advisers may not need to if they are able to rely on one of three new exemptions from registration under the Dodd-Frank Act, including exemptions for advisers solely to venture capital funds, advisers solely to private funds with less than USD150m in assets under management in the US, and certain foreign advisers without a place of business in the US.

However, the SEC can still impose certain reporting requirements upon advisers relying upon either of the first two of these exemptions. The rules regarding exemption for advisers for venture capital funds and certain private fund advisers are effective July 21, 2011.

Finally, the SEC has approved a new rule to define family offices that are to be excluded from the Investment Advisers Act of 1940. Family offices are entities established by wealthy families to manage their wealth and provide other services to family members, such as tax and estate planning services. Historically, family offices have not been required to register with the SEC under the Advisers Act because of the exemption provided to investment advisers with fewer than 15 clients.

The Dodd-Frank Act removed that exemption so the SEC can regulate hedge fund and other private fund advisers, as above. However, the Act also included a new provision requiring the SEC to define family offices in order to continue to exempt them from regulation under the Investment Advisers Act. The new rule adopted by the SEC enables those managing their own family’s financial portfolios to determine whether their family offices can continue to be excluded from the Investment Advisers Act.

A family office will now be defined as any firm that provides investment advice only to “family clients”, as defined by the rule, is wholly owned by family clients and is exclusively controlled by family members and/or family entities, as also defined by the rule, and does not hold itself out to the public as an investment adviser.