This post was written by Sandra Poe and Alicia Powell.
In the Private Fund Investment Advisers Registration Act of 2010, Congress adopted changes to the Investment Advisers Act of 1940 that greatly increase the chances that managers of hedge funds or private equity funds will now have to register as investment advisers. Advisers who are required to register will have about a year to do so — until July 21, 2011. Widely covered in the news as “hedge fund registration” requirements, these amendments actually primarily affect the status of the fund managers, rather than the funds themselves.
What Will Change
Currently, advisers that have fewer than 15 clients generally are exempt from
registration. Advisers that manage private funds can count each fund as a single client. Most private equity and hedge fund managers have been entitled to rely on this exemption. The law change eliminates this so-called “private adviser exemption” in its entirety, and provides that the SEC will replace it with a much narrower exemption for advisers with assets under management of less than $150 million, and who exclusively advise private funds (as defined in the Act). As a result, private fund advisers with $150 million or more in assets under management will be required to register with the SEC. Private fund advisers falling beneath the $150 million threshold must determine whether they are required to register with the securities regulators in one or more states (we note that all states other than Wyoming have some sort of registration requirements).
The New Rules
- Registration on Form ADV — To register, advisers must complete Form ADV, which requires substantial disclosures to the SEC and to the adviser’s clients. Form ADV must be updated at least annually and, with respect to certain key information, at the time of certain changes in the reported information.
- Disclosures to Adviser’s Clients — “Part II” of Form ADV, or the “brochure,” calls for substantial narrative description of the adviser’s business, products, management, material adverse financial or disciplinary matters, conflicts of interest and policies designed to address conflicts of interest. Advisers are required to deliver their brochure to advisory clients annually. The brochure is often used as a means of conveying other required disclosures such as privacy policies.
- Adoption of a Comprehensive Compliance Program — Registered advisers must adopt written policies and procedures designed to prevent violation of the Act and its rules. Such written policies must be reviewed at least annually for adequacy and effective implementation, and a chief compliance officer must be appointed to oversee their administration.
- Adoption of an Anti-Insider Trading Policy — A policy must be designed to ensure that material, non-public information is not misused in violation of the Act or the U.S. Securities Exchange Act of 1934 (the “1934 Act”), and may entail (i) circulating a written policy to all employees, (ii) employee training programs, (iii) creating physical and organizational information barriers, (iv) maintaining restricted lists, watch lists, and rumor lists, and (v) maintaining a procedure for monitoring client and personal trades.
- Adoption of Code of Ethics and Personal Trading Policy for Access Persons — Access persons must report their personal securities holdings and transactions. Some access persons must also obtain pre-clearance before participating in, and may be barred from investing in, initial public offerings and limited offerings.
- Subject to SEC Examination Authority — The SEC conducts periodic examinations of registered advisers. You’ll want to stay abreast of “hot topics” and periodic SEC staff
statements about the focus of the SEC’s examination program.
- Substantial Recordkeeping Obligations — The Act imposes requirements with respect to
adviser records substantiating the basis of performance claims and other records reflecting
the relationship between the adviser and its clients. New legislation would add to these
records for each private fund under management. These records include AUM, the use of
leverage, counterparty credit risk exposure, trading and investment positions, valuation policies, side arrangements or side letters, trading practices, and any other subjects that the SEC, in consultation with the Financial Stability Oversight Council, deems necessary for the public interest, investor protection or the assessment of systemic risk.
- Compliance with Anti-Fraud Laws — The Act generally prohibits an investment adviser from
employing a “device, scheme or artifice” to defraud clients or engaging in a “transaction, practice or course of business” that operates as a “fraud or deceit” on clients. The Act’s anti-fraud provisions also prohibit certain securities transactions absent disclosure to clients, as well as any “act, practice or course of business which is fraudulent, deceptive or manipulative.” Rules under the Act extend these protections to investors in the adviser’s private funds. In addition to the antifraud provisions of the Act, you may also be subject to the anti-fraud and manipulation provisions of the other federal securities laws, such as section 17(a) of the U.S. Securities Act of 1933, as amended, and Rule 10b-5 under the Securities Exchange Act of 1934, as amended.
- Custody Rules — The Act imposes specific measures registered advisers must take to safeguard client assets over which the adviser has, or is deemed to have, custody. These steps include maintenance of client assets with a “qualified custodian” and submission to an annual surprise examination by an independent public accounting firm (or the issuance of annual audited financial statements by private funds advised by the adviser).