23 March 2018
On January 29, 2009, Senators Carl M. Levin (D-MI) and Charles E. Grassley (R-IA) introduced a bill, titled the “Hedge Fund Transparency Act” (the “Bill”), that would require all hedge funds, private equity funds and other private investment funds (such as venture capital funds, real estate funds and “funds of funds”) (“Private Funds”) with at least $50,000,000 of assets under management to register with the Securities and Exchange Commission (the “SEC”) and establish anti-money laundering programs.
The Bill differs from prior efforts to regulate Private Funds that were struck down by the District of Columbia Court of Appeals in Goldstein v. SEC (451 F.3d 873 (D.C. Cir. 2006)). The Bill seeks to impose registration and disclosure obligations directly on the Private Funds under the Investment Company Act of 1940 (the “Company Act”) whereas prior efforts focused on the registration of investment advisers under the Investment Advisers Act of 1940 (the “Advisers Act”) by altering the way in which investment advisery clients were counted.
Private Funds currently seek to avoid the registration requirements of the Company Act by relying on exceptions to the definition of “investment company” in Sections 3©(1) or 3©(7) of the Company Act. Section 3©(1) generally provides for an exemption from registration of any Private Fund whose outstanding interests are beneficially owned by not more than 100 persons. Section 3©(7) provides an exemption for any fund whose outstanding interests are owned exclusively by “qualified purchasers” (generally defined to be persons owning at least $5 million in investable assets or entities with $25 million in investable assets, in each case measured at the time of investment in the fund).
The Bill proposes to delete Sections 3©(1) and 3©(7) but add two new exemptions as Sections 6(a)(6) and 6(a)(7) of the Company Act. The two new Section 6 exemptions would be substantially similar to the deleted Section 3 exemptions, however, Private Funds relying on these new Section 6 exemptions would be required to satisfy additional requirements, as summarized below.
For a Private Fund with $50 million or more in assets to qualify under the new Section 6 exemptions, it would be required to:
1. register with the SEC as an investment company (although the Bill does not define “register”);
2. file an annual disclosure form with the SEC;
3. cooperate with requests for information and inspection by the SEC; and
4. comply with SEC record-keeping standards.
The proposed publicly available annual disclosure form would include disclosure of:
1. the names and addresses of each individual or entity that owned a legal and/or beneficial interest in Private Fund;
2. the name and address of the Private Fund’s primary accountant and primary broker;
3. an explanation of the structure of ownership interests in the Private Fund;
4. information on any affiliation the Private Fund has with another financial institution;
5. a statement of any minimum investment requirement applicable to the Private Fund’s investors;
6. the total number of investors in the Private Fund; and
7. the current value of the Private Fund’s “assets” and “assets under management”.
The Bill defines neither “assets,” nor “assets under management.” It is also noted that the Bill does not address other exemptions currently found in Section 3© of the Company Act.
Anti-Money Laundering Requirements
The Bill further requires Private Funds, whether or not such funds hold assets of $50 million or more, to establish anti-money laundering programs. The Bill would require Private Funds to: (i) establish risk-based anti-money laundering programs; (ii) ascertain the identity of, and “evaluate,” foreign investors; and (iii) monitor and report to the U.S. government regarding suspicious transactions.
The Bill raises a number of potential problems and areas of concern. For example, public disclosure of investor names and addresses could violate applicable privacy laws and regulations and would, almost certainly, require revisions to Private Fund’s internal privacy policies. In addition, disclosing valuation information could be particularly problematic for venture capital and private equity funds, where valuations of portfolio companies are inherently difficult and subjective and are often treated as proprietary information.
The Bill as drafted would also have a significant, and potentially unintended, effect on investment advisers. Most Private Fund advisers currently rely on Advisers Act Section 203(b)(3), which exempts an investment adviser with fewer than 15 clients from registering under the Advisers Act, so long as the adviser does not hold itself out to the public as an investment adviser and does not advise an investment company “registered” under the Company Act. If Private Funds were required to “register” with the SEC under the Company Act, without further clarification, this would mean that their general partners, management companies and similar investment advisers would be required to register under the Advisers Act. If required to register under the Advisers Act, a Private Fund adviser would be obligated to file public disclosures, submit to SEC inspections, adopt a formal regulatory compliance program and satisfy additional requirements.
The Bill is only in its preliminary stages and could be revised substantially as it is integrated with other existing or anticipated proposals for the regulation of Private Funds and as industry participants, regulators and other interested parties express their views on how best to regulate the Private Fund industry in the future. It is also significant to note that the implementing regulations could have a significant impact on how such regulation would impact Private Funds.