On January 29, 2009, Senators Charles Grassley (R-IA) and Carl Levin (D-MI) introduced a new bill called the Hedge Fund Transparency Act, which is intended to clarify current law and remove any doubt that the SEC has the authority to require hedge funds to register. This bill may greatly impact the private equity funds we advise. While the title of the Hedge Fund Transparency Act refers to “hedge funds,” the subject of the new bill, if enacted in its current form, is significantly more broad and will require, hedge funds, venture capital funds, private equity funds and funds-of-funds with $50,000,000 or more in assets, or assets under management, to register with the Securities and Exchange Commission (“SEC”), notwithstanding the exemptions from registration currently available to privately offered funds under Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940, as amended (the “Act”).
The bill is not universally supported. Indeed, opponents of stronger SEC regulation of hedge funds claim that regulation such as the Hedge Fund Transparency Act is not necessary because investors in hedge funds are financially sophisticated and experienced. While the drafters of the bill recognize that hedge funds, unlike mutual funds, do not permit the general public to invest, they believe they need to strike a balance between the financial sophistication of fund investors and the need to protect institutional investors and the financial marketplace. Accordingly, the Hedge Fund Transparency Act is intended to provide greater transparency by requiring hedge funds and other private funds to publicly disclose information, maintain books and records, and cooperate with any SEC information requests or examination. However, commentators are already suggesting that the language of the Hedge Fund Transparency Act be revised to remove the burdens of registration and disclosure on venture capital funds, private equity funds, funds-of-funds, and similar private entities that do not invest in the public market. Irrespective of the ultimate scope of the Hedge Fund Transparency Act’s registration and reporting requirements, it is likely that Congress will give the SEC authority to regulate pooled investment entities (including private equity funds) and their managers.
Requirements for Exemption from Registration as an Investment Company
Hedge funds and private pooled funds often avoid regulatory requirements under the Act due to the exceptions to the definition of “investment company” contained in Sections 3(c)(1) and 3(c)(7) of the Act. Under the Hedge Fund Transparency Act, Sections 6(a)(6) and 6(a)(7) of the Act will replace current Sections 3(c)(1) and 3(c)(7). Sections 6(a)(6) and 6(a)(7) of the Act will not be altered substantively, except that those subsections will now be exemptions from registration, rather than exceptions to the definition of “investment company.”
Notwithstanding the availability of the investment company registration exemptions of new Sections 6(a)(6) and 6(a)(7), investment funds with assets, or assets under management, of $50,000,000 or more will be exempt from registering as investment companies only if they register with the SEC and comply with certain reporting requirements. In particular, funds claiming the exemption from investment company registration would be required to:
- Register with the SEC;
- Maintain books and records as the SEC would require;
- Cooperate with any request by the SEC for information or examination; and
- File an information form with the SEC electronically, at least once a year, in which the fund discloses:
- The name and current address of each individual who is a beneficial owner of the investment company;
- The name and current address of any company with an ownership interest in the investment company;
- An explanation of the structure of ownership interests in the investment company;
- Information on any affiliation with another financial institution;
- The name and current address of the investment company’s primary accountant and primary broker;
- A statement of any minimum investment commitment required of a limited partner, member, or investor;
- The total number of any limited partners, members, or other investors; and
- The current value of the assets of the company and the assets under management by the company.
The Hedge Fund Transparency Act would require the SEC to issue forms and guidance and to implement the Hedge Fund Transparency Act within 180 days after its enactment.
Anti-Money Laundering Obligations
In addition to the registration requirements set forth above, the Hedge Fund Transparency Act includes provisions requiring investment funds that are exempt from registration under new Sections 6(a)(6) or 6(a)(7) to establish Anti-Money Laundering programs and report suspicious transactions under certain provisions of the Bank Secrecy Act (“BSA”). The Treasury Secretary will be required, within 180 days of the enactment of the Hedge Fund Transparency Act, to issue a final rule setting forth minimum requirements for the Anti-Money Laundering program and reporting of suspicious transactions. This rule must require exempted investment companies to “use risk-based due diligence policies, procedures, and controls that are reasonably designed to ascertain the identity of and evaluate any foreign person that supplies funds or plans to supply funds to be invested with the advice or assistance of such investment company.” This rule must also require exempted investment companies to produce account records related to Anti-Money Laundering compliance requested by a federal banking regulator under certain provisions of the BSA.
We will continue to monitor the legislative and regulatory developments related to the Hedge Fund Transparency Act and will issue further updates as significant events transpire.
This Client Alert is prepared for the general information of our clients and other interested persons. This Client Alert is not, and is not intended to be, comprehensive in nature. Due to the general nature of its content, this Client Alert is not and should not be regarded as legal advice.
If you have any questions related to the Hedge Fund Transparency Act and/or its impact, please feel free to contact:
KeithW. Kaplan, Esq. Jon M. Katona, Esq.