The Effect of Dodd-Frank on Hedge Fund Managers
WHAT EVERY HEDGE FUND MANAGER SHOULD KNOW ABOUT
THE PRIVATE FUND INVESTMENT ADVISORS REGISTRATION ACT OF 2010
As of August 18, 2010
Below is our analysis of the areas of the Act expected to most impact hedge fund advisors.
Hedge Fund Registration Requirements
Private Advisor Exemption
Assets Under Management (“AUM”) Threshold
The Act adjusts the jurisdictional boundaries between federal and state regulation of investment advisors. Investment advisors acting solely as advisors to private funds and with AUM in the United States of less than $150 million will be exempted from federal registration with the SEC (previously, the AUM threshold for federal registration was $30 million). The Act defines “private funds” as those funds that would be an investment company but for the respective exemptions contained under Sections 3(c)1 and 3(c)7 of the Investment Company Act.
An investment advisor with clients other than private funds — such as an advisor with separate accounts — will not be subject to federal registration if the advisor has less than $100 million in assets under management and registers with the state in which it maintains its principal place of business and principal office. However, if an advisor otherwise would be required to register with 15 or more states as a result of not registering with the SEC, then the advisor will be allowed to register with the SEC. Advisors that are exempt from federal registration under this exemption will still be subject to certain disclosure and recordkeeping requirements.
Mid-sized Private Fund Advisors
Venture Capital Funds
Foreign Private Advisors
Definition of “Client”
The Act requires investment advisors to private funds to maintain certain records and reports. Advisors must maintain, for each private fund advised by the investment advisor, records of AUM, the use of leverage (including off-balance-sheet leverage), counterparty credit risk exposure, trading and investment positions, valuation policies and practices, types of assets held, side arrangements or side letters, trading practices, and such other information as the SEC might deem important.
The Act also revises the definition of “accredited investor,” as set forth in Regulation D of the Securities Act of 1933. The SEC is required to adjust any net worth standard for an accredited investor as set forth in Regulation D so that the individual net worth of any natural person, or joint net worth with the spouse of that person, at the time of purchase, is more than $1 million, excluding the value of the primary residence of such natural person. This changes the previous net worth standard that allowed inclusion of an investor’s primary residence. The Act specifies that the SEC can review the definition of “accredited investor” as it applies to natural persons to decide if the requirements of the definition should be adjusted or modified to protect investors and for the public interest. Despite the one-year transition rule under the Act, the staff of the SEC has stated that this revision will take effect immediately. The Act directs the SEC not to further adjust the $1 million net worth standard for a period of four years following enactment of the Act, but tasks the SEC to undertake a review of the standard as a whole and make such other changes as it deems appropriate.
In addition to the foregoing changes, due to the increase of overall financial industry regulation and SEC power, advisors should be prepared to invest significantly more staff time preparing for an SEC audit. It is recommended that advisors conduct mock audits, periodic internal compliance review, and designate a contact person to control the inspection. In addition, advisors should closely observe record keeping requirements. If the SEC requests information from advisors, the information should be produced quickly in order to reduce the time SEC has to observe problems during a waiting period. Lastly, advisors should update and simplify their compliance manuals.