January 30, 2009
Yesterday, Senators Charles Grassley (R-IA) and Carl Levin (D-MI) introduced the Hedge Fund Transparency Act (“HFTA”), which would require hedge funds, private equity and other private funds with $50 million or more in assets, or assets under management, to register with the Securities and Exchange Commission (“SEC”), notwithstanding the availability of exemptions from registration for privately offered funds under Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940 (“1940 Act”), as renumbered.
The senators said their legislation is needed because of the 2006 decision by the D.C. Circuit Court of Appeals that overturned Rule 203(b)(3)-2 under the Investment Advisers Act of 1940 (“Advisers Act”). Goldstein v. Securities and Exchange Commission, 451 F.3d 873 (D.C. Cir. 2006). Rule 203(b)(3)-2 would have required hedge fund managers to register as investment advisers. Unlike Rule 203(b)(3)-2 under the Advisers Act, the HFTA would require funds, rather than the managers, to register with the SEC. HFTA also diverges from S. 1402, the Hedge Fund Registration Act of 2007, which Senator Grassley introduced to the Senate in May 2007, and which similarly would have required hedge fund managers to register as investment advisers.
Conditions for Exemption from Investment Company Registration for Hedge Funds
Under HFTA, new Sections 6(a)(6) and 6(a)(7) of the 1940 Act would replace current Sections 3(c)(1) and 3(c)(7) without substantive change, except that those subsections would 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 not less than $50 million would be exempt from registration as investment companies only if they register with the SEC pursuant to new Section 6(g)(1) of the 1940 Act and comply with certain reporting requirements.
In particular, funds claiming the Section 6(g)(1) exemption from investment company registration would be required to:
Notably, the SEC would be required to make the filed information form available to the public at no cost and in an electronically searchable format. The SEC would be required to issue forms and guidance to implement the HFTA within 180 days after its enactment.
Anti-Money Laundering (“AML”) Requirements
In addition to the registration requirements, the HFTA includes provisions, added by Senator Levin, requiring investment funds that are exempt from registration under new Sections 6(a)(6) or 6(a)(7) to establish AML programs and report suspicious transactions under the Bank Secrecy Act (“BSA”). 31 U.S.C. 5318(g) and (h). Currently, only registered investment companies are subject to BSA requirements. In October 2008, the U.S. Treasury withdrew proposed rules that would have required unregistered investment companies to implement AML programs. Within 180 days of the enactment of the HFTA, the Treasury Secretary, in consultation with the SEC and Commodity Futures Trading Commission would be required to issue a final rule setting forth minimum requirements for the AML program and reporting of suspicious transactions. Unlike the rules for registered investment companies, the rule would 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 (including, where appropriate the nominal beneficial owner or beneficiary of a foreign corporation, partnership, trust or other foreign entity) that supplies funds or plans to supply funds to be invested with the advice or assistance of such investment company.” The rule would also require exempted investment companies to produce account records related to AML compliance requested by a federal banking regulator under 31 U.S.C. 5318(k)(2). If a final rule were not issued, the requirements would take effect one year after the date of enactment of the HFTA.
The AML obligations in the Act are similar to provisions that were included in the “Stop Tax Haven Abuse Act,” S.681, available at http://www.govtrack.us/congress/bill.xpd?bill=s110-681, introduced by Senator Carl Levin, Senator Norm Coleman, and then-Senator Barack Obama in February of 2007 following the issuance in August of 2006 by the U.S. Senate Permanent Subcommittee on Investigations of a report into the use of tax havens and offshore entities by U.S. taxpayers to avoid U.S. taxes and creditors. A copy of the report is available on the Senate website.
It is not clear whether and when this legislation will be taken up by the Senate Banking Committee. On one hand, the seniority and importance of the Senators sponsoring the legislation, and the high profile subject matter, cause us to believe that it will be given serious consideration. On the other hand, neither Senator is a member of the committee of jurisdiction, which already has a full agenda. While it is unlikely that HFTA would move as a standalone measure, pieces of the legislation may well become part of the larger regulatory reform bill that the committee will take up at some point during this Congress.
Another variable is the approach taken in the legislation that would require hedge funds rather than their managers to register with the SEC. Presumably, an intent of the legislation is to answer the call for greater transparency about hedge funds in order to enable a regulator to monitor systemic risk. The legislation, however, focuses on providing greater transparency about hedge funds’ owners, and not about their investments, leverage or counterparty exposure.
In addition to the uncertainty about whether (and why) the bill would require fund rather than investment adviser registration, other points of note are:
We continue to monitor legislative and regulatory developments related to hedge fund registration and regulation and will issue further updates as these significant events unfold.
Gibson, Dunn & Crutcher attorneys are available to assist with any questions you may have regarding these issues. Please contact the attorney with whom you work or any of the following:
Michael Bopp (202-955-8256, email@example.com)
Barry R. Goldsmith (202-955-8580, firstname.lastname@example.org)
Amy L. Goodman (202-955-8653, email@example.com)
K. Susan Grafton (202-887-3554, firstname.lastname@example.org)
Brian Lane (202-887-3646, email@example.com)
Amy Rudnick (202-955-8210, firstname.lastname@example.org)
C. William Thomas, Jr. (202-887-3735, email@example.com)
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