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The Registration Act and the Transparency Act are two bills currently before the House and Senate that would require virtually all hedge fund advisers to register under the Investment Advisers Act of 1940. Also, hedge funds with $50 million or more in assets or assets under management would have to file annual information reports, maintain undefined books and records and "cooperate with any request for information or examination by the [Securities and Exchange Commission]."
These bills are largely reactions to both the current financial climate and the decision of the District of Columbia Court of Appeals in Goldstein v. SEC, wherein the Circuit Court stymied the SEC's attempt, through a creative redefinition of the term "client," to require hedge fund advisers to register under the Advisers Act.
Through these bills, Congress is attempting to address the court's invitation to enact legislation to amend the existing registration rules and trigger much greater oversight of the hedge fund industry.
The Hedge Fund Adviser Registration Act of 2009, pending in the House, comprises a single sentence. It is, however, as far-reaching in its impact as it is economical in its length.
The Registration Act strikes in its entirety Section 203(b)(3) of the Advisers Act. That section provides the exemption from registration that virtually all hedge fund advisers rely upon, exempting an adviser who:
By striking this section, the Registration Act, in one fell swoop, subjects virtually all hedge advisers to registration under the Advisers Act.
The bill pending in the Senate, the Hedge Fund Transparency Act of 2009, achieves the same end through a different approach. The Transparency Act amends the Investment Company Act and, most notably, requires hedge funds with $50 million or more in assets or assets under management to "register with the Commission." As mentioned, the Advisers Act provides an exemption from registration only to advisers who do not advise a registered company. By requiring all large funds to register with the SEC, the Transparency Act makes the 203(b)(3) exemption unavailable to a significant number of advisers.
Beyond its impact on advisers, the Transparency Act has significant consequences for funds themselves. All large funds meeting the $50 million threshold are also required to file an annual information form with the SEC, maintain books and records as required by the SEC and cooperate with SEC examinations and requests for information. The annual information form, which must be electronically filed, must disclose the name and address of: (i) each natural person who is a beneficial owner of the fund; (ii) any company with an ownership interest in the fund; and (iii) the primary accountant and broker used by the fund. In addition, it must provide: (i) an explanation of the structure of the ownership interests in the fund; (ii) information as to any affiliation the fund may have with other financial institutions; (iii) a statement as to any minimum investment required of a limited partner, member or other investor; (iv) the total number of partners, members or other investors; and (v) the current value of the fund's assets, as well as that of its assets under management. The SEC is required to make all this information available to the public at no cost in a searchable electronic format.
The other requirements of the Transparency Act, dealing with the maintenance of books and records and cooperation with SEC requests, are not fleshed out in any further detail. Indeed, this lack of detail should cause the hedge fund industry the greatest concern. Nothing in the act would prevent the SEC from inquiring as to the proprietary investment strategy or model employed by a given fund, and nothing prevents this information from being disclosed to the public. The Transparency Act, in its current form, has the potential to make a hedge fund's most closely guarded secrets part of the public domain. In its effort to foster transparency, it has the potential to stymie creative investment strategies and the returns that they bring.
Mark A. Berube is a partner in the white-collar and civil fraud defense practice group at Sheppard, Mullin, Richter & Hampton LLP.
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