Regulation has been looming over the hedge fund and private equity industry since the market collapsed in 2008. With the Senate’s approval of the Conference Report to the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (H.R. 4173) on Thursday, we are one signature away from regulation and registration. Reports indicate that President Obama will be signing the sweeping regulation into law on Wednesday, July 21, 2010. (UPDATE: As expected, President Obama signed the Financial Reform Act into law on Wednesday, July 21, 2010.)
Most hedge funds have been here before. Back in December 2004, the Securities and Exchange Commission (SEC) issued a rule forcing hedge funds to register under the Investment Advisers Act by February 1, 2006. But just a few months after the rule went into effect (June 2006) and after around 2,500 hedge fund advisers had registered, the rule was struck down by the U.S. Court of Appeals.
So now that we’ve walked down memory lane, let’s take a look at what is included in the Dodd-Frank financial reform bill:
The big one is that hedge funds and private equity firms with greater than $150 million in AUM must register with the SEC.
If you’re an adviser of a private fund with less than $150 million in AUM, you’re exempt. That said, if you anticipate growth, you may want to go ahead and act like a registered fund.
The assets threshold for federal regulation of investment advisers is being raised from $30 million to $100 million, a move that will allow for greater state supervision of advisers. With state supervision playing a larger role, the SEC can then dedicate its energy to larger investment advisers, hedge funds and private equity advisers.
The “private adviser” exemption in the Investment Advisers Act of 1940 has been eliminated, “thus registering advisers to private funds with the SEC.”
Reporting requirements to the SEC are going to increase – especially if the SEC thinks your fund poses a systemic risk. They have the power to require advisers to provide information on trades and fund portfolios as necessary to assess systemic risk. Annually, the SEC will report to Congress on how it uses the data to protect investors and market integrity.
The SEC can now also require investment advisers to disclose the identity or investments of their clients for purposes of systemic risk.
An incentive – up to 30% of funds recovered for information provided – has been put in place to encourage whistle-blowing.
Advisers must comply with the new provisions within one year of enactment of the conference report, but of course, you can register earlier with the SEC.
There are also changes to what defines an accredited investor. We’re going to quote an outside expert here – Kevin Scanlan, a partner at Dechert, told HedgeFund.net, “If you’re an adviser who wants to bring in a natural person as an investor, he will generally have to meet the $1 million net worth requirement not including the value of his primary residence. But if you want to charge a performance fee, the same investor would generally need a net worth of $1.5 million which will increase over time because it has to be adjusted for inflation.” To meet the $1.5 million threshold, the value of the primary residence can be included.
Want to read the Conference Report and Joint Explanatory Statement in full details?
Click here for the text of the Conference Report; and
Click here for the Joint Explanatory Statement of the Conferees.
So what can you do today to prepare for registration?
We’ll take from our area of expertise – Technology.
Data Protection: As stated by the President's Working Group's Best Practices for Hedge Funds, “to mitigate financial loss in the event of a disaster, the Manager should establish a comprehensive Business Continuity/Disaster Recovery plan.”
The reality is, having DR is becoming a non-negotiable item on most investors' due diligence checklists. We've seen plenty of investors withhold allocations until a DR system was in place. Check out our article on the disaster recovery considerations for hedge funds to learn how to get started. You can also visit our Disaster Recovery Knowledge Center, which is full of resources and information.
Data Retention: Beyond having a disaster recovery plan, registered firms are advised to retain all internal and external email and IM business communications. An archiving solution, such as Eze Archiving, can help in fulfilling this.
We're following these developments closely and will continue to report on significant events. We'll also be holding an educational webinar on the topic in August, so keep an eye out for the invite or check out our events page next week.