Author Archives: Hedge Fund Lawyer

Hedge Fund Registration Rules Finalized

Registration required by March 30, 2012

We are obviously a bit late on reporting that the hedge fund registration regulations were finalized by the SEC recently (see releases at end of the post).  We are not going to detail all aspects of the regulations in this post, but we will be examining some of the more important issues related to the release over the coming weeks and months.

We do want to provide a quick overview of some of the more important items with respect to the new regulations.  These include:

  1. registration for many hedge fund managers will be required by March 30, 2012 [note: managers will need to file Form ADV with the SEC no later than February 14, 2012 to meet this deadline]
  2. Form ADV has been amended in a number of ways which provide more information regarding a fund’s activities and counterparties
  3. Exempt Reporting Advisers (“ERAs”) will need to complete and file a truncated version of Form ADV by March 30, 2012 [note: ERAs will be subject to recordkeeping requirements and will be subject to SEC examination]
  4. many currently registered fund managers will need to switch from SEC registration to state registration during the first part of 2012

IA Registration Overview and Exemptions

After the passage of the Dodd-Frank Act it was clear than many fund managers would be required to register as investment advisers with the SEC.  In general the following are the registration requirements/exemptions for asset managers:

  • managers to only hedge funds (no managed accounts) must register as an IA with the SEC if Regulatory AUM (discussed below) is over $150M
  • managers to hedge funds and managed accounts must register as an IA with the SEC if Regulatory AUM is over $100M
  • mid-sized advisers ($25M to $100M) will be subject to state registration, if applicable [note: some mid-sized advisers will be subject to SEC registration regardless]
  • managers to only VC funds are exempt from registration;
    • VC funds may have up to 20% of their assets in non-VC investments
    • while managers to VC funds will not be required to register as IAs with the SEC, they will still be Exempt Reporting Advisers and will thus need to completed the truncated Form ADV by March 30, 2012
  • non-U.S. managers who have a place of business in the U.S. and have U.S. clients (either directly or as investors in their fund) will generally be required to register as an IA with the SEC or will be deemed to be an ERA [note: non-U.S. managers with U.S. clients or investors will only be exempt from IA registration with the SEC in only limited circumstances]
  • private equity fund managers are generally going to be treated the same as hedge fund managers according to these regulations

Other Items

The following are some of the important items from the releases:

  • Form PF – Release 3221 makes specific reference to a “Form PF release” which indicates that the SEC will be moving forward with the highly controversial reporting form.
  • Regulatory AUM – a new definition for AUM called regulatory assets under management will be used when determining the thresholds for registration. The big issue is that the definition will include leverage (gross assets) and will also include uncalled capital commitments.  The Release 3221 essentially states that the new Regulatory AUM definition is necessary for more consistent

    reporting of AUM and because Form PF will essentially rely on the new definition.

  • Buffer for Mid-Sized Advisers – there is a buffer zone around the $100M mark for certain managers.  This buffer is put into place so that managers do not have to continually switch to and from SEC registration as AUM increases or decreases.  The buffer is $10M each way meaning a manager will not be required to register with the SEC until AUM reaches $110M and a SEC registered manager would not need to de-register or switch to state registration until the manager had less than $90M AUM.
  • Family Office – family offices are exempt from SEC IA registration.  The SEC defined the term “family office” (see Release IA-3220).

The SEC press release announcing the new regulations and providing an overview of the new regulatory requirements can be found here.

The full releases are below:

  • Release IA-3222 [Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers]
  • Release IA-3221 [Rules Implementing Amendments to the Investment Advisers Act of 1940]
  • Release IA-3220 [Family Offices]

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Cole-Frieman & Mallon LLP provides registration, compliance and other legal services for hedge fund managers.  Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

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SEC Increases Threshold for Performance Fees

New Qualified Client Definition Effective September 19, 2011

The Dodd-Frank Act required the SEC to revise upward the dollar thresholds for a person to be deemed a “qualified client” pursuant to Rule 205-3. The qualified client definition is important because SEC registered investment advisers (including hedge fund managers) cannot charge performance fees to those investors who are not qualified clients. Previously an individual needed to have a net worth of $1.5 million or have $750,000 of AUM with the investment adviser. The new thresholds are $2 million and $1 million respectively.

It does not appear that there are any grandfathering provisions that will be applicable and it is currently unclear whether managers will need to seek confirmation from current investors/clients as to whether such investors meet the new qualified client definition. If managers are required to seek additional confirmation from current investors, this will obviously create additional legal and administrative expenses for managers. Regardless, for any future investors/clients, SEC registered investment

advisers (and those groups that will be registering within the next 9 months) should make sure that the new qualified client definition is included in all subscription documents and other investment advisory contracts.

Another important issue is how this change will affect state registered investment advisers. Many state laws and regulations either mirror the federal laws and regulations or make specific reference to Rule 205-3. It is likely that many states will be coming out with guidance on this issue either through notifications or orders, or through legislative changes. Nonetheless, most state registered investment advisers should begin making plans to adapt to the changes at the federal level.

As more information from the states become available, we will be providing updates on this blog.

The notice of the SEC order is reprinted below and can be found here.

The actual SEC Order can be found here: SEC Order – Qualified Client Definition

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SEC Issues Order Raising Performance Fee Rule Dollar Limit to Adjust for Inflation

FOR IMMEDIATE RELEASE

2011-145

Washington, D.C., July 12, 2011 – The Securities and Exchange Commission today issued an order that raises, to adjust for inflation, two of the thresholds that determine whether an investment adviser can charge its clients performance fees. The order carries out a requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

SEC's Order

Rule 205-3 under the Investment Advisers Act allows an investment adviser to charge a client performance fees if the client meets certain criteria, including two tests that have dollar amount thresholds. Under today’s order, an investment adviser will be able to charge performance fees if the client has at least $1 million under the management of the adviser, or if the client has a net worth of more than $2 million. Either of these tests must be met at the time of entering into the advisory contract. The previous thresholds were $750,000 and $1.5 million respectively, and were last revised in 1998.

The Dodd-Frank Act requires that the Commission issue an order to adjust for inflation these dollar amount thresholds by July 21, 2011 and every five years thereafter. The Commission published a notice of its intent to issue the order on May 10, 2011. The Commission also proposed amendments to rule 205-3, which are currently under consideration.

The order will be effective on September 19, 2011, which will be approximately 60 days after its publication in the Federal Register.

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Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration. He can be reached directly at 415-868-5345.

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CFTC Proposed Regulation 1.71 Article Published in NIBA Journal

Just a quick note that we had an article published in the June issue of the NIBA Journal titled How will the Proposed Swaps Regulations Affect IBs? In the article we discuss how the OTC derivatives regulations have essentially overshadowed some of the CFTC's other rulemaking initiatives like Proposed Regulation 1.71.  Proposed Regulation 1.71 would essentially require certain CFTC registered firms, inc

luding introducing brokers, to implement certain compliance procedures to separate research activities from execution activities.  Proposed Regulation 1.71 has not yet been finalized by the CFTC and we provide updates if new rules are adopted.

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Cole-Frieman & Mallon LLP provides legal services to the managed futures industry including CTA, CPO, and Introducing Broker registration and compliance services.  Bart Mallon can be reached directly at 415-868-5345.

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SEC Open Meeting re: Hedge Fund Registration

We are currently watching the webcast live and are posting our comments below.  You can watch the meeting live here: http://sec.gov/news/openmeetings.shtml.

We will be posting our review of the adopted regulations sometime later today.

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11:05 AM ET: the open meeting has started and Chairman Schapiro (“CS”) is currently providing an overview of the meeting today.

11:12 AM ET: the registration requirements will not go into effect until the first quarter of 2012 to allow the SEC time to prepare their systems to accept all the hedge fund registration applications.

11:15 AM ET: Bob Plaze discussing new rulemakings – hedge fund registration will be extended to March 30, 2012.  [No March 31, 2012 next year because of leap year.]

11:19 AM ET: Devin Sullivan discussing Form ADV amendments – important data on the private funds as well as service providers – auditors, prime brokers, custodians.  Competitively sensitive information will not be required.

11:20 AM ET: Devin Sullivan discussing Exempt Reporting Advisers will be required to complete certain parts of Form ADV.

11:21 AM ET: Devin Sullivan discussing switch for certain SEC registered managers to state registration.  Uniform method to calculate AUM.  Current SEC registered advisers will need to file an amendment to show they can remain SEC registered.

11:22 AM ET: Devin Sullivan discusses pay to play rules and Municipal Advisers.

11:24 AM ET: VC advisers get a break – they can have up to 20% of fund's assets in non-qualifying VC investments.  Other parts of the rule sound similar to the proposal.

11:25 AM ET: VC funds get grandfathering provision.

11:27 AM ET: $150M exemption rule is recommended to be adopted substantially as proposed.  http://www.hedgefundlawblog.com/rule-203m-1-%E2%80%93-private-fund-adviser-exemption.html

11:28 AM ET: Foreign private adviser rule is recommended to be adopted substantially as proposed.  http://www.hedgefundlawblog.com/rule-202a30-1-investment-advisers-act.html

11:29 AM ET: Commissioner Casey (“CC”) talking about VC funds and congressional intent.  Supports VC rule and 20% basket of non-VC investments.  Does not support some of the other rules – especially because of the exempt reporting advisers rule.

11:32 AM ET: CC disagrees with the reporting requirem

ents.  Does not think there is distinction between exempt advisers and registered advisers with respect

to disclosure information on the ADV.  Essentially she thinks this is a slippery slope.

11:34 AM ET: CC says the reporting requirements for exempt advisers needlessly imposes compliance requirements on incubating businesses.

11:36 AM ET: Commissioner Walter (“CW”) generally support the rulemaking.  Believes information from exempt reporting advisers (ERAs) will be important for the SEC.  But would have required broader information from the advisers.  Seems like she wants more information from ERAs; wants to revisit the disclosures in a year.

11:38 AM ET: CW – can we get more information on the 20% basket for VC funds?

11:38 AM ET: Sullivan – Designed to provide flexibility for VC funds.  The big question is whether it is 20% of invested or committed capital.  20% on committed, but the committment m

11:39 AM ET: CW – which states will examine advisers?

11:40 AM ET: Plaze – we asked all of the states about examination; MN would not be subject to examination.  SEC will treat NY advisers as not subject to examination.

11:42 AM ET:  Commissioner Aguilar (“CA”) makes a short statement and thank-yous.

11:44 AM ET:  Commissioner Varedes (“CV”) supports the 20% basket for VC funds.  Would have liked even more flexibility.

11:45 AM ET:  CV disagrees with ERA reporting requirements – reporting requirements too close to registered advisers.

[BM to update the votes]

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Family Office Definition

11:51 AM ET: CS providing background on family offices and proposed definition.  See earlier post: http://www.hedgefundlawblog.com/sec-proposes-family-office-definition.html

11:52 AM ET: Staff member discussing exclusion.  Certain conditions to prevent the family office to provide advice outside of the family, unless there is registration.

11:54 AM ET: Staff member discusses more technical parts of the proposal.

11:56 AM ET: CC, CW and CA did not have any questions for the staff.

11:58 AM ET: CP discusses some issues with respect to some of the changes made from the proposal.

11:59 AM ET: Plaze thanks commenters, especially the ABA, for their comments from a public policy perspective – the staff appreciates such comment letters.

11:59 AM ET: All Commissioners support adopting new family office rule.

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California Extends Hedge Fund Registration Exemption

Emergency Action “Necessary” because of SEC Inaction

The California Department of Corporations has provided a temporary six-month extension of Section 260.204.9 which exempts hedge fund managers from registration in California if the manager has more than $25M of AUM.  The exemption will be slightly modified to account for the changes to federal law as a result of the Dodd-Frank Act.  The exemption is also scheduled to become inoperative on January 21, 2012.

The emergency action was taken by California because the SEC recently announced that they intended to delay implementation of the federal hedge fund registration regulations until 2012.  The SEC is expected to formally announce that registration will be delayed until next year in an Open Meeting on June 22.  On such date we are expected to have a better timeline of when registration might be required.

Reasons for the Emergency Action

California provides the following background on the emergency action and why the state decided to move forward with extending the exemption:

… persons that may be required to register under final SEC rules would have a very limited time period in which to prepare their registration documents. In order to allow such persons to determine how SEC rules will ultimately affect their registration status, it is necessary to provide sufficient time for regulated persons to analyze the final rules and prepare any required application materials.

Additionally, the extension is necessary to allow the Department to study how best to regulate advisers to alternative investment vehicles, while balancing the regulatory burden on such advisers, with any corresponding investor protections issues.

Lastly, this extension is necessary to ensure the stability of California capital and labor markets. Alternative investment vehicles, including venture capital funds, have historically provided a crucial source of financing for California businesses.

…

These emergency regulations address the marketplace uncertainty that exists as a consequence of the operative date of the change in federal law, by temporarily continuing the existing California registration exemption for private advisers. The emergency regulations further will provide the Department and industry the opportunity for thoughtful dialogue on the appropriate measure of state oversight after the federal adoption of rules. These emergency regulations are intended to prevent a marketplace reaction of seeking registration in the face of uncertainly; resulting in businesses prematurely incurring costs to comply with a regulatory scheme that ultimately may prove unnecessary for some private advisers. Moreover, it is likely that most private advisers would not be able to secure registration prior to July 21, 2011, thus requiring that they immediately cease providing investment advisory services for compensation in California.

Other States Next?

There are a number of other states which have IA registration exemptions which are similar to the California exemption.  We expect to see similar pronouncements in the coming weeks from other states.  Then, after the SEC finalizes the registration regulations, we will see states drafting new laws that better integrate with the

new federal regulations.

The modified exemption can be found here: Section 260.204.9 (Effective July 21, 2011)

Background information and the finding of emergency can be found here: California Finding of Emergency

The notice can be found here: Notice of Emergency Action

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Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration. He can be reached directly at 415-868-5345.

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SEC Announces Open Meeting on Hedge Fund Regulations

SEC Considers Whether to Adopt Registration Requirement

Yesterday the SEC announced that they will conduct an Open Meeting on June 22 to determine whether to adopt the new hedge fund registration requirements and related rules. At the Open Meeting the SEC is expected to delay implementation of the regulations until next year.   While the SEC announced in a letter to NASAA that they would likely extend the registration deadline, there has been no official action on this issue.  This has left managers (and lawyers and compliance personnel) unsure of how to proceed.  We will know more after the June 22 meeting.

The notice of the Open Meeting, reprinted below in full, can be found here.  Hat tip to Doug Cornelius at Compliance Building for publishing this story earlier today.

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Notice is hereby given, pursuant to the provisions of the Government in the Sunshine Act, Pub. L. 94-409, that the Securities and Exchange Commission will hold an Open Meeting on June 22, 2011 at 10:00 a.m., in the Auditorium, Room L-002.

The subject matters of the Open Meeting will be:

Item 1: The Commission will consider whether to adopt new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to gi

ve effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration of investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and address reporting by certain investment advisers that are exempt from registration.

Item 2: The Commission will consider whether to adopt rules that would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to venture capital funds and advisers with less than $150 million in private fund assets under management in the United States. These exemptions were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The new rules also would clarify the meaning of certain terms included in a new exemption for foreign private advisers.

Item 3: The Commission will consider whether to adopt a rule defining “family offices” that will be excluded from the definition of an

investment adviser under the Investment Advisers Act of 1940.

At times, changes in Commission priorities require alterations in the scheduling of meeting items.

For further information and to ascertain what, if any, matters have been added, deleted or postponed, please contact:

The Office of the Secretary at (202) 551-5400.

Elizabeth M. Murphy

Secretary

June 8, 2011

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Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration.  He can be reached directly at 415-868-5345.

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California Extends IA Exemption for Hedge Fund Managers

Will Wait for SEC Final Registration Regulations to Propose New Rules

California currently has an exemption from the registration requirements for certain fund managers with more than $25M of AUM (Rule 260.204.9).  Back in March California requested input from the investment management community on how they might change the registration requirements when the SEC finalizes its IA registration rules as a result of the Dodd-Frank act.  At that time it was expected that the SEC would finalize its IA registration rules in time for managers to register before the July 21, 2011 registration deadline.  However, the SEC subsequently indicated that it would likely extend the registration deadline until the first quarter of 2012.  From this story by IA Watch, it looks like the Division of Investment Management is moving closer to officially moving the registration deadline to next year.

Because of the uncertaintly of rulemaking at the federal level, the states are left in limbo as to how to proceed with respect to fund managers who may or may not fit under certain exemptions after the federal laws

become effective (even if new federal rules are not yet effective).  California is addressing this exact scenario in a letter it addressed the investment management community on May 13, 2011.  The letter states:

“some uncertainty may exist about the need to become registered after July 21, 2011, for California IAs who are currently unregistered, in reliace on the existing exemption set forth in Rule 260.204.9.”

The letter goes on to state:

“The Department will soon issue emergency regulations to address this potential uncertainty.  These emergency regulations will amend Rule 260.204.9, but have the effect of preserving the status quo.  Therefore, California IAs who currently rely on the exemption from registration for private advisers, will be able to continue to rely on that exemption until such time as the Deparment adopts final rules related to private fund advisers.”

This is good news for current managers located in California and relying on the exemption from registration in California.  We believe that other states (such as Connecticut which has a similar exemption) will soon follow California and release emergency regulations to deal with issues related to the failure of the SEC to finalize the IA registration regulations.  Until the SEC does issue final regulations, it would seem that states would (or probably should) stop proposing changes to state regulations (see previous post on Massachusetts proposed changes).

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Cole-Frieman & Mallon LLP is a law firm focused on the investment management industry.  The firm provides investment adviser registration services to hedge funds and other investment managers.  Bart Mallon can be reached directly at 415-868-5345.

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SEC Proposes Change to Qualified Client Definition

Higher Threshold for Performance Fee Proposed

Under current SEC Rule 205-3, an SEC registered investment adviser can charge a performance fee (also called a performance allocation, incentive fee or incentive allocation) only to those investors who either has:

  • a $1.5M net worth or
  • at least $750,000 in assets with the manager

Many states have the same rules for state registered advisers or they explicitly make reference to the SEC regulation.

As a result of the Dodd-Frank act, the SEC is now proposing to increase the threshold for managers to be able to charge these performance fees.  The proposal declares that clients or investors of an SEC registered investment adviser can be charged a performance fee only if the client has:

  • a $2M net worth (excluding a primary residence) or
  • at least $1M in assets with the manager

What this means for SEC Registered Managers

While there will likely be a grandfathering provision for current fund managers with current investors who are “qualified clients”, when the new regulations go into effect, SEC registered managers (and potentially state registered managers) will likely need to make sure new investors meet the new threshold in order to charge these investors a performance fee.  Additionally, managers will need to update their offering documents to reflect the new definition (reprinted in full as proposed below).

The new regulation is likely to affect smaller funds disproportionally.  Many times smaller funds have investors who may just meet the qualified client threshold.  [Note: for some managers, they may allow non-qualified clients into the fund, but then just charge them a higher management fee in lieu of a performance allocation.]

Managers are urged to send comments to the SEC.  The comment period is open until July 11, 2011.

The SEC notice can be found here.

The full proposed rule can be found here: Performance Fee Rule Proposal.

Current comments on the proposal can be found here.

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Proposed Changes to Rule 205-3

Section 275.205-3 is amended by:

a.  Revising paragraph (c);

b.  Revising paragraphs (d)(1)(i) and (ii); and

c.  Adding paragraph (e).

The revisions and addition read as follows.

§ 275.205-3  Exemption from the compensation prohibition of section 205(a)(1) for investment advisers.

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(c)  Transition rules.

(1)  Registered investment advisers.  If a registered investment adviser entered into a contract and satisfied the conditions of this section that were in effect when the contract was entered into, the adviser will be considered to satisfy the conditions of this section; Provided, however, that if a natural person or company who was not a party to the contract becomes a party (including an equity owner of a private investment company advised by the adviser), the conditions of this section in effect at that time will apply with regar

d to that person or company.

(2)  Registered investment advisers that were previously exempt from registration. If an investment adviser was exempt from registration with the Commission pursuant to section 203 of the Act (15 U.S.C. 80b-3), section 205(a)(1) of the Act will not apply to an advisory contract entered into when the adviser was exempt, or to an account of an equity owner of a private investment company advised by the adviser if the account was established when the adviser was exempt; Provided, however, that section 205(a)(1) of the Act will apply with regard to a natural person or company who was not a party to the contract and becomes a party (including an equity owner of a private investment company advised by the adviser) when the adviser is no longer exempt.

(d)  Definitions. For the purposes of this section:

(1)  The term qualified client means:

(i)  A natural person who, or a company that, immediately after entering into the contract has at least $1,000,000 under the management of the investment adviser;

(ii)  A natural person who, or a company that, the investment adviser entering into the contract (and any person acting on his behalf) reasonably believes, immediately prior to entering into the contract, either:

(A)  Has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $2,000,000, excluding the value of the primary residence of such natural person, calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property; or

(B)  Is a qualified purchaser as defined in section 2(a)(51)(A) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(51)(A)) at the time the contract is entered into; or

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(e)  Inflation adjustments. Pursuant to section 205(e) of the Act, the dollar amounts specified in paragraphs (d)(1)(i) and (d)(1)(ii)(A) of this section shall be adjusted by order of the Commission, effective on or about May 1, 2016 and issued approximately every five years thereafter. The adjusted dollar amounts established in such orders shall be computed by:

(1)  Dividing the year-end value of the Personal Consumption

Expenditures Chain-Type Price Index (or any successor index thereto), as published by the United States Department of Commerce, for the calendar year preceding the calendar year in which the order is being issued, by the year-end value of such index (or successor) for the calendar year 1997;

(2)  For the dollar amount in paragraph (d)(1)(i) of this section, multiplying $750,000 times the quotient obtained in paragraph (e)(1) of this section and rounding the product to the nearest multiple of $100,000; and

(3)  For the dollar amount in paragraph (d)(1)(ii)(A) of this section, multiplying $1,500,000 times the quotient obtained in paragraph (e)(1) of this section and rounding the product to the nearest multiple of $100,000.

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Cole-Frieman & Mallon LLP is a hedge fund law firm focused on the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

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SALT Conference 2011

Hedge Fund Conference Judged a Success

I had the opportunity to make it to one day of the SALT conference in Las Vegas this week.  As I talked to managers, investors and service

providers, it became clear that the attendees were excited about the speakers, the panels and the networking opportunities.  For the most part, it seemed to me that most people were at the conference for the following reasons:

  • to hear what is going on in areas outside of their expertise
  • promotion – many service providers were there
  • to have in-person meetings with investors
  • to have in-person meetings with managers
  • general networking

I found it to be a great opportunity to have conversations and meetings with fellow service providers as well as potential clients and I certainly look forward to going back next year.

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Cole-Frieman & Mallon LLP is a hedge fund law firm focused on the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

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