Tag Archives: hedge fund registration

Obama Signs Historic Wall Street Reform Bill

Requires Hedge Fund and Private Equity Fund Managers to Register with SEC

As expected President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”) on Wednesday July 24, 2010. The Act was designed to address many of the issues that led to the financial crisis of 2008 and is being hailed as the largest financial regulatory bill since the various securities acts of the 1930s.

For most hedge fund and private equity fund managers, the major concern is the requirement that managers register with the SEC by July 24, 2011. Registration, of course, means that firms are going to be required to appoint a chief compliance office, comply with certain advertising restrictions and implement robust recordkeeping procedures. Along with the increased compliance and reporting requirements, managers should be aware that firms will also be subject to surprise or routine SEC audits.

Fund managers who run section 3(c)(1) funds should also be aware of the fact that the definition of both qualified client and accredited investor are affected. The definition of a qualified client will be required to be initially adjusted by the SEC and then will be adjusted every 5 years thereafter. The definition of an accredited investor now does not include the value of an investor’s primary residence. This definition will be subject to adjustment every 4 years.

Other interesting changes:

Venture Capital Funds – VC funds will not be required to register as investment advisers with the SEC, but the SEC may promulgate rules requiring such managers to keep certain records and make reports to the SEC.
Registered CPOs not subject to IA registration – a commodity pool operator which provides advice to a private fund which invests in securities will not also need to be registered as an investment adviser unless the CPO’s business becomes predominantly securities-related.
Recordkeeping – although hedge fund and private equity fund managers will be subject to reporting requirements, there is the possibility for enhanced confidentiality measures for some groups. [This is an issue we will likely hear much more about in the future.]
Short sale reporting – managers generally with $100M in AUM will be required to report their short positions to the SEC.
SIPC protection for futures – the Act extends SIPC protection for futures and options on futures in portfolio margining accounts.
Futures position limits – in the next 6 months the CFTC will be required to impose aggregate position limits on energy products and metals. In the next 9 months the CFTC will be required to impose aggregate position limits on agricultural commodities.
OTC Derivatives – formerly unregulated derivative transactions will now be regulated by the CFTC, SEC or both. These transactions will generally need to be cleared through central clearinghouses.

Many pundits have noted that most of the “real” change will take place through the agency rule-making process which is expected to commence shortly and last at least 12 months. Both the SEC and CFTC will be releasing rule proposals for comments and we will be reporting on these as they occur.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services to all types of investment managers. Bart Mallon, Esq. can be reached directly at 415-868-5345.

Financial Reform Bill Passes Senate

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As has been widely reported, the Senate passed the Financial Reform Bill setting the stage for President Obama to sign the bill within the next week. With respect to investment advisors, one of the central items is the private equity and hedge fund registration requirement. We will be reporting further on the bill in the coming days and weeks.

Hedge Fund Compliance Guide

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After the passage of the Dodd-Frank financial reform bill, managers and service providers will be preparing to go through the registration process. Managers should note that while the registration process is fairly straightforward, the ongoing compliance requirements under the Investment Advisers Act are perhaps more important. In this guide we will be providing an overview and links to the important compliance considerations.

Specifically, we will be discussing the practical application of the following rules to both hedge fund managers and private equity fund managers:

Rule 204-2 — Books and Records to Be Maintained by Investment Advisers
Rule 204-3 — Written Disclosure Statements
Rule 204A-1 — Investment Adviser Codes of Ethics
Rule 205-3 — Exemption from the Compensation Prohibition of Section 205(a)(1) for Investment Advisers
Rule 206(3)-2 — Agency Cross Transactions for Advisory Clients
Rule 206(4)-1 — Advertisements by Investment Advisers
Rule 206(4)-2 — Custody or Possession of Funds or Securities of Clients
Rule 206(4)-3 — Cash Payments for Client Solicitations
Rule 206(4)-4 — Financial and Disciplinary Information that Investment Advisers Must Disclose to Clients
Rule 206(4)-6 — Proxy Voting
Rule 206(4)-7 — Compliance Procedures and Practices

Business Continuity Plans

Rule 206(4)-8 — Pooled Investment Vehicles

This guide will complement the hedge fund registration guide we have developed as well.

Survey of State Securities Divisions

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Are States Equipped to Handle Increased IA Registrations?

Under the new financial reform bill, expected to be signed into law sometime in July 2010, the state securities divisions will play a larger role in the oversight of investment managers. Under the current system, investment advisers (who generally provide financial planning services or investment advice to individuals) with $30 million of AUM are required to register with the SEC. Under the new laws to take effect under the reform bill, investment advisers with up to $100 million of AUM will be required to register with the state of their principal place of business. This means that thousands of managers who are currently subject to SEC jurisdiction and oversight will become subject to state jurisdiction and oversight. We do not believe that the states have the desire, expertise or, most importantly, the budget to handle an increase in the jurisdiction and oversight. Because we think the states securities divisions are cash strapped, we conducted our own mini-survey to find out the answer. [Note: we also recommend the article The New Sheriffs in Town about this same issue.]

Survey of State Securities Divisions

Over the past couple of weeks, we called each state securities division and tried to speak with a person familiar with each division’s financial situation and other aspects of their operations. While we were not always able to speak with the appropriate person, we were at times able to divine interesting information from our discussion. For many states we have sent in record requests under the Freedom of Information Act and while our reports below are not complete, they do show us that a number of securities divisions are in fact having financial difficulties. These questions focus on the issues we think are important. [Please note: most of the answers below are not official but were instead taken from our informal phone conversations with people in the various divisions.]

Question: Is the securities division facing budget cuts?

Arizona – yes, there have been budget cuts over the last couple of years.
Delaware – no, but statewide salaries have been cut 2.5%
Kansas – there is a constrained budget
New Mexico – yes
Oregon – yes
Pennsylvania – budget restraints
Utah – yes
Vermont – yes, as of 2009
Washington – yes
Other: A number of divisions either stated no or that they could not provide that information.

Question: has the securities divisions faced staff reductions?

Utah – yes
Washington – operating under a hiring freeze
Other: A number of states said there were vacant positions (Alaska, Arizona, Delaware, Kansas, New Mexico (3))

Question: are division staff forced to take furlough days?

California – yes, either 1 or 2 Fridays a month
Colorado – yes, 1 days per month instituted in Fall of 2009
Connecticut – yes, instituted in 2008
Delaware – yes, instituted in 2009
Hawaii – yes
Maine – yes
Michigan – yes
Minnesota – yes
Nevada – yes
New Mexico – in 2009 (5 days) but not in 2010
Oregon – yes
Vermont – yes – instituted in 2009
Virginia – yes
Washington – yes
Wisconsin – yes

[Note: we expect this number to rise as soon as we receive information back from our Freedom of Information Act requests.]

Question: how many staff members does the division employ?

Arkansas – 38
Delaware – 13 (2 examiners)
Indiana – 18-20 (1 examiner)
Louisiana – 11 (2 examiners)
Montana – 5 (2 examiners)
Nebraska – 10 (1 examiner)
New Hampshire – 10 (2 examiners)
New Mexico – 22 (1 examiner)
North Dakota – 9 (3 examiners)
Utah – 19 (5 examiners)
Washington – 38 (8 examiners)
West Virginia – 11 (5 examiners)
Wisconsin – 16 (10 examiners)

Question: how often does the division audit registrants?

Indiana – 3-4 year cycle
Louisiana – 2 year cycle
Montana – 3 year cycle
Nebraska – every 2-3 years
New Hampshire – risk-based cycle
New Mexico – 3 year cycle
Utah – 5 audits per month (3 routine, 2 for cause; mostly broker-dealer issues)
Virginia – 3.5 year cycle
Washington – high-risk firms audited 1-2 years; lower risk firms audited every several years
Wisconsin – 3 year cycle

We will periodically update this information as we receive it from the divisions.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides legal support and hedge fund compliance services. Bart Mallon, Esq. can be reached directly at 415-868-5345.

Wall Street Reform Bill Issues – Performance of State Securities Regulators

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As we move closer to the signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act, more groups are highlighting the fact that state securities divisions are going to be affected by the act. After pressure from NASAA, the association of state securities regulators, Congress has provided that state regulators will be required to provide oversight of investment advisers with up to $100 million of AUM – a significant increase from the current level of $30 million of AUM. Of course this will increase the number of advisers that the states oversee and will make the job of the securities divisions much more difficult. We have consistently stated that we do not think the states, collectively, are going to be capable to provide proper oversight with the increase in responsibility – mostly because of budget issues. We have been surveying the states to see which divisions have budget issues and will be reporting on that shortly. Until then we will examine one securities division which has faced scrutiny from members of the investment community and the state legislature.

Overview of Utah Division of Securities Audit

Over the years there has been a number of complaints about the manner in which the Utah Division of Securities conducts business – a simple Google search will reveal a number of interesting stories. After repeated complaints the state legislature decided to audit the division and released a report in July of 2008 entitled A Performance Audit of the Division of Securities.

The results are nothing less than shocking.

Faith in government agencies is based on the belief that they will act fairly and effectively. The report shows capricious behavior and essentially a belief that members of the investment management community are ‘guilty’ until proven ‘innocent’. Special attention should be paid to the fact that the state securities divisions do have power to make life miserable for a business owner, even if that business owner has not acted wrongly. Redress is difficult and “the Division Always Wins” (see below). It is in with this understanding that we question whether the states will be in the best position to oversee the investment management industry.

Below are a number of direct quotes from the audit – many should make any ready angry and sick. [Please note that we are not saying that all securities divisions have these problems. Additionally, we have not conducted any follow up with Utah so we do not express any opinion on the current state of the division.]

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Reason for audit:

The credibility of the Division of Securities has been challenged by those investigated by the division. Their concerns are with procedural errors, an alleged overzealous pursuit of securities violations, and the perception that those investigated do not receive fair treatment.

While the division protects securities investors, it is alleged the division has abused its power and damaged reputations. The division has significant authority but its credibility depends on using that authority judiciously.

Page i

Ad Hoc Manner of Conducting Investigations:

There does not appear to be a consistent relationship between the number of complaints, number of cases opened, and the number of actions filed. This is because cases can be opened without a resulting action, there can be multiple actions on one case, or the action may not be filed until the following year. In addition, our evaluation leads us to believe the information is not reliable.

Page 3

Reason for Division Audit

Legislators requested this audit based on concerns about how the division managed three cases. We reviewed the division’s administrative process followed in these cases and a number of others brought to our attention. We did not address the legal issues of any of the cases. Our work has been complicated by the desire of many interviewees to keep their names confidential. They fear reprisal for criticizing the division’s actions.

Page 9

Lack of Policies & Procedures Equals Inconsistent Decisions

The division has not been operating under set, written policies and procedures. As a result, division decisions for actions against the regulated industry and the treatment of its employees rest solely with department and division management. Frequent management changes have brought changes in management philosophy and an increased likelihood for inconsistent decisions.

Page 9

Years of No Policies & Procedures

During the course of this audit, we were told that the division did have policies and procedures a number of years ago. However, there have been no written policies and procedures in place, or operational procedures followed, for at least the last four years under the direction of three division directors. Shortly before this audit’s completion, division staff found a discarded copy of a 1993 policies and procedures manual. It is disconcerting that the division has faced procedural control difficulties for a number of years, yet no one in either departmental or divisional leadership noted the lack of policies and procedures.

Page 9 and 10

HUGE ISSUE FOR STATE REGISTERED MANAGERS

Complaints surfaced that those charged with securities violations could not get a fair hearing.

Page 10

Division Bias Ignored

In several cases, it was questionable if the former director had maintained an independent and unbiased perspective. For example, the former director did not recuse himself from serving as the presiding officer after helping to draft the pleadings for the case. It was apparent he was no longer impartial. Even the perception that the presiding officer is biased is concerning as it can give the appearance of unfair treatment.

Page 10

Intimidation…and…the Division always wins…

Those accused of securities violations told us they felt intimidated into settling, given that the division’s former director would likely serve as the presiding officer. One business owner perceived the system as “a stacked deck” because the investigator, jury, and judge are all in the same office. He informed us that during an investigation, a division employee boasted that the division always wins.

Page 11

State Lawyer Effectively Pushed Out

poor communication between the former director and an attorney resulted in the exclusion of the attorney from a decision on how a case would be handled, even though the attorney had been involved in the case for a number of months. The attorney was frustrated and raised concerns when the former director drafted and sent out documents over the attorney’s name, thus implying the AG gave his approval, even though the attorney was not aware a decision had been made and had not reviewed the final document. He learned about the legal action when defendants contacted him because they assumed he represented the division. The former director contends that the attorney was familiar with the document.

Pages 12-13

Questionable Actions

During the audit, many individuals associated with various cases contacted us with complaints about the division. Our review of case files resulted in a number of questionable actions including: inappropriate publicity, emphasis on punishment rather than compliance, the use of intimidation tactics, violating terms of settlement agreements, failure to notify those being investigated, and inconsistent case management.

Page 15

Fear of Retaliation!!??

To evaluate these complaints, we reviewed case files, listened to tapes of hearings, and interviewed staff and attorneys involved with the cases. Many of those who talked with us requested confidentiality because they feared retaliatory action by the division if they were identified.

Page 15

Inconsistent Procedures…

questionable actions often can be attributed to the divisions lack of clearly defined procedures. A discarded policy manual states that “the manual will be reviewed and updated on a yearly basis to reflect current or additional practices.” Not complying with this requirement has resulted in division policies and procedures that are inconsistently applied.

Page 15

Emphasis on Punishment Rather than Compliance

The division appears to emphasize punishment of offenders rather than compliance with securities laws. A number of those involved in the division’s actions believe the division has overzealously pursued securities violations. They criticize that charges are brought one after another, cases are drawn out over long periods of time, and decisions on who to investigate can be arbitrary.

Page 17

Threats and Coercion

The division’s use of intimidation to obtain information has been cited by both those being investigated and others involved with the division. In one case, the accused stated that an investigator attempted to coerce cooperation by intimidating and threatening that the person would be arrested. In another case, investigators seized personal information by copying all information from the business owner’s computer without distinguishing business and personal information. The owner said that he complied with the investigator’s demands only because they threatened to immediately close him down if he refused.

Page 18-19

Does not Honor Settlement Agreements

The division has, at times, violated the terms of its settlement agreements. In one case, the division agreed to not publicize the action or commence further administrative actions and then violated both terms of the agreement. The person accused told us he felt compelled to plead guilty to a lesser criminal charge rather than place his business in jeopardy defending a greater charge. The division agreed to not seek additional charges but nevertheless pursued an administrative action. The respondent then signed the settlement agreement after the division agreed to not publicize it. However, the day the settlement was signed, the division publicized the information on its web page and also published the information in its newsletter the following month.

Page 19-20

Surprised Charges Filed…Harming Innocent Business

According to the business owner, he learned about the investigation only after it was completed and charges were filed. Before he had an opportunity to respond, the media called to ask about the division revoking his license and issuing fraud charges. The media release was damaging to the business and the resulting retraction and apology was damaging to the division.

Page 21

Fines Arbitrary!!??

The division has been criticized for not identifying how fines are set. Board minutes disclosed the former director explained that fines are set to “make it hurt,” which is troublesome to those in the securities industry. The former director explained to us that fines are set based on an evaluation of the seriousness, nature, circumstances, and persistence of the conduct which is consistent with the Financial Industry Regulatory Authority (FINRA) guidelines. However, because the division does not have written guidelines or procedures identifying the process used to set fines, they appear to be set arbitrarily, based solely at the discretion of the division.

Page 22

Staff Demoralized, Scared of Reprisal

Personnel conflicts within the Division of Securities (division) have resulted in management turnover and a demoralized staff. Both the department executive director and the division’s former director have been open about their beliefs that specific employees have seemed reluctant to accept change and may be subverting management authority. A number of division staff feel their jobs are threatened or other forms of management reprisal may occur should they offend management in some way. The escalating conflicts have resulted in reprimands, restructuring, and ultimately, the resignation of the director, and the threat of legal action by several employees.

Page 25

Division Blatantly Breaks Laws at Director’s Direction

After being hired in October 2005, a number of the former director’s actions have been questionable. He was reprimanded and received a one-day suspension without pay for instructing staff to hold fine payment checks without processing them within the three-day time period required by statute (Utah Code 51-4-1). Delaying the deposit would allow the division to retain funds in the division rather than transfer them to the state general fund. By statute, if a balance in the division’s education fund exceeds $100,000 at the close of a fiscal year, the excess must be transferred to the General Fund (Utah Code 61-1-18.7(6)).

Staff related other instances in which they feel the former director gave them inappropriate directions. For example, staff provided information showing the director:

directed staff to sign pleadings that the former director had either drafted or modified, possibly to prevent his name, as the presiding officer, from appearing on documents. Administrative rules state “the signature shall be deemed to be a certification that the signer has read the pleading and that, to the best of his knowledge and belief, there is good ground to support it.”

directed staff to provide protected information to an influential person which violates Utah securities law prohibiting employees from disclosing non-public information filed with or obtained by the division (Utah Code 61-1-18.3).

used coercive settlement tactics by instructing staff to keep unwarranted allegations in the pleadings to serve as a bargaining chip for the negotiations. The respondent agreed to the settlement after the allegations were removed.

Page 30-31

We hope that this provides another look at the issue of having the states responsible for investment advisers with a wide ranging practice which may involve investors from many states.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive formation and hedge fund start up support. Bart Mallon, Esq. can be reached directly at 415-868-5345.

Wall Street Reform and Consumer Protection Act

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Financial Reform Bill Overview & Hedge Fund Registration Requirement

Well over a year after Lehman and Madoff, Congress has finally drafted a single financial reform bill which will be voted on by the House and Senate before being signed by President Obama. Below we have reprinted an overview of the major provisions of the act. As has been regularly discussed over the last few months, hedge funds (and private equity funds) with assets of $100 million will be required to register with the SEC. Additionally, investment advisers who were previously subject to SEC jurisdiction (i.e. mangers with AUM of $30 million to $100 million) will now become subject to state regulation (for more on this terrible idea, please see my article on overburdened state securities divisions).

In addition to hedge fund registration, other major provisions of the bill which will likely have an impact on hedge funds and the investment management industry include:

New Consumer Financial Protection Bureau with a Consumer Hotline
New Financial Stability Oversight Council (could potentially require funds to be subject to supervision by Federal Reserve)
Volcker Rule (limiting bank prop trading and sponsorship of hedge funds)
Increased Transparency into OTC Derivatives (including foreign exchange swaps)
Potential Fiduciary Duty for Brokers furnishing investment advice
Increased SEC funding

The following press release from the House Committee on Financial Services can be found here.

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Dodd-Frank Wall Street Reform and Consumer Protection Act

Create a Sound Economic Foundation to Grow Jobs, Protect Consumers,Rein in Wall Street, End Too Big to Fail, Prevent Another Financial Crisis

Washington, DC – Americans have faced the worst financial crisis since the Great Depression. Millions have lost their jobs, businesses have failed, housing prices have dropped, and savings were wiped out.

The failures that led to this crisis require bold action. We must restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them. We must create a sound foundation to grow the economy and create jobs.

HIGHLIGHTS OF THE LEGISLATION

Consumer Protections with Authority and Independence: Creates a new independent watchdog, housed at the Federal Reserve, with the authority to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, and protect them from hidden fees, abusive terms, and deceptive practices.

Ends Too Big to Fail Bailouts: Ends the possibility that taxpayers will be asked to write a check to bail out financial firms that threaten the economy by: creating a safe way to liquidate failed financial firms; imposing tough new capital and leverage requirements that make it undesirable to get too big; updating the Fed’s authority to allow system-wide support but no longer prop up individual firms; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.

Advance Warning System: Creates a council to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the economy.

Transparency & Accountability for Exotic Instruments: Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated — including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders.

Executive Compensation and Corporate Governance: Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation and golden parachutes.

Protects Investors: Provides tough new rules for transparency and accountability for credit rating agencies to protect investors and businesses.

Enforces Regulations on the Books: Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefits special interests at the expense of American families and businesses.

STRONG CONSUMER FINANCIAL PROTECTION WATCHDOG

The Consumer Financial Protection Bureau

Independent Head: Led by an independent director appointed by the President and confirmed by the Senate.
Independent Budget: Dedicated budget paid by the Federal Reserve system.
Independent Rule Writing: Able to autonomously write rules for consumer protections governing all financial institutions – banks and non-banks – offering consumer financial services or products.
Examination and Enforcement: Authority to examine and enforce regulations for banks and credit unions with assets of over $10 billion and all mortgage-related businesses (lenders, servicers, mortgage brokers, and foreclosure scam operators), payday lenders, and student lenders as well as other non-bank financial companies that are large, such as debt collectors and consumer reporting agencies. Banks and Credit Unions with assets of $10 billion or less will be examined for consumer complaints by the appropriate regulator.
Consumer Protections: Consolidates and strengthens consumer protection responsibilities currently handled by the Office of the Comptroller of the Currency, Office of Thrift Supervision, Federal Deposit Insurance Corporation, Federal Reserve, National Credit Union Administration, the Department of Housing and Urban Development, and Federal Trade Commission. Will also oversee the enforcement of federal laws intended to ensure the fair, equitable and nondiscriminatory access to credit for individuals and communities.
Able to Act Fast: With this Bureau on the lookout for bad deals and schemes, consumers won’t have to wait for Congress to pass a law to be protected from bad business practices.
Educates: Creates a new Office of Financial Literacy.
Consumer Hotline: Creates a national consumer complaint hotline so consumers will have, for the first time, a single toll-free number to report problems with financial products and services.
Accountability: Makes one office accountable for consumer protections. With many agencies sharing responsibility, it’s hard to know who is responsible for what, and easy for emerging problems that haven’t historically fallen under anyone’s purview, to fall through the cracks.
Works with Bank Regulators: Coordinates with other regulators when examining banks to prevent undue regulatory burden. Consults with regulators before a proposal is issued and regulators could appeal regulations they believe would put the safety and soundness of the banking system or the stability of the financial system at risk.
Clearly Defined Oversight: Protects small business from unintentionally being regulated by the CFPB, excluding businesses that meet certain standards.

LOOKING OUT FOR THE NEXT BIG PROBLEM: ADDRESSING SYSTEMIC RISKS

The Financial Stability Oversight Council

Expert Members: Made up of 10 federal financial regulators and an independent member and 5 nonvoting members, the Financial Stability Oversight Council will be charged with identifying and responding to emerging risks throughout the financial system. The Council will be chaired by the Treasury Secretary and include the Federal Reserve Board, SEC, CFTC, OCC, FDIC, FHFA, NCUA and the new Consumer Financial Protection Bureau. The 5 nonvoting members include OFR, FIO, and state banking, insurance, and securities regulators.
Tough to Get Too Big: Makes recommendations to the Federal Reserve for increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, with significant requirements on companies that pose risks to the financial system.
Regulates Nonbank Financial Companies: Authorized to require, with a 2/3 vote, that a nonbank financial company be regulated by the Federal Reserve if the council believe there would be negative effects on the financial system if the company failed or its activities would pose a risk to the financial stability of the US.
Break Up Large, Complex Companies: Able to approve, with a 2/3 vote, a Federal Reserve decision to require a large, complex company, to divest some of its holdings if it poses a grave threat to the financial stability of the United States – but only as a last resort.
Technical Expertise: Creates a new Office of Financial Research within Treasury to be staffed with a highly sophisticated staff of economists, accountants, lawyers, former supervisors, and other specialists to support the council’s work by collecting financial data and conducting economic analysis.
Make Risks Transparent: Through the Office of Financial Research and member agencies the council will collect and analyze data to identify and monitor emerging risks to the economy and make this information public in periodic reports and testimony to Congress every year.
No Evasion: Large bank holding companies that have received TARP funds will not be able to avoid Federal Reserve supervision by simply dropping their banks. (the “Hotel California” provision)
Capital Standards: Establishes a floor for capital that cannot be lower than the standards in effect today.

ENDING TOO BIG TO FAIL BAILOUTS

Limiting Large, Complex Financial Companies and Preventing Future Bailouts

No Taxpayer Funded Bailouts: Clearly states taxpayers will not be on the hook to save a failing financial company or to cover the cost of its liquidation.
Discourage Excessive Growth & Complexity: The Financial Stability Oversight Council will monitor systemic risk and make recommendations to the Federal Reserve for increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, with significant requirements on companies that pose risks to the financial system.
Volcker Rule: Requires regulators implement regulations for banks, their affiliates and holding companies, to prohibit proprietary trading, investment in and sponsorship of hedge funds and private equity funds, and to limit relationships with hedge funds and private equity funds. Nonbank financial institutions supervised by the Fed will also have restrictions on proprietary trading and hedge fund and private equity investments. The Council will study and make recommendations on implementation to aid regulators.
Extends Regulation: The Council will have the ability to require nonbank financial companies that pose a risk to the financial stability of the United States to submit to supervision by the Federal Reserve.
Payment, clearing, and settlement regulation. Provides a specific framework for promoting uniform risk-management standards for systemically important financial market utilities and systemically important payment, clearing, and settlement activities conducted by financial institutions.
Funeral Plans: Requires large, complex financial companies to periodically submit plans for their rapid and orderly shutdown should the company go under. Companies will be hit with higher capital requirements and restrictions on growth and activity, as well as divestment, if they fail to submit acceptable plans. Plans will help regulators understand the structure of the companies they oversee and serve as a roadmap for shutting them down if the company fails. Significant costs for failing to produce a credible plan create incentives for firms to rationalize structures or operations that cannot be unwound easily.
Liquidation: Creates an orderly liquidation mechanism for FDIC to unwind failing systemically significant financial companies. Shareholders and unsecured creditors bear losses and management and culpable directors will be removed.
Liquidation Procedure: Requires that Treasury, FDIC and the Federal Reserve all agree to put a company into the orderly liquidation process because its failure or resolution in bankruptcy would have adverse effects on financial stability, with an up front judicial review.
Costs to Financial Firms, Not Taxpayers: Taxpayers will bear no cost for liquidating large, interconnected financial companies. FDIC can borrow only the amount of funds to liquidate a company that it expects to be repaid from the assets of the company being liquidated. The government will be first in line for repayment. Funds not repaid from the sale of the company’s assets will be repaid first through the claw back of any payments to creditors that exceeded liquidation value and then assessments on large financial companies, with the riskiest paying more based on considerations included in a risk matrix
Federal Reserve Emergency Lending: Significantly alters the Federal Reserve’s 13(3) emergency lending authority to prohibit bailing out an individual company. Secretary of the Treasury must approve any lending program, and such programs must be broad based and not aid a failing financial company. Collateral must be sufficient to protect taxpayers from losses.
Bankruptcy: Most large financial companies that fail are expected to be resolved through the bankruptcy process.
Limits on Debt Guarantees: To prevent bank runs, the FDIC can guarantee debt of solvent insured banks, but only after meeting serious requirements: 2/3 majority of the Board and the FDIC board must determine there is a threat to financial stability; the Treasury Secretary approves terms and conditions and sets a cap on overall guarantee amounts; the President activates an expedited process for Congressional approval.

REFORMING THE FEDERAL RESERVE

Federal Reserve Emergency Lending: Limits the Federal Reserve’s 13(3) emergency lending authority by prohibiting emergency lending to an individual entity. Secretary of the Treasury must approve any lending program, programs must be broad based, and loans cannot be made to insolvent firms. Collateral must be sufficient to protect taxpayers from losses.
Audit of the Federal Reserve: GAO will conduct a one-time audit of all Federal Reserve 13(3) emergency lending that took place during the financial crisis. Details on all lending will be published on the Federal Reserve website by December 1, 2010. In the future GAO will have authority to audit 13(3) and discount window lending, and open market transactions.
Transparency – Disclosure: Requires the Federal Reserve to disclose counterparties and information about amounts, terms and conditions of 13(3) and discount window lending, and open market transactions on an on-going basis, with specified time delays.
Supervisory Accountability: Creates a Vice Chairman for Supervision, a member of the Board of Governors of the Federal Reserve designated by the President, who will develop policy recommendations regarding supervision and regulation for the Board, and will report to Congress semi-annually on Board supervision and regulation efforts.
Federal Reserve Bank Governance: GAO will conduct a study of the current system for appointing Federal Reserve Bank directors, to examine whether the current system effectively represents the public, and whether there are actual or potential conflicts of interest. It will also examine the establishment and operation of emergency lending facilities during the crisis and the Federal Reserve banks involved therein. The GAO will identify measures that would improve reserve bank governance.
Election of Federal Reserve Bank Presidents: Presidents of the Federal Reserve Banks will be elected by class B directors – elected by district member banks to represent the public – and class C directors – appointed by the Board of Governors to represent the public. Class A directors – elected by member banks to represent member banks – will no longer vote for presidents of the Federal Reserve Banks.
Limits on Debt Guarantees: To prevent bank runs, the FDIC can guarantee debt of solvent insured banks, but only after meeting serious requirements: 2/3 majority of the Federal Reserve Board and the FDIC board determine there is a threat to financial stability; the Treasury Secretary approves terms and conditions and sets a cap on overall guarantee amounts; the President initiates an expedited process for Congressional approval.

CREATING TRANSPARENCY AND ACCOUNTABILITY FOR DERIVATIVES

Bringing Transparency and Accountability to the Derivatives Market

Closes Regulatory Gaps: Provides the SEC and CFTC with authority to regulate over-the-counter derivatives so that irresponsible practices and excessive risk-taking can no longer escape regulatory oversight.
Central Clearing and Exchange Trading: Requires central clearing and exchange trading for derivatives that can be cleared and provides a role for both regulators and clearing houses to determine which contracts should be cleared. Requires the SEC and the CFTC to pre-approve contracts before clearing houses can clear them.
Market Transparency: Requires data collection and publication through clearing houses or swap repositories to improve market transparency and provide regulators important tools for monitoring and responding to risks.
Regulates Foreign Exchange Transactions: Foreign exchange swaps will be regulated like all other Wall Street contracts. At $60 trillion, this is the second largest component of the swaps market and must be regulated.
Increases Enforcement Authority to Punish Bad Behavior: Regulators will be given broad enforcement authority to punish bad actors that knowingly help clients defraud third parties or the public such as when Wall Street helped Greece use swaps to hide the true state of the country’s finances and doubles penalties for evading the clearing requirement.
Higher standard of conduct: Establishes a code of conduct for all registered swap dealers and major swap participants when advising a swap entity. When acting as counterparties to a pension fund, endowment fund, or state or local government, dealers are to have a reasonable basis to believe that the fund or governmental entity has an independent representative advising them.

NEW OFFICES OF MINORITY AND WOMEN INCLUSION

At federal banking and securities regulatory agencies, the bill establishes an Office of Minority and Women Inclusion that will, among other things, address employment and contracting diversity matters. The offices will coordinate technical assistance to minority-owned and women-owned businesses and seek diversity in the workforce of the regulators.

MORTGAGE REFORM

Require Lenders Ensure a Borrower’s Ability to Repay: Establishes a simple federal standard for all home loans: institutions must ensure that borrowers can repay the loans they are sold.
Prohibit Unfair Lending Practices: Prohibits the financial incentives for subprime loans that encourage lenders to steer borrowers into more costly loans, including the bonuses known as “yield spread premiums” that lenders pay to brokers to inflate the cost of loans. Prohibits pre-payment penalties that trapped so many borrowers into unaffordable loans.
Establishes Penalties for Irresponsible Lending: Lenders and mortgage brokers who don’t comply with new standards will be held accountable by consumers for as high as three-years of interest payments and damages plus attorney’s fees (if any). Protects borrowers against foreclosure for violations of these standards.
Expands Consumer Protections for High-Cost Mortgages: Expands the protections available under federal rules on high-cost loans — lowering the interest rate and the points and fee triggers that define high cost loans.
Requires Additional Disclosures for Consumers on Mortgages: Lenders must disclose the maximum a consumer could pay on a variable rate mortgage, with a warning that payments will vary based on interest rate changes.
Housing Counseling: Establishes an Office of Housing Counseling within HUD to boost homeownership and rental housing counseling.

HEDGE FUNDS

Raising Standards and Regulating Hedge Funds

Fills Regulatory Gaps: Ends the “shadow” financial system by requiring hedge funds and private equity advisors to register with the SEC as investment advisers and provide information about their trades and portfolios necessary to assess systemic risk. This data will be shared with the systemic risk regulator and the SEC will report to Congress annually on how it uses this data to protect investors and market integrity.
Greater State Supervision: Raises the assets threshold for federal regulation of investment advisers from $30 million to $100 million, a move expected to significantly increase the number of advisors under state supervision. States have proven to be strong regulators in this area and subjecting more entities to state supervision will allow the SEC to focus its resources on newly registered hedge funds.

CREDIT RATING AGENCIES

New Requirements and Oversight of Credit Rating Agencies

New Office, New Focus at SEC: Creates an Office of Credit Ratings at the SEC with expertise and its own compliance staff and the authority to fine agencies. The SEC is required to examine Nationally Recognized Statistical Ratings Organizations at least once a year and make key findings public.
Disclosure: Requires Nationally Recognized Statistical Ratings Organizations to disclose their methodologies, their use of third parties for due diligence efforts, and their ratings track record.
Independent Information: Requires agencies to consider information in their ratings that comes to their attention from a source other than the organizations being rated if they find it credible.
Conflicts of Interest: Prohibits compliance officers from working on ratings, methodologies, or sales; installs a new requirement for NRSROs to conduct a one-year look-back review when an NRSRO employee goes to work for an obligor or underwriter of a security or money market instrument subject to a rating by that NRSRO; and mandates that a report to the SEC when certain employees of the NRSRO go to work for an entity that the NRSRO has rated in the previous twelve months.
Liability: Investors can bring private rights of action against ratings agencies for a knowing or reckless failure to conduct a reasonable investigation of the facts or to obtain analysis from an independent source. NRSROs will now be subject to “expert liability” with the nullification of Rule 436(g) which provides an exemption for credit ratings provided by NRSROs from being considered a part of the registration statement.
Right to Deregister: Gives the SEC the authority to deregister an agency for providing bad ratings over time.
Education: Requires ratings analysts to pass qualifying exams and have continuing education.
Eliminates Many Statutory and Regulatory Requirements to Use NRSRO Ratings: Reduces over-reliance on ratings and encourages investors to conduct their own analysis.
Independent Boards: Requires at least half the members of NRSRO boards to be independent, with no financial stake in credit ratings.
Ends Shopping for Ratings: The SEC shall create a new mechanism to prevent issuers of asset backed-securities from picking the agency they think will give the highest rating, after conducting a study and after submission of the report to Congress.

EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE

Gives Shareholders a Say on Pay and Creating Greater Accountability

Vote on Executive Pay and Golden Parachutes: Gives shareholders a say on pay with the right to a non-binding vote on executive pay and golden parachutes. This gives shareholders a powerful opportunity to hold accountable executives of the companies they own, and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and in turn the broader economy.
Nominating Directors: Gives the SEC authority to grant shareholders proxy access to nominate directors. Also requires directors to win by a majority vote in uncontested elections. These requirements can help shift management’s focus from short-term profits to long-term growth and stability.
Independent Compensation Committees: Standards for listing on an exchange will require that compensation committees include only independent directors and have authority to hire compensation consultants in order to strengthen their independence from the executives they are rewarding or punishing.
No Compensation for Lies: Requires that public companies set policies to take back executive compensation if it was based on inaccurate financial statements that don’t comply with accounting standards.
SEC Review: Directs the SEC to clarify disclosures relating to compensation, including requiring companies to provide charts that compare their executive compensation with stock performance over a five-year period.
Enhanced Compensation Oversight for Financial Industry: Requires Federal financial regulators to issue and enforce joint compensation rules specifically applicable to financial institutions with a Federal regulator.

IMPROVEMENTS TO BANK AND THRIFT REGULATIONS

Volcker Rule: Implements a strengthened version of the Volcker rule by not allowing a study of the issue to undermine the prohibition on proprietary trading and investing a banking entity’s own money in hedge funds, with a de minimis exception for funds where the investors require some “skin in the game” by the investment advisor–up to 3% of tier 1 capital in the aggregate
Abolishes the Office of Thrift Supervision: Shuts down this dysfunctional regulator and transfers authorities mainly to the Office of the Comptroller of the Currency, but preserves the thrift charter.
Stronger lending limits: Adds credit exposure from derivative transactions to banks’ lending limits.
Improves supervision of holding company subsidiaries: Requires the Federal Reserve to examine non-bank subsidiaries that are engaged in activities that the subsidiary bank can do (e.g. mortgage lending) on the same schedule and in the same manner as bank exams, Providesthe primary federal bank regulator backup authority if that does not occur.
Intermediate Holding Companies: Allows use of intermediate holding companies by commercial firms that control grandfathered unitary thrift holding companies to better regulate the financial activities, but not the commercial activities.
Interest on business checking: Repeals the prohibition on banks paying interest on demand deposits.
Charter Conversions: Removes a regulatory arbitrage opportunity by prohibiting a bank from converting its charter (unless both the old regulator and new regulator do not object) in order to get out from under an enforcement action.
Establishes New Offices of Minority and Women Inclusion at the federal financial agencies

INSURANCE

Federal Insurance Office: Creates the first ever office in the Federal government focused on insurance. The Office, as established in the Treasury, will gather information about the insurance industry, including access to affordable insurance products by minorities, low- and moderate- income persons and underserved communities. The Office will also monitor the insurance industry for systemic risk purposes.
International Presence: The Office will serve as a uniform, national voice on insurance matters for the United States on the international stage.
Streamlines regulation of surplus lines insurance and reinsurance through state-based reforms.

INTERCHANGE FEES

Protects Small Businesses from Unreasonable Fees: Requires Federal Reserve to issue rules to ensure that fees charged to merchants by credit card companies for credit or debit card transactions are reasonable and proportional to the cost of processing those transactions.

CREDIT SCORE PROTECTION

Monitor Personal Financial Rating: Allows consumers free access to their credit score if their score negatively affects them in a financial transaction or a hiring decision. Gives consumers access to credit score disclosures as part of an adverse action and risk-based pricing notice.

SEC AND IMPROVING INVESTOR PROTECTIONS

SEC and Improving Investor Protections

Fiduciary Duty: Gives SEC the authority to impose a fiduciary duty on brokers who give investment advice –the advice must be in the best interest of their customers.
Encouraging Whistleblowers: Creates a program within the SEC to encourage people to report securities violations, creating rewards of up to 30% of funds recovered for information provided.
SEC Management Reform: Mandates a comprehensive outside consultant study of the SEC, an annual assessment of the SEC’s internal supervisory controls and GAO review of SEC management.
New Advocates for Investors: Creates the Investment Advisory Committee, a committee of investors to advise the SEC on its regulatory priorities and practices; the Office of Investor Advocate in the SEC, to identify areas where investors have significant problems dealing with the SEC and provide them assistance; and an ombudsman to handle investor complaints.
SEC Funding: Provides more resources to the chronically underfunded agency to carry out its new duties.

SECURITIZATION

Reducing Risks Posed by Securities

Skin in the Game: Requires companies that sell products like mortgage-backed securities to retain at least 5% of the credit risk, unless the underlying loans meet standards that reduce riskiness. That way if the investment doesn’t pan out, the company that packaged and sold the investment would lose out right along with the people they sold it to.
Better Disclosure: Requires issuers to disclose more information about the underlying assets and to analyze the quality of the underlying assets.

MUNICIPAL SECURITIES

Better Oversight of Municipal Securities Industry

Registers Municipal Advisors: Requires registration of municipal advisors and subjects them rules written by the MSRB and enforced by the SEC.
Puts Investors First on the MSRB Board: Ensures that at all times, the MSRB must have a majority of independent members, to ensure that the public interest is better protected in the regulation of municipal securities.
Fiduciary Duty: Imposes a fiduciary duty on advisors to ensure that they adhere to the highest standard of care when advising municipal issuers.

TACKLING THE EFFECTS OF THE MORTGAGE CRISIS

Neighborhood Stabilization Program: Provides $1 billion to States and localities to combat the ugly impact on neighborhood of the foreclosure crisis — such as falling property values and increased crime – by rehabilitating, redeveloping, and reusing abandoned and foreclosed properties.
Emergency Mortgage Relief: Building on a successful Pennsylvania program, provides $1 billion for bridge loans to qualified unemployed homeowners with reasonable prospects for reemployment to help cover mortgage payments until they are reemployed.
Foreclosure Legal Assistance. Authorizes a HUD administered program for making grants to provide foreclosure legal assistance to low- and moderate-income homeowners and tenants related to home ownership preservation, home foreclosure prevention, and tenancy associated with home foreclosure.

TRANSPARENCY FOR EXTRACTION INDUSTRY

For Investors

Public Disclosure: Requires public disclosure to the SEC payments made to the U.S. government relating to the commercial development of oil, natural gas, and minerals on federal land.
SEC Filing Disclosure: The SEC must require those engaged in the commercial development of oil, natural gas, or minerals to include information about payments they or their subsidiaries, partners or affiliates have made to a foreign government for such development in their annual reports and post this information online.

Congo Conflict Minerals:

Manufacturers Disclosure: Requires those who file with the SEC and use minerals originating in the Democratic Republic of Congo in manufacturing to disclose measures taken to exercise due diligence on the source and chain of custody of the materials and the products manufactured.
Illicit Minerals Trade Strategy: Requires the State Department to submit a strategy to address the illicit minerals trade in the region and a map to address links between conflict minerals and armed groups and establish a baseline against which to judge effectiveness.
Deposit Insurance Reforms: Permanent increase in deposit insurance for banks, thrifts and credit unions to $250,000, retroactive to January 1, 2008.
Restricts US Funds for Foreign Governments: Requires the Administration to evaluate proposed loans by institutions such as the IMF or World Bank to a middle-income country if that country’s public debt exceeds its annual Gross Domestic Product, and oppose loans unlikely to be repaid.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP provides comprehensive formation and regulatory support for hedge fund managers. Cole-Frieman & Mallon LLP also provides private equity registration support. Bart Mallon, Esq. can be reached directly at 415-868-5345.

Hedge Fund Registration

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Hedge Fund Registration Overview

After the Wall Street Reform and Consumer Protection Act, hedge funds will be required to register. When the bill is signed into law, we will update this page with all of the information on the new registration requirement (which will apply to private equity funds as well).

More forthcoming…

State Budget Shortfalls and Investment Adviser Registration

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Financial Reform Bill May Devastate Overburdened State Securities Divisions

As many states are facing huge budget shortfalls, government services have been cutback and certain states have furloughed workers in certain divisions. In a number of states (including California) these budget cuts have affected the state securities divisions and accordingly the many state securities divisions are running dangerously lean. For example, I just recently talked with an examiner in the Oregon Division of Finance and Corporate Securities regarding a state blue sky filing for a hedge fund manager. The examiner told me that because of budget cuts and furlough days, the division will not even have a chance to review the blue sky filing we submit for five months! (Of course, they will cash the check immediately.)

This is obviously a huge issue and is only one instance of a state which does not currently have the resources to adequately perform oversight of the investment and securities activity which occur within its borders. In fact, many states currently don’t have the staff or expertise to adequately oversee the investment advisers and brokers registered with their securities division. While this is troubling, the problem is only going to get worse if the Financial Reform Bill proceeds as currently drafted.

While many have lauded the Senate bill, which will require hedge fund registration for managers with $100MM in AUM or more, an important issue has been overlooked. All investment advisers (in addition to hedge fund managers) with AUM of less than $100MM will be subject to state and not SEC registration. The $100MM threshold is an increase from the current threshold of $25MM. This means that a financial planner overseeing $90MM in assets (which was previously subject to SEC registration and periodic examination) will now be subject to regulation, generally, by the state in which that manager resides.

This means that if the financial reform bill goes through as currently drafted in the senate, the states are suddenly going to be responsible for overseeing a larger pool of managers. Even though the state will have increased responsibility, it is unlikely that state budgets will provide the securities divisions with more funding to properly oversee the new managers the divisions will be responsible for regulating. We find this troubling for investor protection reasons and for manager business continuity – that is, managers would be better off registered at the SEC level and subject to examination by SEC staff better trained (presumably) than state regulators.

We concede that the SEC has its own problems with funding and this provision allows them to focus on larger, more systemically important managers. However, we believe that states are going to be greatly burdened by the increase in jurisdictional oversight. Accordingly, we believe either Congress or the SEC provide a grandfathering provision which would allow current managers who exceed the $25MM threshold (but not the new $100MM threshold) to register or remain registered with the SEC.

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Other related hedge fund law articles:

Cole-Frieman & Mallon LLP is one of the top hedge fund law firms and provides comprehensive formation and regulatory support for hedge fund managers. Bart Mallon, Esq. can be reached directly at 415-868-5345.

Private Fund Investment Advisers Registration Act of 2010

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Full Text of PFIARA of 2010 (requiring Hedge Fund Registration)

The following is the full text of the Private Fund Investment Advisers Registration Act of 2010 which was part of the recently passed Senate financial regulation bill. The central part of this act eliminates the Section 203(b)(3) exemption for registration for hedge fund managers (see Section 403). The act also requires hedge fund managers to provide the SEC with certain information about their trading program and investment positions (see Section 404).

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TITLE IV—REGULATION OF ADVISERS TO HEDGE FUNDS AND OTHERS

SEC. 401. SHORT TITLE.

This title may be cited as the ‘‘Private Fund Investment Advisers Registration Act of 2010’’.

SEC. 402. DEFINITIONS.

(a) INVESTMENT ADVISERS ACT OF 1940 DEFINITIONS.—Section 202(a) of the Investment Advisers Act of1940 (15 U.S.C. 80b–2(a)) is amended by adding at the end the following:

‘‘(29) The term ‘private fund’ means an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a–3), but for section 3(c)(1) or 3(c)(7) of that Act.

‘‘(30) The term ‘foreign private adviser’ means any investment adviser who—

‘‘(A) has no place of business in the United States;

‘‘(B) has, in total, fewer than 15 clients who are domiciled in or residents of the United States; on DSKH9S0YB1PROD with BILLS

‘‘(C) has aggregate assets under management attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser of less than $25,000,000, or such higher amount as the Commission may, by rule, deem appropriate in accordance with the purposes of this title; and

‘‘(D) neither—

‘‘(i) holds itself out generally to the public in the United States as an investment adviser; nor

‘‘(ii) acts as—

‘‘(I) an investment adviser to any investment company registered under the Investment Company Act of 1940; or

‘‘(II) a company that has elected to be a business development company pursuant to section 54 of the Investment Company Act of 1940 (15 U.S.C. 80a–53), and has not withdrawn its election.’’.

(b) OTHER DEFINITIONS.—As used in this title, the terms ‘‘investment adviser’’ and ‘‘private fund’’ have the same meanings as in section 202 of the Investment Advisers Act of 1940, as amended by this title.

SEC. 403. ELIMINATION OF PRIVATE ADVISER EXEMPTION; LIMITED EXEMPTION FOR FOREIGN PRIVATE ADVISERS; LIMITED INTRASTATE EXEMPTION.

Section 203(b) of the Investment Advisers Act of 1940 (15 U.S.C. 80b–3(b)) is amended—

(1) in paragraph (1), by inserting ‘‘, other than an investment adviser who acts as an investment adviser to any private fund,’’ before ‘‘all of whose’’;

(2) by striking paragraph (3) and inserting the following:

‘‘(3) any investment adviser that is a foreign private adviser;’’; and

(3) in paragraph (5), by striking ‘‘or’’ at the end; (4) in paragraph (6), by striking the period at the end and inserting ‘‘; or’’; and (5) by adding at the end the following: ‘‘(7) any investment adviser, other than any entity that has elected to be regulated or is regulated as a business development company pursuant to section 54 of the Investment Company Act of 1940 (15 U.S.C. 80a–54), who solely advises— ‘‘(A) small business investment companies that are licensees under the Small Business Investment Act of 1958; ‘‘(B) entities that have received from the Small Business Administration notice to proceed to qualify for a license as a small business investment company under the Small Business Investment Act of 1958, which notice or license has not been revoked; or ‘‘(C) applicants that are affiliated with 1 or more licensed small business investment companies described in subparagraph (A) and that have applied for another license under the Small Business Investment Act of 1958, which application remains pending.’’.

SEC. 404. COLLECTION OF SYSTEMIC RISK DATA; REPORTS; EXAMINATIONS; DISCLOSURES.

Section 204 of the Investment Advisers Act of 1940 (15 U.S.C. 80b–4) is amended—

(1) by redesignating subsections (b) and (c) as subsections (c) and (d), respectively; and

(2) by inserting after subsection (a) the following:

‘‘(b) RECORDS AND REPORTS OF PRIVATE FUNDS.—

‘‘(1) IN GENERAL.—The Commission may require any investment adviser registered under this title—

‘‘(A) to maintain such records of, and file with the Commission such reports regarding, private funds advised by the investment adviser, as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk by the Financial Stability Oversight Council (in this subsection referred to as the ‘Council’); and

‘‘(B) to provide or make available to the Council those reports or records or the information contained therein.

‘‘(2) TREATMENT OF RECORDS.—The records and reports of any private fund to which an investment adviser registered under this title provides investment advice shall be deemed to be the records and reports of the investment adviser.

‘‘(3) REQUIRED INFORMATION.—The records and reports required to be maintained by a private fund and subject to inspection by the Commission under this subsection shall include, for each private fund advised by the investment adviser, a description of—

‘‘(A) the amount of assets under management and use of leverage;

‘‘(B) counterparty credit risk exposure;

‘‘(C) trading and investment positions;

‘‘(D) valuation policies and practices of the fund;

‘‘(E) types of assets held;

‘‘(F) side arrangements or side letters, whereby certain investors in a fund obtain more favorable rights or entitlements than other investors;

‘‘(G) trading practices; and

‘‘(H) such other information as the Commission, in consultation with the Council, determines is necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk, which may include the establishment of different reporting requirements for different classes of fund advisers, based on the type or size of private fund being advised.

‘‘(4) MAINTENANCE OF RECORDS.—An investment adviser registered under this title shall maintain such records of private funds advised by the investment adviser for such period or periods as the Commission, by rule, may prescribe as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk.

‘‘(5) FILING OF RECORDS.—The Commission shall issue rules requiring each investment adviser to a private fund to file reports containing such information as the Commission deems necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.

‘‘(6) EXAMINATION OF RECORDS.—

‘‘(A) PERIODIC AND SPECIAL EXAMINATIONS.—The Commission—

‘‘(i) shall conduct periodic inspections of all records of private funds maintained by an investment adviser registered under this title in accordance with a schedule established by the Commission; and

‘‘(ii) may conduct at any time and from time to time such additional, special, and other examinations as the Commission may prescribe as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk.

‘‘(B) AVAILABILITY OF RECORDS.—An investment adviser registered under this title shall make available to the Commission any copies or extracts from such records as may be prepared without undue effort, expense, or delay, as the Commission or its representatives may reasonably request.

‘‘(7) INFORMATION SHARING.—

‘‘(A) IN GENERAL.—The Commission shall make available to the Council copies of all reports, documents, records, and information filed with or provided to the Commission by an investment adviser under this subsection as the Council may consider necessary for the purpose of assessing the systemic risk posed by a private fund.

‘‘(B) CONFIDENTIALITY.—The Council shall maintain the confidentiality of information received under this paragraph in all such reports, documents, records, and information, in a manner consistent with the level of confidentiality established by the Commission pursuant to paragraph (8). The Council shall be exempt from section 552 of title 5, United States Code, with respect to any information in any report, document, record, or information made available, to the Council under this subsection.’’.

‘‘(8) COMMISSION CONFIDENTIALITY OF REPORTS.—Notwithstanding any other provision of law, the Commission may not be compelled to disclose any report or information contained therein required to be filed with the Commission under this subsection, except that nothing in this subsection authorizes the Commission—

‘‘(A) to withhold information from Congress, upon an agreement of confidentiality; or

‘‘(B) prevent the Commission from complying with—

‘‘(i) a request for information from any other Federal department or agency or any self-regulatory organization requesting the report or information for purposes within the scope of its jurisdiction; or

‘‘(ii) an order of a court of the United States in an action brought by the United States or the Commission.

‘‘(9) OTHER RECIPIENTS CONFIDENTIALITY.— Any department, agency, or self-regulatory organization that receives reports or information from the Commission under this subsection shall maintain the confidentiality of such reports, documents, records, and information in a manner consistent with the level of confidentiality established for the Commission under paragraph (8).

‘‘(10) PUBLIC INFORMATION EXCEPTION.—‘‘(A) IN GENERAL.—The Commission, the Council, and any other department, agency, or self-regulatory organization that receives information, reports, documents, records, or information from the Commission under this subsection, shall be exempt from the provisions of section 552 of title 5, United States Code, with respect to any such report, document, record, or information. Any proprietary information of an investment adviser ascertained by the Commission from any report required to be filed with the Commission pursuant to this subsection shall be subject to the same limitations on public disclosure as any facts ascertained during an examination, as provided by section 210(b) of this title.

‘‘(B) PROPRIETARY INFORMATION.—For purposes of this paragraph, proprietary information includes—

‘‘(i) sensitive, non-public information regarding the investment or trading strategies of the investment adviser;

‘‘(ii) analytical or research methodologies;

‘‘(iii) trading data;

‘‘(iv) computer hardware or software containing intellectual property; and

‘‘(v) any additional information that the Commission determines to be proprietary.

‘‘(11) ANNUAL REPORT TO CONGRESS.—The Commission shall report annually to Congress on how the Commission has used the data collected pursuant to this subsection to monitor the markets for the protection of investors and the integrity of the markets.’’.

SEC. 405. DISCLOSURE PROVISION ELIMINATED.

Section 210(c) of the Investment Advisers Act of 1940 (15 U.S.C. 80b–10(c)) is amended by inserting before the period at the end the following: ‘‘or for purposes of assessment of potential systemic risk’’.

SEC. 406. CLARIFICATION OF RULEMAKING AUTHORITY.

Section 211 of the Investment Advisers Act of 1940 (15 U.S.C. 80b–11) is amended—

(1) in subsection (a), by inserting before the period at the end of the first sentence the following:

‘‘, including rules and regulations defining technical, trade, and other terms used in this title, except that the Commission may not define the term ‘client’ for purposes of paragraphs (1) and (2) of section 206 to include an investor in a private fund managed by an investment adviser, if such private fund has entered into an advisory contract with such adviser’’; and

(2) by adding at the end the following:

‘‘(e) DISCLOSURE RULES ON PRIVATE FUNDS.—The Commission and the Commodity Futures Trading Commission shall, after consultation with the Council but not later than 12 months after the date of enactment of the Private Fund Investment Advisers Registration Act of 2010, jointly promulgate rules to establish the form and content of the reports required to be filed with the Commission under subsection 204(b) and with the Commodity Futures Trading Commission by investment advisers that are registered both under this title and the Commodity Exchange Act (7 U.S.C. 1a et seq.).’’.

SEC. 407. EXEMPTION OF VENTURE CAPITAL FUND ADVISERS.

Section 203 of the Investment Advisers Act of 1940 (15 U.S.C. 80b–3) is amended by adding at the end the following:

‘‘(l) EXEMPTION OF VENTURE CAPITAL FUND ADVISERS.—No investment adviser shall be subject to the registration requirements of this title with respect to the provision of investment advice relating to a venture capital fund. Not later than 6 months after the date of enactment of this subsection, the Commission shall issue final rules to define the term ‘venture capital fund’ for purposes of this subsection.’’.

SEC. 408. EXEMPTION OF AND RECORD KEEPING BY PRIVATE EQUITY FUND ADVISERS.

Section 203 of the Investment Advisers Act of 1940 (15 U.S.C. 80b–3) is amended by adding at the end the following:

‘‘(m) EXEMPTION OF AND REPORTING BY PRIVATE EQUITY FUND ADVISERS.—

‘‘(1) IN GENERAL.—Except as provided in this subsection, no investment adviser shall be subject to the registration or reporting requirements of this title with respect to the provision of investment advice relating to a private equity fund or funds.

‘‘(2) MAINTENANCE OF RECORDS AND ACCESS BY COMMISSION.—Not later than 6 months after the date of enactment of this subsection, the Commission shall issue final rules—

‘‘(A) to require investment advisers described in paragraph (1) to maintain such records and provide to the Commission such annual or other reports as the Commission taking into account fund size, governance, investment strategy, risk, and other factors, as the Commission determines necessary and appropriate in the public interest and for the protection of investors; and

‘‘(B) to define the term ‘private equity fund’ for purposes of this subsection.’’.

SEC. 409. FAMILY OFFICES.

(a) IN GENERAL.—Section 202(a)(11) of the Investment Advisers Act of 1940 (15 U.S.C. 80b–2(a)(11)) is amended by striking ‘‘or (G)’’ and inserting the following:

‘‘; (G) any family office, as defined by rule, regulation, or order of the Commission, in accordance with the purposes of this title; or (H)’’.

(b) RULEMAKING.—The rules, regulations, or orders issued by the Commission pursuant to section 202(a)(11)(G) of the Investment Advisers Act of 1940, as added by this section, regarding the definition of the term ‘‘family office’’ shall provide for an exemption that—

(1) is consistent with the previous exemptive policy of the Commission, as reflected in exemptive orders for family offices in effect on the date of enactment of this Act; and

(2) recognizes the range of organizational, management, and employment structures and arrangements employed by family offices.

SEC. 410. STATE AND FEDERAL RESPONSIBILITIES; ASSET THRESHOLD FOR FEDERAL REGISTRATION OF INVESTMENT ADVISERS.

Section 203A(a)(1) of the Investment Advisers Act of 1940 (15 U.S.C. 80b–3a(a)(1)) is amended —

(1) in subparagraph (A)—

(A) by striking ‘‘$25,000,000’’ and inserting ‘‘$100,000,000’’; and

(B) by striking ‘‘or’’ at the end;

(2) in subparagraph (B), by striking the period at the end and inserting ‘‘; or’’; and

(3) by adding at the end the following:

‘‘(C) is an adviser to a company that has elected to be a business development company pursuant to section 54 of the Investment Company Act of 1940, and has not withdrawn its election.’’.

SEC. 411. CUSTODY OF CLIENT ASSETS.

The Investment Advisers Act of 1940 (15 U.S.C. 80b–1 et seq.) is amended by adding at the end the following new section:

‘‘SEC. 223. CUSTODY OF CLIENT ACCOUNTS.

‘‘An investment adviser registered under this title shall take such steps to safeguard client assets over which such adviser has custody, including, without limitation, verification of such assets by an independent public accountant, as the Commission may, by rule, prescribe.’’.

SEC. 412. ADJUSTING THE ACCREDITED INVESTOR STANDARD FOR INFLATION.

The Commission shall, by rule—

(1) increase the financial threshold for an accredited investor, as set forth in the rules of the Commission under the Securities Act of 1933, by calculating an amount that is greater than the amount in effect on the date of enactment of this Act of $200,000 income for a natural person (or $300,000 for a couple) and $1,000,000 in assets, as the Commission determines is appropriate and in the public interest, in light of price inflation since those figures were determined; and

(2) adjust that threshold not less frequently than once every 5 years, to reflect the percentage increase in the cost of living.

SEC. 413. GAO STUDY AND REPORT ON ACCREDITED INVESTORS.

The Comptroller General of the United States shall conduct a study on the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds, and shall submit a report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives on the results of such study not later than 1 year after the date of enactment of this Act.

SEC. 414. GAO STUDY ON SELF-REGULATORY ORGANIZATION FOR PRIVATE FUNDS.

The Comptroller General of the United States shall—

(1) conduct a study of the feasibility of forming a self-regulatory organization to oversee private funds; and

(2) submit a report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives on the results of such study, not later than 1 year after the date of enactment of this Act.

SEC. 415. COMMISSION STUDY AND REPORT ON SHORT SELLING.

(a) STUDY.—The Division of Risk, Strategy, and Financial Innovation of the Commission shall conduct a study, taking into account current scholarship, on the state of short selling on national securities exchanges and in the over-the-counter markets, with particular attention to the impact of recent rule changes and the incidence of—

(1) the failure to deliver shares sold short; or

(2) delivery of shares on the fourth day following the short sale transaction.

(b) REPORT.—The Division of Risk, Strategy, and Financial Innovation shall submit a report, together with any recommendations for market improvements, including consideration of real time reporting of short sale positions, to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives on the results of the study conducted under subsection (a), not later than 2 years after the date of enactment of this Act.

SEC. 416. TRANSITION PERIOD.

Except as otherwise provided in this title, this title and the amendments made by this title shall become effecttive 1 year after the date of enactment of this Act, except 5 that any investment adviser may, at the discretion of the investment adviser, register with the Commission under the Investment Advisers Act of 1940 during that 1-year period, subject to the rules of the Commission.

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Cole-Frieman & Mallon LLP is a hedge fund law firm which provides comprehensive formation and regulatory support for hedge fund managers. Bart Mallon, Esq. can be reached directly at 415-868-5345.

Hedge Fund Manager Registration to Cost Taxpayers $140 Million (at least)

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CBO Calculates Cost of House Hedge Fund Bill

This past week the Congressional Budge Office (“CBO”) released a cost estimate of H.R. 3818, the Private Fund Investment Advisers Registration Act of 2009. In a number of private conversations I have had about hedge fund registration over the last 9-12 months one of the issues that was continually raised was appropriate funding for the SEC. As we have seen recently (most notably from the Inspector General’s Madoff report), the SEC’s budget is not large enough to adequately fulfill their investor protection mandate. Adding hedge fund registration would obviously further burden the cash-strapped agency (for more see Schumer Proposal to Double SEC Budget). According to the CBO, and based on the SEC’s estimates that it will need to add 150 employees, the estimated outlays over four years will be equal to $140 million.

However, taxpayers should understand that this assumes that registration will only be required for those managers with at least $150 million in assets under management. At the $150 million AUM level, the CBO expects that 1,300 hedge fund managers would be required to register. The current draft of the Senate hedge fund registration bill calls for managers with $100 million in AUM to register – lowering the AUM exemption threshold will increase the amount of managers required to register. Additionally, there are outstanding political issues. First, it is unclear whether the final bill will require private equity fund managers and venture capital fund managers to register – we do not necessarily understand the arguably arbitrary carve-out for these industries. Second, it is clear that a majority of the state securities commissions are unable and unwilling to be responsible for overseeing managers with up to $100 million in assets. Hedge fund managers who would subject to state oversight would rightly want to be subject to SEC oversight (which does not say much for many state securities commissions). These issues will continue to be addressed during the political sausage-making process.

Of additional interest – the CBO estimates that hedge fund registration is likely to cost around $30,000 per each SEC registrant which is welcome news to investment adviser compliance consultants and hedge fund lawyers!

For full report, please see full CBO Hedge Fund Cost Estimate.

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Other related hedge fund law articles include:

Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs the Hedge Fund Law Blog and provides hedge fund manager registration service through Cole-Frieman & Mallon LLP He can be reached directly at 415-868-5345.