On 1 October 2009, Allen & Overy LLP in London hosted the 10th annual Live from the SEC, jointly presented by the Securities and Exchange Commission (SEC) and the American Bar Association Section of International Law.
Through this conference, the staff of the Securities and Exchange Commission (SEC) reached out to the international community concerning proposed US regulatory reform in response to the global economic crisis. The staff's presentation regarding registration initiatives for private pools of capital, although initially hewing close to the consensus view that all fund advisers should register, was surprisingly prescient.
Proposals for advisers of private funds and pools
Proposals to require registration of fund advisers under the Advisers Act appeared as early as January. The first two congressional initiatives addressing registration of fund advisers -- the Hedge Fund Registration Act and the Hedge Fund Transparency Act – made no effort to recognise the different business models pursued by different types of investment funds. Essentially, both would have required registration for all or nearly all advisers to private pools of capital.
In March, Treasury Secretary Timothy Geithner proposed requiring advisers to private pools of capital to register with the SEC and to be subject to disclosure requirements and regulatory reporting to enable regulators to assess the level of threat these funds pose to the financial system. In early May, Richard H. Baker, the president of the Managed Funds Association, added his organization's voice to the chorus supporting the requirement for fund advisers to register with the SEC.
The Obama Administration published a draft version of the Private Investment Adviser Registration Act (PFIARA) in July that would require nearly all fund advisers to register with the SEC. PFIARA was the subject of hearings and a mark-up by the House Financial Services Committee, and it was ultimately passed at the end of October.
Industry support for registration
Industry support for registration is not as surprising as it may sound. The fund management industry in the United States was subject to registration, albeit briefly, in December 2004, when a deeply divided SEC voted 3 to 2 to promulgate the Hedge Fund Rule, or Rule 203(b)3-2, under the Advisers Act. For the purposes of determining the number of an adviser's clients, the Hedge Fund Rule looked through investment fund clients to count the number of underlying US investors, the effect of which was to require most investment advisers to hedge funds to register under the Advisers Act. Although in June 2006 the United States Court of Appeals for the District of Columbia voided Rule 203(b)3-2 on the basis that the SEC had exceeded its authority (in Goldstein v. SEC), the experience of many fund advisers with SEC registration meant that the prospect of greater regulatory oversight was not the industry's bogeyman, as it has often been portrayed in the media.
As mentioned above, members of the SEC staff had a chance to share their views on the proposals to increase regulation of private equity advisers during the Live from the SEC session. David Grimm from the Division of Investment Management suggested that the best statement of the SEC staff's views on adviser registration could be found in the congressional testimony given in July by the Director of the Division, Andrew Donohue.
Donohue noted that the lack of oversight of funds and their advisers was a 'significant regulatory gap' that needed to be closed. Despite noting that the Goldstein decision had effectively tied the SEC's hands from requiring the registration of fund advisers, he also stated the Commission's belief that all private fund advisers should be subject to regulatory oversight.
Different funds, different strategies
Donohue also observed that any reform efforts should acknowledge that different types of fund advisers – including hedge funds, private equity funds and venture capital funds – pursue different strategies; given this, regulatory oversight should be tailored to the risks to investors and markets posed by each. A key theme in the proposals regarding registering fund advisers is the authorization of the SEC to collect data from private funds for the purposes of assessing systemic risk, and, moreover, for the SEC to share this information with other regulators. Grimm noted that the SEC and international regulators were making a concerted effort to coordinate their reform efforts and pointed to a recent meeting between the SEC and the UK Financial Services Authority to harmonize the data collection requirements across their jurisdictions for the purposes of managing the systemic impact of private funds.
In addition, although the SEC is committed to ensuring it has oversight of any entity that could pose a systemic threat to the US financial system, the SEC nevertheless recognizes that there are limits to its jurisdiction. Therefore, Grimm stated, non-US advisers may be subject to somewhat less burdensome regulation.
Current reform proposals' chances of passage
Grimm felt that the likelihood is good that the current reform proposals will be enacted into law. The nearly unanimous approval of PFIARA by the House Financial Services Committee is one strong sign. The striking similarity between the provisions of PFIARA and the Restoring America's Financial Stability Act of 2009 (RAFSA), the reform bill published by Senator Christopher Dodd (D-CT), also indicates a bipartisan consensus on the major elements of reforming the regulation of fund advisers.
However, despite the steady drumbeat of support for requiring registration of all fund advisers, several recent amendments to reform legislation and new proposals suggest that reform is not yet a done deal, and advisers to private equity funds could escape a significant increase in regulatory oversight. For example, several last-minute amendments to PFIARA prior to its passage by the House Financial Services Committee would significantly water down the registration requirements by establishing an exemption for advisers to private funds, each of which has less than $150 million in assets under management. And they would provide exemptions from registration for advisers to venture capital funds (to be defined by the SEC after enactment). Notably, RAFSA also contains an additional exemption from registration for advisers to private equity funds (to be defined by the SEC after enactment). Both bills would also raise the threshold for requiring registration at the federal level, rather than the state level, for advisers with assets under management of at least USD100 million, rather than USD30 million currently.
Regulating funds proportionate to risk
In the face of these developments, SEC Chairman Mary Schapiro stated recently that she would oppose the burgeoning set of exemptions from registration and reiterated her support for a requirement that all advisers to private funds must register with the SEC. The legislative process in Congress has many more twists and turns before a bill arrives on President Obama's desk for signature, so the question of whether final reforms will benefit advisers to private equity funds is not yet certain. What is increasingly clear, however, is that policymakers appear to be heeding Andrew Donohue's call to ensure that the regulation of funds is proportionate to the risks posed by the fund's investment strategy.
Carolyn H. Jackson serves as counsel at Allen & Overy, London and is the head of the US Financial Services Regulatory practice in London. Her practice includes US securities and commodities law regulation of the international securities and derivatives markets as well as advising on the US regulatory issues involved in the structuring of complex securities and derivatives transactions.
Nathaniel W. Lalone is an associate in the US Financial Services Regulatory practice at Allen & Overy, London.
This article first appeared on Complinet on 3 December 2009. © Copyright 2009 by Complinet Inc., www.complinet.com, a leading provider of compliance solutions for the financial services industry.