Category: Private Investment Funds

Hedge Fund Adviser Registration Act of 2009

capuanoCongressmen Mike Capuano of Massachusetts and Mike Castle of Delaware introduced the Hedge Fund Adviser Registration Act of 2009 (H.R. 711). The Act, if passed, would delete Section 203(b)(3) from the Investment Advisers Act of 1940.

This section of the Investment Advisers Act exempts from registration an investment adviser who has fewer than 15 clients and does not hold themselves out to the public as an investment adviser. The general partner of a private investment fund is generally considered an investment adviser to that fund. Many private investment funds use this exemption if they have less than 15 funds.

Since the bill was just proposed on January 27, 2009 it is too early to speculate as to whether it will be passed.

This act falls into the bucket with the Hedge Fund Transparency Act of 2009 as one of several prospective changes to the private investment fund industry.

Electronic Filing of Form D and Amendments Becomes Mandatory on March 16

Beginning March 16, 2009, Form D filings are required to be made electronically on EDGAR. See SEC Release No. 33-8891 (February 6, 2008).  Form D is commonly used for offerings made under the Rule 506 safe harbor to accredited investors. While the filing of a Form D is not a condition to the exemption, it is a requirement pursuant to SEC Rule 503.

To prepare for the transition, issuers need to obtain access codes for the SEC’s EDGAR system.

The electronic format is intended to make it easier for the SEC and state regulators  to spot compliance problems in private offerings.  As Katten points out in its client advisory:

Form D filers should also be aware of the federal and state regulatory enforcement implications of the Form D data being readily available to the regulators. For example, whenever placement commissions are contemplated, an issuer should obtain the proposed recipient’s CRD number in advance to confirm that the placement agent is properly registered with the SEC and with any state in which it intends to make solicitations. There is little doubt that the states (and possibly also the SEC) will be screening this aspect of the filing for persons acting in a placement capacity without appropriate licensure.

In a client alert from Goodwin Procter, they summarize three choices for filing in the near future, depending on your business plan:

Electronic Form D Amendments. Electronic amendments may – and starting March 16, 2009 must – be made using the new Form D adopted by the SEC. Electronically filed Form Ds will be publicly searchable through the EDGAR system, and involve new disclosure requirements, including: (i) the date of first sale of Fund securities; (ii) a CRD registration number for every person who receives compensation for sales of Fund securities, including brokers, dealers and finders; and (iii) the specific exclusion from registration under the Investment Company Act of 1940 upon which the Fund may be relying (e.g., Section 3(c)(7)). Electronic amendments will be most appropriate for Funds that expect to continue an ongoing offering after March 16, 2009, particularly open-end Funds.

Paper Amendments Using New Form D. The SEC has provided a transition period during which issuers can make filings using a paper version of the new electronic Form D. After the transition period ends on March 15, 2009, all Form D filings must be made electronically. This method may be appropriate for Funds that wish to manage the time schedule of their transition to the new electronic Form D and defer obtaining EDGAR access codes until a later date.

Paper Amendments Using Temporary Form D. Issuers also have the option to file a paper amendment using a Temporary Form D that is essentially the same as the previous paper Form D. This method may be appropriate for Funds that wish to defer disclosures on the new Form D because they expect their securities offering to cease in the near future.

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Proposal to Tax Carried Interests as Ordinary Income

2010budgetThe Obama Administration has labeled their 2010 budget as A New Era of Responsibility. Part of that responsibility appears to be taxing carried interest as ordinary income.

On page 122 of the budget there is a single line item: “Tax carried interest as ordinary income,” with projections of $2,742 million in 2011, $4,347 million in 2012 and an overall $23,894 million for the ten year period.

There is no corresponding text about how the tax would be implemented, so it is premature to be thinking about how this might affect the business plan of a private investment fund.

Unlike a fixed fee, a carried interest aligns the interests of sponsors and investors with the success of the fund. Under current law, the grant of a carried interest generally is not taxable. Instead, the sponsor recognizes income and gain when allocations of partnership income and gain are made. For a partnership that generates long-term capital gains, the carried interest share of the gains would be taxed at the long-term capital gains rates (currently 15%) instead of ordinary income.

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Stop Tax Haven Abuse Act

senator_levin_michigan

Senator Levin of Michigan has introduced the Stop Tax Haven Abuse Act (S.506). It is a wide ranging bill that would require disclosure of beneficial ownership of foreign entities, implementation of anti-money laundering by formation agents, limit patents on tax planning inventions, change the tax opinion standard for penalties, and many other changes. There is a lot wrapped up into this bill. It was just sent into committee so it is hard to tell what may come of it at this point.

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Report of Congressional Oversight Panel on Regulatory Reform

Modernizing the American Financial Regulatory System: Recommendations for Improving Oversight, Protecting Consumers and Ensuring Stability (.pdf)

In response to the escalating crisis, on October 3, 2008, Congress provided the U.S. Department of the Treasury with the authority to spend $700 billion to stabilize the U.S. economy, preserve home ownership, and promote economic growth. Congress created the Office of Financial Stabilization (OFS) within Treasury to implement a Troubled Asset Relief Program (TARP). At the same time, Congress created the Congressional Oversight Panel to “review the current state of financial markets and the regulatory system.” The Panel is empowered to hold hearings, review official data, and write reports on actions taken by Treasury and financial institutions and their effect on the economy. Through regular reports, the Panel must oversee Treasury’s actions, assess the impact of spending to stabilize the economy, evaluate market transparency, ensure effective foreclosure mitigation efforts, and guarantee that Treasury’s actions are in the best interests of the American people. In addition, Congress has instructed the Panel to produce a special report on regulatory reform that will analyze “the current state of the regulatory system and its effectiveness at overseeing the participants in the financial system and protecting consumers.”

This report is short on particulars, but does give me a sense that private investment funds are likely to be subject to more regulatory oversight in the near future.

Number three on the list of critical problems and recommendations for improvement is to modernize the supervision of the “shadow” financial system. The report lumps private equity funds in the same basket with OTC derivatives, off-balance sheet SIVs and hedge funds.

The Group of Thirty Report on Financial Reform

Group of Thirty Financial ReformThe Group of Thirty released their latest report: Financial Reform – A Framework for Financial Stability.(.pdf)

The report focuses on flaws in the global financial system and provides recommendations to improve the systems. The report project was led by Paul Volcker, Chairman, and Tommaso Padoa-Schioppa and Arminio Fraga Neto, Vice Chairmen. The rrport does not focus on the current actions and capital injections. It looks to the policies and regulations that control the financial markets.

I focused on Recommendation number 4 on the oversight of private pools of capital:

Recommendation 4:

a. Managers of private pools of capital that employ substantial borrowed funds should be required to register with an appropriate national prudential regulator. There should be some minimum size and venture capital exemptions from such registration requirement.
b. The prudential regulator of such managers should have authority to require periodic regulatory reports and public disclosures of appropriate information regarding the size, investment style, borrowing, and performance of the funds under management. Since introduction of even a modest system of registration and regulation can create a false impression of lower investment risk, disclosure, and suitability standards will have to be reevaluated.
c. For funds above a size judged to be potentially systemically significant, the prudential regulator should have authority to establish appropriate standards for capital, liquidity, and risk management.
d. For these purposes, the jurisdiction of the appropriate prudential regulator should be based on the primary business location of the manager of such funds, regardless of the legal domicile of the funds themselves. Given the global nature of the markets in which such managers and funds operate, it is imperative that a regulatory framework be applied on an internationally consistent basis.

Hedge Fund Transparency Act of 2009

Senators Chuck Grassley and Carl Levin introduced the Hedge Fund Transparency Act (S.344). Instead of amending the Investment Advisers Act of 1940 (as Senator Grassley tried with S.1402 in the 110th Congress), this bill would amend the Investment Company Act of 1940.

The first step is defining a “hedge fund.” (Not an easy task)

Rather than trying to define a hedge fund, the proposed law instead applies to any investment company that has at least $50 million in assets or assets under management and relies on Sections 3(c)(1) or (7) as an exemption from the requirements under the Investment Company Act.

The proposed law will not require full compliance with Investment Company Act, but instead submit to a limited regulatory regime:

  1. Register with the SEC.
  2. Maintain books and records that the SEC may require.
  3. Cooperate with any request by the SEC for information or examination.
  4. File an information form with the SEC electronically, at least once a year. This form must be made freely available to the public in an electronic, searchable format. The form must include:
    • The name and current address of each individual who is a beneficial owner of the investment company.
    • The name and current address of any company with an ownership interest in the investment company.
    • The primary accountant and primary broker used by the investment company
    • An explanation of the structure of ownership interests in the investment company.
    • Information on any affiliation with another financial institution.
    • The name and current address of the investment company’s primary accountant and primary broker.
    • A statement of any minimum investment commitment required of a limited partner, member, or investor.
    • The total number of any limited partners, members, or other investors.
    • The current value of the assets of the company and the assets under management by the company.
  5. Establish an anti-money laundering program and report suspicious transactions

This bill is far from becoming law. BUT, there is a groundswell of support in Washington to increase the regulation of private investment funds. We will keep an eye on this legislation.

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First Report of the Walker Guidelines Monitoring Group

The Guidelines Monitoring Group has published its First Report (.pdf) on the UK private equity industry’s conformity with the Walker Guidelines.

The Guidelines are intended to have funds enhance their reporting and the reporting by their large portfolio companies. They define a portfolio company as one with a market capitalization (prior to be acquired) was in excess of £300 million, more than 50% of the revenues were generated in the UK and the UK employees totaled in excess of 1,000 full-time equivalents.

The Guidelines propose that the portfolio companies should annually disclose:

  • the identity of the private equity fund (or funds) that own the company
  • the composition of the portfolio company’s board
  • a financial review of its risk management and uncertainties facing the company
  • a business review in compliance with Section 417 of the Companies Act.

The Guidelines propose that a private equity firm should publish a description of its investment approach, investment holding periods, leadership of the firm, arrangements for dealing with conflicts of interest, and categorization of its limited partners/investors.

Thirty two firms made reports. (see Appendix 1 of the Report) and 54 portfolio companies (See Appendix 2 of the Report).

Model Due Diligence Questionnaire for Hedge Fund Investors

The Managed Funds Association put together a Model Due Diligence Questionnaire for Hedge Fund Investors (.pdf). This questionnaire was designed to identify the kinds of questions that a potential investor may wish to consider before investing in a Hedge Fund. The questions that may help amplify on or provide additional details to the disclosure in a Hedge Fund’s offering documents.