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SEC Proposes Regulations Implementing Dodd-Frank Mandated Hedge and Private Equity Fund Reporting Regime

By Jim Hamilton

The SEC has proposed regulations implementing the regulatory regime for hedge funds and private equity funds mandated by the Dodd-Frank Act. Under the proposed rules, advisers to hedge funds and private funds would have to register with the SEC and provide information on the basic organizational and operational information about the funds they manage, such as information about the amount of assets held by the fund, the types of investors in the fund, and the adviser's services to the fund. The hedge fund and private funds would also have to identify five categories of "gatekeepers" that perform critical roles for advisers and the private funds they manage (i.e., auditors, prime brokers, custodians, administrators and marketers). According to the SEC, these new reporting requirements are designed to help identify practices that may harm investors, deter advisers' fraud, and facilitate earlier discovery of potential misconduct. And this information would provide for the first time a census of this important area of the asset management industry.

In addition, the Commission proposed other amendments to the adviser registration form to improve its regulatory program. These amendments would require all registered advisers to provide more information about their advisory business, including information about the types of clients they advise, their employees, and their advisory activities, as well as their business practices that may present significant conflicts of interest (such as the use of affiliated brokers, soft dollar arrangements and compensation for client referrals). The proposal also would require advisers to provide additional information about their non-advisory activities and their financial industry affiliations.

Dodd-Frank exempted from SEC registration advisers solely to venture capital funds and advisers solely to private funds with less than $150 million in assets under management in the U.S. However, Congress authorized the SEC to impose reporting requirements on these exempt advisers.

Under proposed rules, exempt reporting advisers would nonetheless be required to file, and periodically update, reports with the Commission, using the same registration form as registered advisers. Rather than completing all of items on the form, exempt reporting advisers would fill out a limited subset of items, including basic identifying information for the adviser and the identity of its owners and affiliates, information about the private funds the adviser manages and about other business activities that the adviser and its affiliates are engaged in that present conflicts of interest that may suggest significant risk to clients, and disciplinary history of the adviser and its employees that may reflect on their integrity. Exempt reporting advisers would file reports on the Commission's investment adviser electronic filing system (IARD), and these reports would be publicly available on the Commission's website.

Directed by the Dodd-Frank Act to define the term "venture capital fund," the Commission has proposed a definition designed to effect Congress' intent in enacting this exemption. Under the proposed definition, a venture capital fund is a private fund that represents itself to investors as being a venture capital fund, only invests in equity securities of private operating companies to provide primarily operating or business expansion capital (not to buy out other investors), U.S. Treasury securities with a remaining maturity of 60 days or less, or cash, is not leveraged and its portfolio companies may not borrow in connection with the fund's investment, offers to provide a significant degree of managerial assistance, or controls its portfolio companies and does not offer redemption rights to its investors. Under a proposed grandfathering provision, existing funds that make venture capital investments would generally be deemed to meet the proposed definition, as long as they have represented themselves as venture capital funds. The Commission is proposing this approach because it could be difficult or impossible for advisers to conform existing funds, which generally have terms in excess of 10 years, to the new definition.

According to SEC Chair Mary Schapiro, the proposed definition distinguishes venture capital funds from hedge funds and private equity funds by focusing on the lack of leverage of venture capital funds and the non-public, start-up nature of the companies in which they invest. The rule therefore focuses on the provision of capital for the operating and expansion of start-up businesses, rather than buying out prior investors. the SEC head described this as a challenging line-drawing exercise.

Full post as published by Jim Hamilton's World of Securities Regulation on November 20, 2010 (boomark / email).