Authors: George Mentz and Benjamin Terner
The Securities and Exchange Commission (SEC) recently adopted rules that require advisers to hedge funds and other private funds to register with the SEC. The new rules also establish exemptions from SEC registration and reporting requirements for certain advisers, and reallocate regulatory responsibility.
The rules adopted by the SEC implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act regarding investment advisers, including those that advise hedge funds.
The rules provide for a transitional exemption period so that private advisers, including hedge fund and private equity fund advisers, who are required to register should do so by March 30, 2012. However, certain rules regarding exemptions for venture capital fund and certain private fund advisers are effective July 21, 2011.
The rules come on the heels of the financial crisis as legislation to protect consumers was a Congressional prerogative. That’s because generally a significant number of individuals and institutions invest a substantial amount of assets in private funds, such as hedge funds and private equity funds.
However, until the passage of the Dodd-Frank Act, advisers managing those assets were subject to, what some consider, not enough regulatory oversight.
With the Dodd-Frank Act, Congress attempts to close the “regulatory gap” by generally extending the registration requirements under the Investment Advisers Act to the advisers of these funds. The new law also provided the SEC with the ability to require the limited number of advisers to private funds that will not have to register to file reports about their business activities.
It has been the case that for many years advisers to private funds were not required to register with the SEC because of an exemption that applies to advisers with fewer than 15 clients – an exemption that counted each fund as a client, as opposed to each investor in a fund. As a result, some advisers to hedge funds and other private funds have remained outside of the SEC’s regulatory oversight even though those advisers could be managing large sums of money for the benefit of hundreds of investors.
Nevertheless, Title IV of the Dodd-Frank Act eliminated this private adviser exemption. Consequently, many previously unregistered advisers, particularly those to hedge funds and private equity funds, will have to register with the SEC and be subject to its regulatory oversight, rules and examination. This process will come at a great expense to those now under SEC control.
This can be attributed to the fact that these advisers will now be subject to the same registration requirements, regulatory oversight, and other requirements that apply to other SEC-registered investment advisers.
The SEC is also requiring additional information from investment advisers that are required to register with the Commission. Generally these individuals provide information in their registration form that is not only used for registration purposes, but that is used by the SEC in a variety of ways “to support its mission to protect investors.”
To “enhance its ability to oversee investment advisers to private funds”, the SEC is beginning to require advisers to provide additional information about the private funds they manage. The information obtained as a result of these amendments is designed to help the SEC in fulfilling its increased responsibility for private fund advisers arising from the Dodd-Frank Act.
In conclusion, all persons are subject to federal laws and the laws of the SEC. As an example, insider trading (10 B-5) applies to all of us. The question is whether this is duplication of regulation? As you know, FINRA regulates their licensed advisors while the SEC also can regulate these advisors. Also, 3rd party custodians and administrators are generally regulated by the SEC. An example of a 3rd Party would be Schwab or Fidelity which both provide “Institutional & Administrative” services for a fee to hedge funds, money managers and independent RIAs. While protecting the consumer is a great idea, having 3-4 layers of regulation over the same accounts and securities becomes somewhat cumbersome. On top of that, many states have these same advisors under their supervision and regulation.
While this all sounds confusing, this is just for securities. When the customer or advisor deals with banking and insurance, these are supervised by other agencies at both the state and federal levels.
While the concept of Dodd-Frank may be a good idea from a consumer protection point of view, we have to wonder if there will be too many regulators and too little producers. In sum, this could be the best time in history to start a career in financial compliance.
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