Regulation of Hedge Funds a Challenging New World

WAISC 20109th Annual World Alternative Investment Summit Canada

NIAGARA FALLS, CANADA MARIANNE K. SMYTHESEPTEMBER 13 15, 2010Regulation of Hedge Funds a Challenging New WorldAdviser RegistrationOnce upon a time, investment advisers with business in the United States, had to register with the Securities and Exchange Commission, unless . . . .

Private Adviser Exemption from RegistrationThey managed money for fewer than fifteen (15) clients and none of those clients was a registered investment company (the private adviser exemption); or

Intrastate ExemptionThey and all their clients were located in a single state (the intrastate exemption), or

Foreign Adviser ExemptionThey were located offshore (the foreign adviser exemption); or

Family Office ExemptionThe clients were members of a family group (the family office exemption).

Exemptions from RegistrationNow, these exemptions are going, going, going . . . .

Exemptions from Registration. . . . gone!

Exemptions from RegistrationOne year from July 21, 2010, thanks to the

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010,

these exemptions will be . . .Exemptions from RegistrationDEAD!!

Exemptions from RegistrationWell, maybe not altogether dead!

Exemptions from RegistrationNothing is ever that simple that comes out of Washington, D.C.

Exemptions from RegistrationIn truth, now an adviser will need an advanced degree to determine whether it needs to register with the SEC.

Exemptions from RegistrationThere are many friendly lawyers who will be more than happy to help an adviser wander through the thicket.

Exemptions 101Four different criteria:

MONEY

LOCATION

TYPE OF FUND

FAMILY TIES

Money!!Short summary:

Manage $$1.0 million or more, you register with the SEC --

Unless all your clients are private funds in which case,

If you manage $1.5 million or more you register with the SEC.Money Again!SODoes the adviser manage $100 million or more? If yes,

Unless, all the advisers clients are private funds? If so, does the adviser manage $150 million or more? If yes, REGISTER with SEC !!

REGISTER with SEC!!

Money Again!REGISTER with state(s) in which the adviser does business!!

D0es the adviser manage less than $100 million (or $150 million if all the clients are private funds)? If yes,

Money AgainAre you with me so far?

If the adviser manages $100 million or more than it must register with the SEC unless all its clients are private funds (i.e., no separate accounts), in which case the adviser does not have to register with the SEC unless it manages $150 million or more. Advisers whose money thresholds do not require registration with the SEC will register with the relevant state.Location, Location, Location!!Where the adviser does its managing also matters.

If the adviser has a place of business in the United States . .

REGISTER with the SEC!!!UNLESS . . . .

Location Intrastate ExemptionThe adviser is eligible or consigned to the intrastate exemption.But wait!! Didnt we just learn that the intrastate exemption was eliminated?Oh my, thats why were having such fun!!

Location Intrastate ExemptionRemember, previously, if all an advisers clients were in a single U.S. state, and the adviser was also located in that state, the adviser did not have to register with the SEC.

Location Intrastate ExemptionNow -- money matters, not location!!

$100/$150 million under management, the SEC is your destiny even if all the clients are in a single state.

Location Intrastate ExemptionExcept, the Dodd-Frank Act offers relief to advisers with less under management who thus would have to register with fifteen (15) or more states. These advisers will be permitted to register with the SEC.

Location Foreign Adviser ExemptionDoddFrank seeks to capture advisers who have waded offshore to manage money.

Location Foreign Adviser ExemptionSuch advisers will have to register with the SEC unless during the preceding 12 months the adviser:

Has had assets under management attributable to U. S clients of less than $25,000,000, or such higher amount as the SEC may fix by rule;

Has had fewer than 15 clients in the United States; andLocation Foreign Adviser ExemptionHas neither held itself out generally to the public in the United States as an investment adviser, nor acted as an investment adviser to any registered investment company or business development company.

Location Foreign Adviser ExemptionAND, one more IMPORTANT thing . . . .For the purposes of counting the number of clients and client assets, an adviser that manages a private fund, has to look through that fund to determine if there are U.S. investors in the fund.

Location Foreign Adviser ExemptionThis last point is a GREAT example of why you all need lawyers.

Location Foreign Adviser ExemptionCounting fund clients as clients:YES for counting the dollar amount of assets (under $25g);

YES for counting the number of clients (fewer than 15).

Location Foreign Adviser ExemptionNO!!!!! for treating a client of a fund as a client of the adviser for the purposes of the anti-fraud provisions of the Investment advisers Act of 1940.

Location Foreign Adviser ExemptionHere is what Congress said in plain English!!! (really)

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 entered into an advisory contract with such adviser.

Type-of-Fund Issues for RegistrationGeneral Rule: Advisers to private funds have to register with the SEC unless they qualify for a state or foreign exemption.So, the next question is . . . .

Type of FundWhat is a PRIVATE FUND?

A private fund is an investment fund that would be required to register as an investment company under the Investment Company Act of 1940, except that the fund is exempt from registration because it has 100 or fewer investors, or it has 500 or fewer qualified investors.

Type of Fund Issues for RegistrationMost hedge funds, venture capital funds and family funds are private funds.

The Dodd-Frank bill offers exemption from registration for two types of private funds Venture Capital Funds and Family Funds. To paraphrase from George Orwell, in Animal Farm . . . .Type of Fund Issues for RegistrationALL FUNDS ARE PRIVATE, BUT SOME ARE MORE PRIVATE THAN OTHERS . . . . ..

Dodd-Frank Exempts Two Types of Private FundThe SEC has one year from July 21 to promulgate rules defining those terms. There will be intense discussion about the meaning of the term venture capital fund.

Obligations of RegistrantsThe next question is . . . .

SO WHAT? What is the big deal about registration?

Obligations of RegistrantsThe first obligation . . . REGISTER!!That means filing a form ADV with the SEC.The SEC has just announced improvements to the form.

Obligations of RegistrantsRegistration requires the adviser, among other things to have:A written compliance program;

A chief compliance officer;

A code of ethics;

An insider trading policy;AND . . . .

Obligations of Registrants -- RecordkeepingToujours Paperwork!!The records required to be kept include the usual records relating to customer circumstances and goals. The Dodd-Frank Act expands the recordkeeping requirements to include:

Obligations of Registrants --RecordkeepingCounterparty identity and credit risk

Trading and investment positions

Types of assets held

Leverage

Obligations of Registrants --RecordkeepingAUM

Valuation practices and policies

Liquidity

Brokerage practices

Systemic risk indicators

Side letters

AND

Obligations of Registrants --RecordkeepingSuch other information as the Commission, in consultation with the Council, determines is necessary and appropriate in the public interest and for the protection of investorsor 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.

Recordkeeping The records must be:

Maintained;

Filed with the SEC when required;

Available for . . . .Obligations of Registrants--InspectionsInspections on site!

A thoroughly enjoyable experience!!

Nothing is Ever Quite Clear

Nothing is Ever Quite ClearAdvisers that are not required to register because they manage only venture capital funds may still be required to keep certain records as prescribed by the SEC.

StudiesIf at first you dont succeed, try try the outfield!!

Oooops sorry.

StudiesIf at first you dont succeed order a STUDY!!!

StudiesThe Act orders up lots of studies too many to remember. Remember these:GAO STUDY AND REPORT ON ACCREDITED INVESTORS;GAO STUDY ON SELF-REGULATORY ORGANIZATION FOR PRIVATE FUNDS;COMMISSION STUDY AND REPORT ON SHORT SELLING;COMPTROLLER GENERAL STUDY ON CUSTODY RULE COSTS.

Wait Until Next YearIt will all be clear as a bell!!