Client Memorandum. Funds. Global. Private Fund Investment Advisers Registration Act of 2009

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1 Funds Global Client Memorandum Private Fund Investment Advisers Registration Act of 2009 On July 15, 2009, the Obama Administration proposed the Private Fund Investment Advisers Registration Act of 2009 ( Advisers Registration Act ). The effect of the Advisers Registration Act would be to require most U.S. investment advisers that advise Section 3(c)(1) and Section 3(c)(7) exempt investment companies to register with the SEC. Such investment advisers would be subject to new records and reporting requirements. The Advisers Registration Act would also grant the SEC broad powers to define technical, trade and other business terms under the Investment Advisers Act of 1940 ( Advisers Act ) and Investment Company Act of 1940 ( Investment Company Act ), which could result in a broader reading of the term client for purposes of Section 203(b)(3) so as to encompass all fund investors, thereby reversing the Goldstein decision and broadening the SEC s ability to police conduct. Below, we discuss the Advisers Registration, its relationship to other proposals dealing with investment advisers and investment funds and provide our recommendations with regard to the future of the Advisers Registration Act. For more information, please contact: Addison Braendel Tel: addison.d.braendel@bakernet.com Seth Chertok Tel: seth.chertok@bakernet.com (1) Proposed Amendments to Section 203 under the Advisers Act Currently, all investment advisers (that is, firms that provide investment advice or investment management services with respect to client investments at least some of which are in securities) with at least $30 million in assets under management are required to register with the SEC under the Advisers Act, unless an exemption applies. Many firms that fall within the definition of investment adviser nevertheless are currently exempt from registration by virtue of section 203(b) of the Advisers Act. Specifically, Section 203(b)(3) exempts advisers with 14 or fewer clients an exemption that many large fund sponsors typically rely on. The Advisers Registration Act deletes that provision, except with respect to foreign private advisers. The result? Most exempt investment advisers will have to register with the SEC and be subject to the full scope of regulation under the Advisers Act, including, anti-fraud, record keeping, disclosure and investment advisory Article originally published by Bloomberg Law Reports.

2 fee restrictions. Currently, investment advisers exempt under Section 203(b) are for the most part only subject to the broad antifraud provision in Section 206 of the Advisers Act and the related rules thereunder. (A) Proposed Amendment to Section 203(b)(1) Intra-State Advisers Under the Advisers Registration Act, investment advisers that advise private funds would not be able to rely upon the exemption in Section 203(b)(1) of the Advisers Act. 1 Private funds would include an investment fund (i) that would be an investment company but for the exemptions in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940 ( Investment Company Act ), and (ii) is organized under the laws of the United States or any state thereof, or has 10% of its outstanding securities owned by U.S. persons. Section 203(b)(1) exempts from registration any investment adviser all of whose clients are residents of the state within which such investment adviser maintains its principal office and place of business, and who does not furnish advice or issue analyses or reports with respect to securities listed or admitted to unlisted trading privileges on any national securities exchange. Under the Advisers Registration Act, funds that advised real estate funds solely relying upon Section 3(c)(5)(C) and other funds relying on Investment Company Act exemptions other than Section 3(c)(1) and Section 3(c)(7) would continue to be able to rely upon Section 203(b)(1) of the Advisers Act. An adviser could also still rely upon Section 203(b)(1) if it advised funds organized outside of the United States or any state thereof, and had less than 10% of their outstanding securities owned by U.S. persons. (B) Proposed Amendments to Section 203(b)(3) Fewer Than 15 Clients Under the Advisers Registration Act, only foreign private advisers could rely upon the exemption from registration in Section 203(b)(3) of the Advisers Act. 2 Section 203(b)(3) currently exempts investment advisers who advise non-registered funds who during the course of the preceding 12 months had fewer than 15 clients and who do not hold themselves out to the public as investment advisers. That provision gets deleted in favor of a foreign private advisers provision. This new exemption will cover any investment adviser who (A) has no place of business in the United States; (B) during the preceding 12 months has had (i) fewer than 15 clients in the United States; (ii) assets under management attributable to clients in the United States of less than $25 million or such higher amount as the SEC may by rule deem appropriate; and (C) neither holds itself out generally to the public in the United States as an investment adviser, nor acts as an investment adviser to any investment company registered under the Investment Company Act, or a company which has elected to be a business development company pursuant to Section 54 of the Investment Company Act, and has not withdrawn its election. (C) Proposed Amendments to Section 203(b)(6) Commodity Trading Advisers 1 Advisers Registration Act, Section Advisers Registration Act, Section 403.

3 The Advisers Registration Act would affect the exemption from registration under Section 203(b)(6) of the Advisers Act. 3 Section 203(b)(6) currently exempts investment advisers registered with the Commodities Futures Trading Commission ( CFTC ) as a commodity trading adviser ( CTA ) whose business does not consist primarily of acting as an investment adviser, and that does not act as an investment adviser to (A) registered investment companies; or (B) a company which has elected to be a business development company pursuant to Section 54 of the Investment Company Act and has not withdrawn its election. The Advisers Registration Act would not allow investment advisers to avoid registration who were primarily CTAs, but who nonetheless advised private funds (as defined above). Investment advisers who are primarily CTAs could still advise exempt funds other than Section 3(c)(1) and Section 3(c)(7) exempt funds, such as Section 3(c)(5)(C) exempt real estate funds. (D) Combined Effect of Amendments to Section 203(b) The combined effect of the proposed amendments to Section 203(b) would be effectively to force most domestic fund advisers to register as investment advisers under the Advisers Act, except for intra-state investment advisers that only advised exempt funds other than Section 3(c)(1) and Section 3(c)(7) exempt funds. Registration would subject such investment advisers to the full scope of regulation under the Advisers Act, whereas unregistered investment advisers are currently for the most part only subject to Section 206 of the Advisers Act and the related rules and regulations thereunder. (2) Proposed Amendments to Section 204 The Advisers Registration Act would impose new records and reporting requirements on registered investment advisers by adding a new Section 204(b) to the Advisers Act. 4 Proposed Section 204(b)(1) would authorize the SEC to require any registered investment adviser to maintain such records of and submit to SEC such reports regarding private funds advised by the investment adviser as are necessary or appropriate in the public interest and for the assessment of systemic risk by the Board of Governors of the Federal Reserve System and the Financial Services Oversight Council, and to provide to these governmental organizations those reports, records and the information contained therein. Section 204(b)(1) grants the SEC broad powers regarding the transparency of private funds advised by registered investment advisers. However, it would not apply when registered investment advisers advised exempt investment funds other than Section 3(c)(1) and Section 3(c)(7) exempt investment funds, such as Section 3(c)(5)(C) real estate funds. The records and reports filed with the SEC under proposed Section 204(b) (2) would include but not be limited to the following information for each 3 Advisers Registration Act, Section Advisers Registration Act, Section 404.

4 private fund advised by the registered investment adviser: (A) amount of assets under management, use of leverage (including off-balance sheet leverage), counterparty credit risk exposures, trading and investment positions, and trading practices; and (B) such other information as the SEC, in consultation with the Federal Reserve System, determines necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk. A registered investment adviser would be required under proposed Section 204(b)(3) to maintain and keep such records of private funds advised by the investment adviser for such period as the SEC, by rules and regulations, may prescribe as necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk. All records of a private fund maintained by a registered investment adviser would be subject under proposed Section 204(b)(4), at any time, to periodic, special and other examinations by the SEC. Registered investment advisers must make available to the SEC any copies or extracts from such records as the SEC may reasonably request. The SEC would be required under proposed Section 204(b)(5) to make available to the Board of Governors of the Federal Reserve System and the Financial Services Oversight Council copies of all reports, documents, records and information filed with or provided to the SEC under Section 204(b) as necessary for the purpose of assessing the systemic risk of a private fund or assessing whether a private fund should be designated a Tier 1 financial company. Registered investment advisers would be required under proposed Section 204(b)(6) to provide such reports, records and other documents to investors, prospective investors, counterparties and creditors of any private fund adviser by the investment adviser as the SEC may prescribe as necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk. Under proposed Section 204(b)(7), the SEC would not have the obligation to disclose any supervisory report or information contained therein required to be filed with the SEC under Section 204(b), but this provision is limited by certain obligations of the SEC to Congress and other governmental and SRO entities. The SEC and CFTC would be required, under proposed Section 211(e), 5 after consultation with the Board of Governors of the Federal Reserve System, within 6 months after the date of enactment of the Advisers Registration Act, to jointly promulgate rules to establish the form and content of reports required to be filed with the SEC under Section 204(b) and the CFTC by investment advisers that are registered under the Advisers Act and the Commodity Exchange Act ( CEA ). 5 Advisers Registration Act, Section 406.

5 (3) Proposed Amendments to Section 210(c) The Advisers Registration Act would delete Section 210(c) of the Advisers Act. Section 210(c) currently provides that the SEC cannot require investment advisers to disclose the identity, investments or affairs of any client, except in connection with proceedings or investigations. (4) Proposed Amendments to Section 211(a) The Advisers Registration Act would alter the powers of the SEC to engage in rulemaking. The Advisers Registration Act gives the SEC authority to define technical, trade and other terms under in the Advisers Act and the Investment Company Act, including giving the SEC the right to ascribe different meanings to different terms including the term client. The Advisers Registration Act could thereby reverse the Goldstein decision. 6 The Goldstein decision held that the SEC could not by regulation define that a client was a shareholder of a fund for purposes of Section 203(b)(3). The court held that each fund was a client, rather than each investor, in part based upon Congress s intended meaning of the word client. The Advisers Registration Act would give the SEC the latitude to define client. Thus, foreign private advisers could be ineligible for Section 203(b)(3) if they advise 15 or more U.S. investors, rather than 15 or more U.S. funds. (5) Comparison to Other Recent Proposals As of the date of this article, there are four other proposals dealing with proposed amendments to the Advisers Act and the Investment Company Act that could also apply to funds. We briefly discuss the relevance of each of these proposals below, but such analysis in not an exhaustive discussion of every issue. (A) Proposed Private Fund Transparency Act of 2009 The proposed Advisers Registration Act is largely modeled on the Private Fund Transparency Act or 2009 ( Private Fund Transparency Act ), which was introduced on June 16, The Advisers Registration Act is similar to the Private Fund Transparency Act to the extent that both proposals would (i) eliminate Section 203(b)(3) under the Advisers Act except for use by foreign private advisers, (ii) amend Section 204 of the Advisers Act to require records and reporting; and (iii) alter the powers of the SEC to engage in rulemaking. However, the Advisers Registration Act is a more developed version of the Private Fund Transparency Act in that the Advisers Registration Act provides more detail on reports and record requirements. (B) Proposed Hedge Fund Adviser Registration Act of 2009 The proposed Hedge Fund Adviser Registration Act of 2009 ( Hedge Fund Adviser Registration Act ), introduced on January 27, 2009, proposed deleting Section 203(b)(3). It is unlikely that this proposal will be entirely followed, since the Private Fund Transparency Act and the Advisers Registration Act each maintain Section 203(b)(3) solely with respect to foreign private advisers. 6 Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006).

6 (C) Hedge Fund Transparency Act The proposed Hedge Fund Transparency Act, introduced on January 29, 2009 and discussed in our Bloomberg article dated March 23, 2009, 7 would require a scaled back form of registration and certain disclosure for private funds with at least $50 million in assets under management. The Hedge Fund Transparency Act would impose anti-money laundering obligations on all private investment funds. The main difference between the Hedge Fund Transparency Act and the Advisers Registration Act is that the Hedge Fund Transparency Act relates to the registration and other obligations of funds, whereas the Advisers Registration Act relates to the registration and other obligations of investment advisers. Some of the disclosure required by private funds with at least $50 million in assets under management under the Hedge Fund Transparency Act would overlap with the disclosure required under the Advisers Registration Act. Both would require disclosure regarding the value of assets under management of the fund. However, the Advisers Registration Act could require considerably more disclosure as the SEC would have the authority to prescribe disclosure rules in the public interest. The Hedge Fund Transparency Act and the Advisers Registration Act could be complementary schemes as well as alternative schemes. Smaller fund advisers would likely prefer enacting the Hedge Fund Transparency Act in lieu of the Advisers Registration Act, since the registration provisions of the Hedge Fund Transparency Act do not apply to private funds with less than $50 million in assets under management. (D) Investor Protection Act of 2009 The proposed Investor Protection Act of 2009 ( Investor Protection Act ), introduced on July 10, 2009 and discussed in our forthcoming Bloomberg article, 8 would amend several provisions under the Advisers Act, the Investment Company, the Securities Act and the Exchange Act. Most importantly, the Investor Protection Act would (i) impose disclosure, fiduciary duty and substantive obligations on investment advisers (as well as broker-dealers); (ii) bar certain persons who had committed certain bad acts while being associated with broker-dealers, municipal securities dealers, transfer agents and investment advisers from being associated with such parties; and (iii) establish broader aiding and abetting liability under the Advisers Act, the Investment Company and the Securities Act that extended beyond control person liability. 7 Addie Braendel and Seth Chertok, Open Issues in the Hedge Fund Transparency Act, Bloomberg Law Reports Securities Law (March 23, 2009). 8 Addie Braendel and Seth Chertok, Investor Protection Act of 2009, Bloomberg Law Reports Securities Law (forthcoming).

7 The Investor Protection Act could complement the Advisers Registration Act and the Hedge Fund Transparency Act, or could be enacted as an alternative mechanism. Investment advisers may find the Investor Protection Act to be the most cumbersome of the proposals, since it would prescribe substantive standards that apply to investment advisers. (6) Our Recommendations for the Advisers Registration Act If the Advisers Registration Act is enacted, we recommend that Congress provide an exemption for smaller investment advisers for whom the burden of registration and compliance would be too great. An exemption could apply to investment advisers, for example, with assets under management of less than $50 million, which would parallel the provisions of the proposed Hedge Fund Transparency Act. About our Global Funds Practice Group Our team of Funds lawyers spans across 67 offices in 39 countries and the group focuses on acting for GP s on the structuring and formation of funds; acting for LP s in connection with investments in funds and ongoing issues arising; and acting for buyers and sellers on secondary fund transactions. We regularly represent sponsors and investors in a wide variety of private investment funds, including private equity funds, buyout funds, energy funds, mezzanine funds, hedge funds, merchant banking funds, carbon credit trading funds, real estate funds and distressed company funds. Coupled with our unique international tax capabilities, we are able to provide end-to-end advice on all aspects of structuring and investing in funds. For more information on our Funds structuring and formation capabilities, please contact: Asia Pacific Jason Ng, Partner Hong Kong jason.ng@bakernet.com Europe & the Middle East James Burdett, Partner London james.burdett@bakernet.com North America Addison Braendel, Partner Chicago addison.d.braendel@bakernet.com 2009 Baker & McKenzie. All rights reserved. Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm. This may qualify as Attorney Advertising requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome.