Proposed Hedge Fund Legislation Would Cover More Than Just Hedge Funds

Transcription

1 February 2009 / Issue 4 A legal upate from Dechert s Financial Services Group Propose Hege Fun Legislation Woul Cover More Than Just Hege Funs Propose Bill Woul Require SEC Registration of All Securities- Relate Investment Vehicles with $50 Million or More in Assets, Incluing Hege Funs, Venture Capital Funs, Private Equity Funs, Many Real Estate Funs, an Many CDOs an CLOs Uner propose legislation, any investment fun that traes or hols securities as a significant part of its assets will be require to register uner the Investment Company Act, if it has $50 million or more in assets. The propose bill ientifies hege funs, but its scope is much broaer. In aition to hege funs, the legislation woul apply to venture capital funs, private equity funs, many real estate funs, many collateralize ebt obligations ( CDOs ), collateralize loan obligations ( CLOs ), an other structure proucts, some larger family partnerships, an potentially many others. While the new type of registration woul not impose substantive limits on investment strategy, it woul require significant public isclosures, incluing possibly the ientities of investors. Moreover, the investment aviser for these newly registere vehicles woul be require to register uner the Avisers Act. On January 29, 2009, Senators Charles Grassley of Iowa an Carl Levin of Michigan introuce the Hege Fun Transparency Act of 2009 (the Bill ). 1 The Bill woul effectively eliminate the exceptions uner sections 3(c)(1) an 3(c)(7) of the Investment Company Act of 1940, as amene (the Investment Company Act ), an instea convert them into conitional 1 The Bill is available at: 009/hegefunsbill pf. exemptions uner section 6(a) of the Investment Company Act. 2 In effect, an exception removes 2 Senator Grassley commente that the intent of the Bill was to clarify an remove any uncertainty that hege funs were subject to regulation by the SEC an the effect of the 2006 ecision by the Court of Appeals for the DC Circuit (Golstein v SEC, 451 F (D.C. Cir.2006)). See Press release, ate January 23, 2009 (available at: tomel_atapageid_1502=18922); see also DechertOnPoint, Propose Hege Fun Registration Act Falters in Senate ate July 2007 (Issue 18).

2 an issuer from the scope of the Investment Company Act while an exemption isapplies some of the provisions of the Investment Company Act. Section 6(a) exempts certain entities otherwise meeting the efinition of investment company from the substantive provisions of the Investment Company Act, unless otherwise provie by such statute. 3 Privately offere investment funs relying on sections 3(c)(1) or 3(c)(7) of the Investment Company Act ( Private Funs ) seeking to rely on the new exemptions must: in the case of certain large Private Funs, register with the Securities an Exchange Commission (the SEC ) an isclose specifie information, incluing possibly information regaring investors; an comply with specifie anti-money launering requirements. Private Funs woul be exempt investment companies rather than excepte from the efinition of investment company Although the title of the Bill refers to hege funs, the Bill oes not istinguish among the ifferent entities that rely on the exceptions currently provie by sections 3(c)(1) an 3(c)(7) of the Investment Company Act. As a result, the Bill woul affect not only hege funs but also other types of privately offere funs, incluing venture capital funs, private equity funs, real estate funs, many CDOs, CLOs an other structure proucts, some larger family partnerships, an potentially many others. 4 Currently, Private Funs generally rely on the exceptions from the efinition of investment company pursuant to sections 3(c)(1) or 3(c)(7) of the Investment Company Act. Private Funs entitle to rely on those exceptions o not require any significant regulatory 3 The language in current section 3(c)(1) of the Investment Company Act relating to anti-pyramiing provisions of section 12()(1) of the Investment Company Act appears to have been elete from propose section 6(a)(6). Given statements from the Bill s sponsors that the propose changes are technical rather than substantive, this may have been an oversight or a case of unclear rafting. 4 The efinition of investment company is highly technical an may capture many entities that are not typically viewe as investment companies or investment funs. compliance proceures uner the Investment Company Act. Uner the propose Bill, the exceptions offere by sections 3(c)(1) an 3(c)(7) of the Investment Company Act woul become exemptions; the text of sections 3(c)(1) an 3(c)(7) of the Investment Company Act woul be move to section 6(a) of the Investment Company Act an renumbere as sections 6(a)(6) an 6(a)(7) respectively. 5 The terms of sections 3(c)(1) an 3(c)(7) woul not change substantively. 6 Uner propose section 6(a), small Private Funs woul be exempt from propose Investment Company Act registration requirements; larger Private Funs woul be require to register an be subject to further compliance requirements as iscusse in greater etail below. Registration of certain large Private Funs uner the Investment Company Act Although the Bill provies that Private Funs woul generally be exempt from the registration requirements of the Investment Company Act, a Private Fun with assets, or assets uner management, of $50 million or more (a Large Private Fun ) coul only avail itself of the exemptions uner new sections 6(a)(6) an 6(a)(7) if it: registers with the SEC; maintains books an recors as require by the SEC; cooperates with any request for information or examination by the SEC; an 5 Certain Private Funs may be able to rely on exceptions provie uner other provisions of the Investment Company Act. For example, section 3(c)(5) of, or Rule 3a-7 uner, the Investment Company Act may be available to certain structure prouct vehicles or certain real estate funs. 6 For example, registere investment avisers to Private Funs relying on new section 6(a)(7) woul continue to be able to rely on the exemption relating to performance fees. However, it shoul be note that there is one significant substantive change with respect to section 6(a)(7) exempte investment companies. Uner the Bill, such an exempte investment company woul be require to look through any exempte Private Fun investors (e.g., a fun of funs) that hel 10% or more of the voting securities of the exempte investment company to etermine if all of its investors were qualifie purchasers. Currently, this look through requirement only applies to Private Funs relying on section 3(c)(1) of the Investment Company Act. February 2009 / Issue 4 2

3 iscloses to the SEC the following: Impact of registration requirement the name an current aress of each natural person with a beneficial ownership interest in the Private Fun; Avisers to Large Private Funs woul be require to register with the SEC as investment avisers the name an current aress of each company with an ownership interest in the Private Fun; the primary accountant an primary broker use by the Private Fun; an explanation of the Private Fun s ownership structure; information on the Private Fun s affiliation with another financial institution; 7 the minimum investment commitment require from an investor; the total number of investors in the Private Fun; an the current value of the assets, an assets uner management, of the Private Fun. The Bill woul require the foregoing information to be isclose electronically to the SEC, at least annually, an woul be available to the public in electronic searchable format. Within 180 ays of passage of the Bill, the SEC woul be require to issue forms an other guiance implementing the Bill. Notwithstaning the current language of the Bill, the Bill s sponsors have clarifie that the Bill oes not require isclosure of the ientities of investors in Private Funs, but rather isclosure regaring the managers of Private Funs that collect fees to operate such funs. 8 It now appears that this requirement of the Bill may be amene. 9 7 The term financial institution is not efine in the Bill, although it is efine in the Bank Secrecy Act, 31 U.S.C See joint statement issue by Senators Charles Grassley of Iowa an Carl Levin of Michigan on February 5, 2009, a copy of which is available at 9 Investment companies that register uner the Investment Company Act are not typically require to isclose the ientity of their investors except in certain instances. Registration statements (e.g., Forms N-1A an N-2) for trai- Currently section 203(b)(3) of the Investment Avisers Act of 1940, as amene (the Avisers Act ) generally exempts an aviser from the requirement to register provie that such aviser avises fewer than 15 clients, oes not publicly hol itself out as proviing investment avice, an oes not avise any investment company registere uner the Investment Company Act. This exemption woul no longer be available to avisers to Large Private Funs registere with the SEC. 10 Similarly, an aviser primarily engage in futures traing may no longer be able to rely on an exemption from registration with the SEC as an investment aviser. The Avisers Act currently exempts an aviser from the requirement to register with the SEC if such aviser is registere with the U.S. Commoity Futures Traing Commission ( CFTC ) as a commoity traing aviser, provies avice primarily on investing in futures, an oes not avise investment companies registere uner the Investment Company Act. 11 Registration obligations may affect Private Fun operations The registration of Large Private Funs uner the Investment Company Act presents the possibility of SEC oversight an examination. Private Funs shoul also consier whether any of the following may be triggere by the Bill s registration obligation: whether registration of a Private Fun may trigger notice requirements or efault provisions uner existing agreements (such as CDO an other tional investment companies o not require the ientification of each investor, although such registration statements o require certain isclosures regaring an investment company s control persons an principal holers. 10 Currently, it is not clear how the Bill woul affect a non- U.S. aviser require to register with the SEC as the result of avising registere Large Private Funs. Uner Uniao e Banco e Brasileiros S.A., SEC Staff No-Action Letter (pub. avail. July 28, 1992) an other no-action letters, a registere non-u.s. aviser that avises only non-u.s. clients is generally not subject to the full regulatory regime of the Avisers Act; such an aviser however woul be subject to the full requirements of the Avisers Act with respect to any U.S. clients. 11 See section 203(b)(6) of the Avisers Act. February 2009 / Issue 4 3

4 structure prouct inentures in which transaction vehicles rely on sections 3(c)(1) or 3(c)(7), sie letters, an service provier agreements, incluing prime brokerage ocuments); whether registration of the Private Fun s investment aviser an registration of the Private Fun may result in notice requirements to investors an possibly the opportunity to reeem from such Private Fun; an whether registration of the Private Fun may result in competing regulatory requirements in the case of Private Funs forme or liste or forme in offshore jurisictions or subject to approval by non-u.s. regulators. Uncertainty regaring application to non-u.s. funs The Bill woul require Large Private Funs to register with the SEC, regarless of whether the aviser were a U.S. or non-u.s. aviser. It is unclear whether, or how, the SEC staff s prior position regaring the application of the Investment Company Act to foreign investment companies 12 woul be affecte by the Bill. The Touche, Remnant & Co. no-action letter ( Touche Remnant ) 13 generally recognize that for purposes of applying certain requirements uner the Investment Company Act, a foreign investment company nee only look to its U.S. offering an its investors who are U.S. persons. 14 If the principles of Touche Remnant an subsequent 12 A foreign investment company is generally an investment company organize uner laws other than the U.S. that is not registere uner the Investment Company Act. Touche, Remnant & Co., SEC Staff No-Action Letter (pub. avail. August 27, 1984). See also Wilmer, Cutler & Pickering an Davis Polk & Warell, SEC Staff No-Action Letter (pub. avail. October 5, 1998). 13 I. See also Goowin, Procter & Hoar, SEC Staff No-Action Letter (pub. avail. Feb 28, 1997). 14 Touche Remnant recognize that the U.S. jurisictional interest in a foreign investment company is base on a non-u.s. investment fun s specific actions in the U.S. or the effect in the U.S. of its activities conucte abroa an state that only those beneficial owners that are resient in the U.S., rather than the total number of investors, woul be consiere for the purpose of calculating the applicable threshol with respect to the Investment Company Act. For example, non-u.s. Private Funs relying on section 3(c)(1) generally nee only count U.S. investors for purposes of the 100 beneficial owner test, an non-u.s. Private Funs relying on section 3(c)(7) generally nee only etermine qualifie purchaser status for U.S. investors. relate no-action letters continue to apply, it may be possible for a foreign investment company to inclue towar the $50 million threshol only those investments mae by U.S. investors for purposes of etermining whether such foreign investment company qualifies as a Large Private Fun; similarly, a foreign investment company may only be require to report information relating to its U.S. investors (e.g., the total number of investors). Alternatively, it is possible that a foreign investment company eeme to be a Large Private Fun registere uner the Investment Company Act woul be require to isclose information relating to all investors because it woul not meet the existing test for a foreign investment company. 15 Uncertainty regaring isclosure an filing obligations In aition to the above consierations, the current language of the Bill oes not aress the following issues which may be significant to potential Large Private Funs: whether or not feeer funs an master funs may be aggregate for purposes of the registration requirement; whether the test for assets or assets uner management is a net or gross test an the relevant time at which the $50 million threshol is applie; an the metho for valuing assets or assets uner management of the Private Fun. Uncertain tax treatment The Bill oes not aress the tax treatment of Private Funs that woul be require to register uner the Investment Company Act. As currently rafte, the Bill may inirectly result in a change in the tax treatment of certain Private Funs that are now relying on the socalle qualifying income exception to avoi taxation as a corporation uner the publicly trae partnership rules in section 7704 of the Internal Revenue Coe (the Coe ). 16 The qualifying income exception currently is 15 Uner sections 7() an 8 of the Investment Company Act, non-u.s. investment companies may register as investment companies provie they receive an orer from the SEC. In practice, this has only rarely happene. 16 Uner current law, absent an available exception, Private Funs that o not have sufficient restrictions on transfers an/or reemptions of interests in such Private Funs may be treate as publicly trae partnerships ( PTPs ) that are generally taxe as corporations uner Coe sec- February 2009 / Issue 4 4

5 not available to Funs that are registere uner the Investment Company Act. 17 Either the Bill or the Coe shoul be moifie to allow Private Funs that are require to register uner the Bill to retain tax treatment as a partnership uner the qualifying income exception. 18 Anti-money launering requirements The Bill also requires each investment company relying on the exemptions uner new sections 6(a)(6) an 6(a)(7) to establish an anti-money launering program an report suspicious transactions to the Department of the Treasury s Financial Crimes Enforcement Network (FinCEN). These requirements apply to all such exempte investment companies, regarless of whether they are Large Private Funs. The Treasury Secretary, in consultation with the SEC an CFTC, is require to propose implementing rules within 90 ays after the Bill becomes law, an to enact final rules within 180 ays after the Bill becomes law. Uner the Bill, the new rules to be aopte by the Department of the Treasury woul also require exempte investment companies to aopt risk-base ue iligence policies, proceures, an controls reasonably esigne to ascertain the ientity of, an evaluate, any foreign persons that supply or plan to supply funs to the exempte investment company (incluing if appropriate look-through to beneficial owners). The Bill also woul subject exempte investment companies to the 120 Hour Rule, a statute enacte as part of the USA Patriot Act that requires banks an broker-ealers (but not registere investment tion One exception frequently relie upon by a Private Fun to avoi taxation as a corporation uner the PTP rules is the qualifying income exception. This exception applies if at least 90% of a Private Fun s annual gross income is erive from certain qualifying sources. Coe section 7704(c)(1). 17 See Coe section 7704(c)(3). 18 If a U.S. Private Fun registers uner the Investment Company Act, it coul elect to be taxe as a regulate investment company ( RIC ) if it is able to also satisfy requirements for RIC status, incluing certain requirements relating to the source of income an gains an iversification of assets. Coe section 851. RICs must also satisfy certain minimum istribution requirements. Coe section 852. companies) to respon to requests for information from an appropriate feeral banking agency within 120 hours of receiving such a request. 19 An appropriate feeral banking agency may require a financial institution to provie information an account ocumentation for any account opene, maintaine, aministere or manage in the Unite States by the financial institution. It is currently unclear which banking regulatory agency woul have authority to submit such requests to exempte investment companies. Ultimate fate of the Bill The Bill has been submitte for consieration to the Senate Committee on Banking, Housing, an Urban Affairs, an significant changes may be inclue. As a result, it is ifficult at this time to preict whether or when the Bill will be ebate or passe, or even the content of any final legislation. Likewise, we cannot preict the nature or scope of regulatory guiance that may be issue in connection with final legislation. Next DechertOnPoint: Hege Fun Aviser Registration Act of 2009 In aition to the Bill, separate legislation was introuce on January 27, 2009 by Representatives Michael Capuano of Massachusetts an Michael Castle of Delaware entitle the Hege Fun Aviser Registration Act of 2009 (the House Bill ). The House Bill woul eliminate the exemption containe in section 203(b)(3) of the Avisers Act that exempts an investment aviser from the requirement to register with the SEC provie that (i) such aviser has avise fewer than 15 clients in the course of the preceing 12 months, (ii) oes not hol itself out generally to the public as an investment aviser, an (iii) oes not avise any investment company registere uner the Investment Company Act. The elimination of this exemption woul effectively require all investment avisers to register with the SEC, without regar to the number of clients or types of clients avise by such investment avisers, unless a ifferent exemption were available (except small avisers allocate to the States for registration). The House Bill has the potential to affect a greater number of avisers than the SEC s prior rule on 19 See 31 U.S.C. 5318(k)(2). February 2009 / Issue 4 5

6 hege fun aviser registration. 20 Regarless of their size or client base, avisers (whether to a hanful of clients, small family offices or investment funs with numerous investors) woul be subject to SEC registration, inspection, an examination. A separate DechertOnPoint will be issue iscussing the impact of the House Bill in greater etail. 20 Registration Uner the Avisers Act of Certain Hege Fun Avisers, 69 Fe. Reg. 72,054 (Dec. 10, 2004) (coifie at 17 C.F.R. 275, 279). This rule has been nullifie by a subsequent case, Golstein v SEC, 451 F (D.C. Cir. 2006). See also footnote 2. This upate was authore by Davi A. Vaughan ( , ; avi.vaughan@echert.com), Keith T. Robinson ( ; keith.robinson@echert.com), Richar Hervey ( ; richar.hervey@echert.com), Tram N. Nguyen ( ; tram.nguyen@echert.com), Niamh A. Curry ( ; niamh.curry@echert.com), Fiona T. Young ( ; fiona.young@echert.com), an Thomas Bogle ( ; thomas.bogle@echert.com). Practice group contacts For more information, please contact the authors, one of the attorneys liste, or any Dechert attorney with whom you regularly work. Visit us at Karen L. Anerberg Lonon karen.anerberg@echert.com Elliott R. Curzon elliott.curzon@echert.com Joseph R. Fleming joseph.fleming@echert.com Margaret A. Bancroft margaret.bancroft@echert.com Carl A. e Brito carl.ebrito@echert.com Brenan C. Fox brenan.fox@echert.com Saner M. Bieber saner.bieber@echert.com Douglas P. Dick ouglas.ick@echert.com Weny Robbins Fox weny.fox@echert.com Stephen H. Bier stephen.bier@echert.com Jennifer O. Epstein Lonon jennifer.epstein@echert.com Robert M. Frieman robert.frieman@echert.com Daphne T. Chisolm Charlotte aphne.chisolm@echert.com Ruth S. Epstein ruth.epstein@echert.com Thomas J. Friemann thomas.friemann@echert.com Christopher D. Christian christopher.christian@echert.com Susan C. Ervin susan.ervin@echert.com Davi M. Geffen avi.geffen@echert.com February 2009 / Issue 4 6

7 Davi J. Harris Jack W. Murphy Kevin P. Scanlan Robert W. Helm John V. O Hanlon john.ohanlon@echert.com Freerick H. Sherley Charlotte freerick.sherley@echert.com Paul Huey-Burns paul.huey-burns@echert.com Jeffrey S. Puretz jeffrey.puretz@echert.com Patrick W. D. Turley patrick.turley@echert.com Jane A. Kanter jane.kanter@echert.com Jon S. Ran jon.ran@echert.com Brian S. Vargo Philaelphia brian.vargo@echert.com Geoffrey R.T. Kenyon geoffrey.kenyon@echert.com Robert A. Robertson Newport Beach robert.robertson@echert.com Davi A. Vaughan / / avi.vaughan@echert.com Angelyn Lim Hong Kong angelyn.lim@echert.com Keith T. Robinson Hong Kong keith.robinson@echert.com Anthony H. Zacharski Hartfor anthony.zacharski@echert.com George J. Mazin george.mazin@echert.com Alan Rosenblat alan.rosenblat@echert.com Jay Zagoren Philaelphia jay.zagoren@echert.com Dechert LLP. All rights reserve. Materials have been abrige from laws, court ecisions, an aministrative rulings an shoul not be consiere as legal opinions on specific facts or as a substitute for legal counsel. This publication, provie by Dechert LLP as a general informational service, may be consiere attorney avertising in some jurisictions. Prior results o not guarantee a similar outcome. U.S. Austin Charlotte Hartfor Newport Beach Philaelphia Princeton San Francisco Silicon Valley EUROPE Brussels Lonon Luxembourg Munich Paris ASIA Beijing Hong Kong February 2009 / Issue 4 7