On May 15, 2007, Senator Chuck Grassley (R- Iowa), the ranking member of the United States Senate Committee on Finance, introduced legislation in the United States Senate which would requireinvestment advisers of most hedge funds and other private investment funds to register with the Securities and Exchange Commission (“SEC”) under the Investment Advisers Act of 1940 (the “AdvisersAct”) and would subject such advisers to regulation under the Advisers Act.
The bill, known as the “Hedge Fund Registration Act of 2007,” is a direct response to the D.C. Circuit Court of Appeals ruling in June 2006 that invalidated Rule 203(B)(3)-1 of the Advisers Act, which the SEC had promulgated in an effort to require certain hedge fund advisers to register under the Advisers Act.
However, the proposed legislation in its current form is broader than the invalidated SEC rule that it is intended to replace in several respects. As background, Section 203 of the Advisers Act generally requires investment advisers to register under the Advisers Act unless the adviser provides investment advice to fewer than 15 clients in the course of the preceding 12 months, does not hold itself out to the public as an investment adviser, and does not provide advice to a registered investment company. Under current law, fund advisers may count the fund as a single client, without “looking through” to count as clients the underlying fund investors.
The proposed legislation, like Rule 203(B)(3)-1 before it, would change this by mandating a look-through to the fund’s investors in most cases. However, the SEC rule had included an exception in the case of funds that had at least a two-year “lock-up” period preventing investor withdrawal during such period. Thus, traditional closed-end real estate (and private equity) fund managers were spared the impact of the rule. The newly proposed legislation, however, includes no such exception. As a consequence, if the legislation is adopted in its current form, many real estate fund managers could find themselves required to register under the Advisers Act and subject to its terms. (Although true “dirt” real estate funds would be excluded because the Advisers Act pertains to advice with regard to securities, many funds make investments in real estate-related assets that would be considered securities for purposes of the Advisers Act.)
It is unclear whether this difference from the prior SEC rule was intentional or not. We expect that this and other aspects of the bill are likely to stir controversy and opposition among fund managers of many stripes. We will keep you apprised of developments as this proposed legislation proceeds through Congress.
