While all but the smallest private equity firms in the United States are preparing to come under the regulatory umbrella of the Securities and Exchange Commission, current legislation proposed by the Obama administration, as currently written, also will impact investment advisers based outside US borders. This in turn could cause some non-US general partners to limit the number of US investors in their funds.
A recent bill sent by the Treasury Department to Congress requires hedge funds, private equity funds and venture capital funds to register with the Securities and Exchange Commission if their assets under management exceed $30 million. SEC-registered managers of private funds will be subject to recordkeeping requirements, disclosure requirements with respect to investors, creditors and counterparties, as well as undefined reporting requirements to a “systematic risk” evaluator.
For firms based outside the US but who do business in the States, both the Treasury bill and a similar measure in the Senate introduce the concept of a “foreign private adviser” (FPA), which may enjoy an exemption from registration if it:
- has fewer than 15 clients in the US (with “client” currently defined as a fund; see below)
- has assets under management attributable to those clients of less than $25 million
- does not market itself as an investment adviser to the US public, or
- acts as an adviser to a US-registered company
However, even these exemptions may be limited by certain aspects of both bills.
For instance, each bill grants the SEC authority to change the definition of a “client”, which could lead to individual investors in a fund rather than the funds themselves being counted as clients. Such a change would greatly expand the number of non-advisers that qualify for registration under the 15-client rule, with such firms then having to comply with the substantive provisions of the Investment Advisers Act of 1940 with their US clients.
In addition, while no asset limitation currently exists, the $25 million asset threshold that is being proposed could result in registration for foreign firms with just one significant US private client or investor. Dechert partner Jennifer Wood says that any foreign firm that seeks out US investors and the resulting regulatory burdens and compliance issues would likely be seeking to raise enough to offset such costs.
“Effectively, any investment manager that has gone through the trouble of arranging for that would have at least one fund that had more than $25 million of US money in it,” she said. “So I can see where there would be a fairly significant number of non-US managers who would be impacted by that.”
But while some foreign advisers may respond by limiting their presence in the US, others may decide that it is pointless to try and fight the current regulatory momentum around the globe. For instance, across the pond the European Parliament is preparing to debate even more burdensome regulations that would affect leveraged fund managers with more than €100 million in assets and unleveraged funds with more than €500 million in assets.
“I think there are probably three camps of people: there’s the set of people who will avoid having US investors because they want to avoid having the burden, there is a subset of non-US advisers that is already registered and there is a third set of people who will take the requirement to have to be registered as part of the cost of doing business in a new world order where regulation of investment advisers around the globe is required,” Wood said. “I don’t think anyone who has looked at the European movements in this area will be terribly surprised if you need to be authorized in multiple countries to run a hedge fund that will be sold to investors in multiple countries.”