The Gibson, Dunn & Crutcher Financial Markets Crisis Group is closely tracking government responses to the turmoil that has catalyzed a dramatic and rapid reshaping of our capital and credit markets. We are providing updates on key regulatory and legislative issues, as well as information on legal and oversight issues, that we believe could prove useful as firms and other entities navigate these challenging times.
This update focuses on the House Financial Services Committee’s consideration and approval on October 27, 2009 of H.R. 3818, the Private Fund Investment Advisers Registration Act of 2009. The full text of the bill as amended by the Committee is not yet available.
Overview of Process
While few things are predictable and nothing is certain about the legislative process, the Private Fund Investment Advisers Registration Act has a decent chance of becoming law in a form not unlike that which was reported out of the House Financial Services Committee last week. The once-controversial bill was the subject of a remarkably bipartisan mark-up, particularly in contrast to the Consumer Financial Protection Agency Act (H.R. 3126) mark-up, which followed shortly thereafter. Most amendments to the bill were adopted by near-unanimous voice votes, and the Committee approved the bill, as amended, by a vote of 67 to 1 (Representative Ron Paul (R-TX) was the lone dissent).
Given its overwhelming support in committee, H.R. 3818 would likely have little difficulty passing on the House floor. Less certain would be its fate as a standalone measure in the Senate, where a single senator could hold up the legislation. However, the bill’s chance of passage is improved if, as is likely, it is part of larger financial regulatory reform legislation. A version of the bill is likely to be considered by the Senate Banking Committee as part of financial regulatory reform. Since the legislation is part of the Obama Administration’s regulatory reform plan and a senior Banking Committee member, Senator Jack Reed (D-RI), introduced an investment adviser registration bill earlier this year, the chances of a version of it reaching the Senate floor — most likely next year — are good.
Introduction to the Bill
The Private Fund Investment Advisers Registration Act would require investment advisers to hedge funds, private equity funds, and other private pools of capital to register with the SEC under the Investment Advisers Act of 1940 and be subject to reporting requirements, including reporting relating to systemic risk. Representative Paul Kanjorski (D-PA) introduced the legislation, explaining that it would allow a systemic risk regulator to understand where capital is located. The bill introduced by Representative Kanjorski was identical to the legislation proposed by the Obama Administration in July (see Gibson Dunn Client Alert, "The Private Fund Investment Advisers Act of 2009," July 16, 2009), except for inclusion of the "venture capital fund" exception discussed below. The bill approved by the Committee also includes a $150 million small fund exemption, also discussed below.
Ranking Member Spencer Bachus (R-AL) supported the bill, but expressed concern that the SEC had not testified about it before the Committee. Representative Kanjorski replied that the SEC has been closely involved in drafting the bill, but Ranking Member Bachus emphasized that conferring with the SEC is not the same as having its staff testify before Congress. In public statements, Mary Schapiro, Chairman of the SEC, expressed concern about creating broad carve-outs or exceptions from the proposed registration requirement for investment advisers to private funds.
Highlights of the Bill
Significant differences between the bill approved by the Committee and the Obama Administration’s proposal include:
1. Venture Capital Fund Exemption
The legislation introduced by Representative Kanjorski included a proposed exemption from the registration requirements for investment advisers to "venture capital funds." The proposed legislation does not define venture capital funds; instead the SEC would have authority to define the term. Venture capital funds would still make their information available to a systemic risk regulator on a reconstituted Form D, so that their exemption from the registration requirements would not defeat the legislation’s goal.
2. Expanded Coverage of Offshore Funds
In the initial bill, investment funds formed outside the United States were only included in the definition of "private funds" if 10% or more of the outstanding securities by value of the offshore fund were owned by United States persons. The 10% threshold was eliminated in the bill approved by the Committee. Offshore investment advisers will still be exempt from registration if they meet the definition of a "foreign private fund adviser," as set forth in the bill. Domestic investment advisers advising offshore funds that might have otherwise not been subject to registration because the assets of United States persons in their offshore funds were sufficiently small, however, would no longer be exempt.
3. Definition of "Client"
In the initial bill, the SEC was given broad authority to ascribe different meanings to different terms, including the term "client." The Committee approved an amendment offered by Ranking Member Bachus to clarify that the term client cannot include an investor in a private fund if the private fund has an investment advisory agreement with the investment adviser. The purpose of the amendment was to prevent a conflict of interest by ensuring that investment advisers owe duties to the funds they manage, not to the individual investors in each fund.
4. Small Fund Exemption
Based on existing SEC rules, under the initial bill, investment advisers managing less than $30 million of assets would still be exempt from registration. Throughout the mark-up, Representative Kanjorski stood firm against introducing exemptions into the legislation. Nonetheless, at the end of the mark-up members approved an amendment that would exempt investment advisers to private funds, if each such private fund has assets under management in the United States of less than $150 million. The SEC is directed to establish the details of this exemption. Investment advisers exempt from registration would still be subject to records and reporting requirements on an annual basis as prescribed by the SEC.
5. Transition Period for Registration
The Committee approved an amendment offered by Representative Suzanne Kosmas (D-FL) to allow a one-year transition period from the time the bill becomes law for investment advisers to register.
6. Exemption for Advisers to SBICs
Representatives Shelley Moore Capito (R-WV) and Erik Paulsen (R-MN) offered an amendment to exempt investment advisers who only advise Small Business Investment Companies from the registration and reporting requirements, arguing that SBICs already register with the Small Business Administration and are subject to thorough inspections and reporting requirements. Representative Kanjorski opposed creating another exemption, but it was approved by the Committee.
7. Investor Qualifications
The Committee approved an amendment offered by Representative Himes (D-CT) to provide that investor qualifying tests based on assets and income be indexed to inflation and reset every five years.
One noteworthy amendment that was offered that was not approved related to registration of hedge fund advisers. Representative Hensarling (R-TX) offered an amendment to exempt hedge fund advisers on the same basis as advisers to venture capital funds, paralleling the language in the underlying bill. He argued that hedge funds did not play a role in the economic turmoil of the past year. Representative Kanjorskiresponded that although he could not point to one hedge fund that caused a problem, hedge funds collectively removed liquidity from the market.