Proposed Legislation Would Increase Oversight of Funds

A bill recently introduced in the U.S. Senate could have major implications on the disclosures that hedge, private equity, venture capital and other private investment funds must provide to the federal government. On January 29, 2009, Michigan Democrat Senator Carl Levin and Iowa Republican Senator Charles Grassley introduced the Hedge Fund Transparency Act (the Act), which would give the Securities and Exchange Commission (SEC) the statutory authority to cause private investment funds to register with government authorities. According to Senator Grassley's floor statement, the Act's registration requirements on private investment funds are necessary "so the government knows who they are and what they're doing."

At present, private investment funds are able to avoid the SEC's regulatory oversight by claiming exceptions under the Investment Company Act of 1940 (ICA). ICA governs only those entities defined as "investment companies," and it provides specific exclusions from that definition. For example, Section 3(c)(1) of ICA excludes private investment funds with 100 or fewer beneficial owners that are not proposing to make a public offering of their securities. Additionally, ICA Section 3(c)(7) excludes private investment funds whose outstanding securities are owned by persons or companies with over $5 million in certain investments. Thus, because most private investment funds have been crafted with such guidelines in mind, they are able to escape the regulations enumerated in ICA.

The Levin-Grassley legislation would cause Sections 3(c)(1) and (7) of ICA to no longer be exceptions from the actual definition of an "investment company" under ICA, and instead would place them as new Sections 6(a)(6) and 6(a)(7) of ICA. Section 6 of the ICA's statutory scheme lists certain exemptions from ICA, which still allows the SEC to place certain requirements on qualifying companies, as opposed to the current outright exception that private investment funds currently enjoy.

The conditions of the exemptions would be revealed in new Section 6(g) of ICA, which would place limitations on exemptions for large investment companies. An investment company with at least $50 million of assets or assets under management would be forced to provide information to the SEC, even if it were to meet the exemption criteria of Sections 6(a)(6) or (7) of ICA. Such disclosures would include:

1. registering with the SEC;

2. maintaining such books and records as the SEC may require;

3. cooperating with any request by the SEC for information or examination; and

4. annually filing an information form with the SEC that would demand, among other things, the names and addresses of all beneficial owners of the private investment fund, an explanation of the private investment fund's ownership structure, the names and addresses of the private investment fund's primary accountant and broker, and the current value of both the assets of the private investment fund and the assets under management by the private investment fund.

However, to clarify that the bill would not result in a private investment fund's investors being publicly disclosed, Senators Grassley and Levin asserted in a joint statement released on February 5, 2009, that only the "fund's beneficial owners, who profit from the fees generated in operating the fund," would need to be provided to the SEC under the Act.

Furthermore, all private investment funds, both large and small, that are exempt under Sections 6(a)(6) and (7) of ICA would have to institute anti-money laundering programs and also be required to report certain suspicious transactions to the government, the purpose of which is to safeguard against the financing of terrorist organizations. Such programs would have to be established within one year of the enactment of the Levin-Grassley legislation, and the Treasury Secretary would have the authority to establish minimum requirements for such programs.

While the title of the Act implies that the legislation is aimed at only hedge funds, private equity firms and venture capital funds would also fall under its purview. Not only is there no definition of "hedge fund" in the Act, but Senator Levin revealed the broad nature of the legislation's impact by stating that the current exclusions from the definition of an investment company are claimed by "a wide variety of entities…and they refer to themselves by a wide variety of terms – hedge funds, private equity funds, venture capitalists, small investment banks, and so forth. Rather than attempt a futile exercise of trying to define the specific set of companies covered by the bill and thereby invite future claims by parties that they are outside the definitions and thus outside the SEC's authority, the bill applies to any investment company that has at least $50 million in assets or assets under its management and relies on" Sections 3(c)(1) or (7) of ICA. As pointed out in the Wall Street Journal, the $50 million dollar threshold "encompasses virtually every private-equity firm." Peter Lattman, Bill Aims for Disclosure by Private Equity, Wall St. J., Feb. 4, 2009, at C3. Thus, the requirements of the Act would have a broad impact on all types of private investment funds.

As the Act was introduced only a few weeks ago and has not yet been taken up for consideration by the Senate Committee on Banking, Housing, and Urban Affairs, there is no guarantee that the legislation will be passed, let alone what changes will occur as the legislative process transpires. However, what is clear is that some members of Congress are intent on increasing the oversight of private investment funds which were generally unregulated in the past.

Ice Miller LLP will continue to follow the course of the legislation and will provide updates as necessary. For more information on this legislation please contact Mark Alson.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.