SEC Staff Issues Guidance on Registration of Hedge Fund Advisers
On August 10, 2006, the SEC’s Division of Investment Management (Staff) issued a letter on the effects of the decision of the U.S. Court of Appeals for the D.C. Circuit in Goldstein v. SEC. In vacating the SEC’s rule requiring registration of certain hedge fund advisers, Rule 203(b)(3)-2 under the Investment Advisers Act of 1940 (Advisers Act), the Goldstein decision referred to the entire SEC Release that accompanied the adoption of the rule. As a result, the D.C. Circuit appears to have vacated the entire rulemaking, which included rule amendments in addition to the registration requirement itself.
The Staff’s letter addresses a number of issues created by the Goldstein decision, including:
Hedge Fund Advisers that Withdraw from Registration. The Staff indicated that a registered hedge fund adviser may withdraw from registration in reliance on the exemption from registration provided by Section 203(b)(3) of the Advisers Act without regard to whether the adviser (i) held itself out generally to the public while it was registered, or (ii) had more than 14 clients while it was registered (counting each private fund as a single client). A hedge fund adviser relying on this position must withdraw its registration by no later than February 1, 2007. For the first 12 months following withdrawal, the adviser may assess its eligibility for the Section 203(b)(3) exemption by determining the number of clients it has had using a period of time beginning on the date of withdrawal, which may be a period of less than 12 months.
Hedge Fund Advisers that Remain Registered. The Staff’s letter effectively permits hedge fund advisers that remain registered to operate as if the rule amendments adopted along with Rule 203(b)(3)-2 had not been vacated. Among other areas, the Staff addressed the following:
Performance Fees. The Staff indicated that a registered hedge fund adviser could receive performance-based compensation if and to the extent the adviser would have been exempt from the prohibition on receiving this compensation under vacated Rule 205-3(c)(2) or Rule 205-3(c)(3). Those rules allowed hedge fund advisers to continue receiving performance-based compensation from funds with non-qualified investors and from other clients who are not “qualified clients” if those persons became equity investors in the fund or entered into investment advisory contracts with the adviser before the registration rule became effective on February 10, 2005.
Books and Records. However, the Staff also noted that a registered adviser must make records available for examination in accordance with Section 204 of the Advisers Act, and may not evade this requirement by holding records by or through any other person, including a related person or private fund. The D.C. Circuit’s decision vacated an amendment to Rule 204-2 that provided that the records of a private fund are records of the adviser (and thus subject to examination by the SEC Staff), if the adviser or any related person acts as the private fund’s general partner, managing member, or in a comparable capacity.
Delivery of Audited Financial Statement by Funds of Funds. The D.C. Circuit’s decision vacated an amendment to Rule 206(4)-2 under the Advisers Act, which extended the deadline for delivery of audited financial statements of a "fund of funds" from 120 to 180 days following a fiscal year end. An adviser to a "fund of funds" (as defined in vacated rule 206(4)2(c)(4)) may now rely on the "annual audit exception" of Rule 206(4)-2 if the audited financial statements of the fund of funds are distributed to its investors within 180 days of the fund of fund’s fiscal year end.
Investment Management FYI is a service of the Investment Management Practice Group of Morgan Lewis. If you have any questions concerning these important legal developments reflected herein, please contact any of the following Morgan Lewis attorneys:
Washington, D.C.
Thomas S. Harman
202.739.5662
tharman@morganlewis.com
Monica Parry
202.739.5692
mparry@morganlewis.com
Miami
Ethan W. Johnson
305.415.3394
ejohnson@morganlewis.com
New York
Louis H. Singer
212.309.6603
lsinger@morganlewis.com
Jedd H. Wider
212.309.6605
jwider@morganlewis.com