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Update on Financial Services Reform for Private Fund Managers

Scott A. Moehrke, Lisa Cawley, Stephanie Biggs and Joshua Westerholm of Kirkland & Ellis LLP


As widely reported in the financial press, the Senate Banking Committee recently approved financial services reform legislation proposed by Senator Dodd (the "Dodd Bill"), containing a number of significant differences from the House bill approved at the end of 2009 (the "House Bill"),[1] including a potentially broadened exemption from federal investment adviser registration for private equity and venture capital fund managers.

The Dodd Bill would eliminate the existing Investment Advisers Act exemption from registration for advisers with fewer than 15 clients. Without an exemption based on a limited number of clients, most managers of certain types of private funds (e.g., hedge funds) with $100 million or more of assets under management ("AUM") would be required to register with the Securities and Exchange Commission ("SEC") as an investment adviser within a one-year transition period. However, the Dodd Bill would:

  • Exempt from federal investment adviser registration a manager of "private equity funds" and "venture capital funds" (terms to be defined by the SEC within six months after the Dodd Bill's passage, apparently without regard to the number of such funds advised by a manager).
  • Exempt from federal investment adviser registration a "foreign private adviser" with: (1) no place of business in the United States; (2) fewer than 15 clients domiciled or resident in the United States; (3) AUM attributable to clients and investors in the United States less than $25 million (or more if specified by the SEC); and (4) no client that is a registered investment company or business development company.
  • Create new recordkeeping and confidential reporting obligations for private funds, such as hedge funds, advised by registered advisers, including: assets under management and use of leverage; counterparty credit risk exposures; trading and investment positions; valuation policies and practices; types of assets held; side letter arrangements; trading practices; and other information that the SEC, in conjunction with a new Financial Stability Oversight Council, may deem necessary or appropriate to assess the private fund's systemic risk. Private equity funds not advised by a registered adviser would be subject to reporting requirements as determined by the SEC within six months of the Dodd Bill's passage.
  • Raise the current AUM threshold of $25 million for federal investment adviser registration to $100 million. U.S. advisers with less than $100 million AUM would be regulated by the states.
  • Require the SEC to update (when the legislation becomes effective and every five years) for inflation longstanding "accredited investor" income and net worth standards for individual investors.
  • Change Regulation D's uniform state filing procedures for private offerings, potentially subjecting private funds to substantially greater state information and filing obligations.
  • Require the GAO to complete a feasibility study within one year to determine whether a self-regulatory organization ("SRO") should be created to oversee and regulate private funds, including private equity and venture capital funds.[2]

The Dodd Bill also includes the so-called "Volcker Rule," previously announced by the Obama administration, which would restrict insured depository institutions, bank holding companies and their subsidiaries from engaging in proprietary trading, (i.e., trading for their own account), owning, sponsoring or investing in private funds, or entering into certain transactions or relationships (e.g., custodial or brokerage relationships) with private funds advised by such banks.

The scope of the final legislation remains uncertain. As with the House Bill, the Dodd Bill may change significantly during the amendment process, with approximately 400 amendments currently under consideration. Moreover, even if private equity and venture capital fund advisers are ultimately exempted from investment adviser registration, there could be renewed calls at the state level for registration of such advisers. In addition, ongoing uncertainty as to how narrowly the SEC would define terms such as "private equity fund" or "venture capital fund" leaves open the possibility that even advisers that might classify themselves as private equity or venture capital may not qualify for the new exemptions.

E.U. Alternative Investment Fund Managers (AIFM) Directive

Numerous revised versions of the AIFM directive have been proposed over the last few weeks in an attempt to reach E.U. inter-governmental agreement. It was thought that E.U. finance ministers would vote on revised legislation at a recent meeting; however, the vote has been postponed until June, indicating significant political disagreement.

Depositary and valuation requirements are still sources of disagreement, but the agenda's key issue is the treatment of funds managed by non-E.U. fund managers, and by U.S. fund managers in particular. The most recent proposal would have allowed non-E.U. fund managers to continue marketing to institutional investors within the European Union under the private placement regime in each country, but on the condition that such firms comply with the directive's new transparency and disclosure rules in the same way as an E.U.-based fund manager. These new requirements would include:

  • producing a directive-compliant annual report for each fund with E.U. investors (primarily financial information and compensation disclosures);
  • providing directive-compliant information to investors, which would require additional disclosures in PPMs;
  • providing certain required information to the national regulator in each jurisdiction in which the fund is marketed; and
  • providing disclosure and reporting requirements in relation to majority-owned European portfolio companies.

However, it is now clear that E.U. finance ministers have not reached agreement on this proposal and further changes are likely. In the meantime, the European Parliament continues to debate the directive, so the next key development is expected to be the publication of the Parliamentary Committee's final report, expected in April. It is still anticipated that there will be a two-year implementation period after the directive is agreed at the E.U. level, so any new rules are highly unlikely to come into force before mid-2012.


Scott A. Moehrke, P.C., Partner, scott.moehrke@kirkland.com

A partner in Kirkland's Corporate Practice Group, Scott A. Moehrke leads the Firm's Investment Management Practice Group, where he practices in securities and corporate law with significant experience representing financial services companies, such as investment advisers, investment companies, business development companies and broker-dealers. His practice focuses on complex business transactions, including registered and exempt fund formations and ongoing operations, mergers, acquisitions and joint ventures of funds and fund managers, public and private securities offerings, novel product design and structuring, SEC compliance, board of directors and governance matters and institutional shareholder rights matters.

Lisa Cawley, Partner, lisa.cawley@kirkland.com

Lisa is a regulatory partner in the London office of Kirkland & Ellis International LLP. Lisa has extensive experience in financial regulation and corporate matters, including the establishment of new investment, banking and insurance businesses in the UK, the negotiation of regulatory approval for changes of control, the management of regulatory issues in connection with funds and the provision of investment, banking and insurance services on a cross-border basis.

Stephanie Biggs, Partner, stephanie.biggs@kirkland.com

Stephanie is a partner in the private equity team in Kirkland's London office. Stephanie has wide-ranging experience in private equity fund formation, with particular expertise in regulatory and compliance issues affecting private equity firms. She also has extensive knowledge of corporate and partnership law, and has advised on matters ranging from the establishment of limited liability partnerships as vehicles for fund managers to complex share capital reorganisations for UK portfolio companies. Stephanie is a member of the BVCA Legal and Technical Committee.

Joshua Westerholm, Associate, joshua.westerholm@kirkland.com

Josh Westerholm is an associate in the Investment Management practice group of the corporate department of Kirkland & Ellis LLP, where he focuses his practice on the representation of private investment funds, investment advisers, broker-dealers, commodity pool operators and commodity trading advisors. Josh has significant experience forming and representing various private funds, including both domestic and offshore hedge funds, commodity pools, funds of funds, private equity funds, real estate funds, managed account structures, ERISA funds and Exchange Act-registered funds, and in forming and representing their registered and unregistered investment adviser sponsors in documentation, structuring and compliance matters.

Kirkland & Ellis LLP

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[1] Discussed in a previous Kirkland PEN.

[2] The SRO model is used for broker-dealers, with the Financial Industry Regulatory Authority ("FINRA") providing day-to-day oversight and regulation.