Proposed US hedge fund legislation could encompass real estate fund managers

Draft legislation introduced last month by a US senator to reinstate registration of most hedge fund managers with the Securities and Exchange Commission could also drag managers of real estate funds into the purview of the US regulator, according to partners at Los Angeles-based law firm Paul, Hastings, Janofsky & Walker.

On May 15, Senator Chuck Grassley, the most senior member of the Senate finance committee, introduced Hedge Fund Registration Act of 2007, which would require investment advisers of most hedge funds and other private investment funds to register with the SEC under the 1940 Investment Advisers Act and subject them to regulation under the Advisers Act.

The bill is a response to decision by the D.C. Circuit Court of Appeals in June last year, which quashed the registration requirement introduced by the SEC in an effort to require certain hedge fund advisers to register under the Advisers Act.

However, according to Larry Hass and Josh Sternoff of Paul Hastings, in its current form the proposed legislation is broader in several respects than the invalidated SEC rule it is intended to replace.

For example, they say, Section 203 of the Advisers Act generally requires investment advisers to register under the Advisers Act unless the adviser provides investment advice to fewer than 15 clients in the course of the preceding 12 months, does not hold itself out to the public as an investment adviser, and does not provide advice to a registered investment company.

Under current law, fund advisers may count the fund as a single client, without looking through the vehicle to count as clients the underlying fund investors. The proposed legislation, like the SEC's short-lived Rule 203(B)(3)-1 before it, would change this by mandating a look-through to the fund's investors in most cases.

However, the SEC rule included an exception in the case of funds that had at least a two-year lock-up period during which investors could not withdraw their capital, a measure designed to avoid the registration requirement affecting traditional closed-end real estate and private equity fund managers.

However, Grassley's proposed legislation includes no such exception. As a consequence, say Hass and Sternoff, if the legislation is adopted in its current form, many real estate fund managers could find themselves required to register under the Advisers Act and subject to its terms.

Although funds that invest exclusively in direct real estate would be excluded because the Advisers Act is limited to advice with regard to securities, many funds make investments in real estate-related assets that would be considered securities for purposes of the Act.

Hass and Sternoff say it is unclear whether this difference from the overturned SEC rule is intentional or not. They expect that this and other aspects of the bill to stir controversy and opposition among fund managers of many types.

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