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Regulatory Update: SEC prepares for registration proposals next week

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The SEC is set to reveal its final thinking on the registration of hedge fund advisers at an open meeting in Washington on Wednesday 14 July.

The SEC is set to reveal its final thinking on the registration of hedge fund advisers at an open meeting in Washington on Wednesday 14 July.

The Commission will consider whether to propose rule 203(b)(3)-2 under the Investment Advisers Act of 1940 to require hedge fund advisers to register with the Commission.

The Commission also will consider whether to propose certain conforming and transitional amendments to rules 203(b)(3)-1, 204-2, 205-3, 206(4)-2 and Form ADV.

The proceedings will be keenly watched across the Atlantic by the non-US hedge funds industry.

In March this year, the London-based Alternative Investment Management Association (AIMA) revealed that the majority of its members are opposed to the suggested additional registration of hedge fund advisers (or managers) in the USA.

They are also concerned whether there may be exemptions for some advisers. Their concerns were prompted by the publication of the SEC Report, “Implications of the Growth of Hedge Funds”, which was issued last September indicating that compulsory registration with the SEC may be required for all hedge fund managers operating in the US or having US investors.

AIMA issued a strong response to the SEC’s Staff Report, stating that its members “are almost all already subject to efficient regulation in the places where they are established and/or operate”.

AIMA stated: “The likely impact on AIMA’s global membership of registration requirements as proposed in the Report is so great that we must respond.  AIMA does not usually involve itself in lobbying activities in the USA.”

AIMA stated: “With regard to non-US based funds, managers and other parties, the potential effect is of serious concern to our members as a whole; many would be affected by the proposed registration.  Almost all non-US hedge fund managers have US investors in their funds: the consequences for them of the proposals in the Report are significant.  The possible impact on those managers and other interested parties would be very considerable and onerous”. 

“In our Response, we have primarily presented arguments on behalf of non-US interests, resisting registration for non-US hedge fund managers and pointing out the undesirability of, and difficulties inherent in, separate regulatory and enforcement regimes which may be conflicting and irreconcilable and duplicate requirements.”

“In addition, we have pointed out that it is likely that non-US managers would weigh up the alternatives of the cost and encumbrance of registration with and regulation by the SEC against foregoing US investors.  The possible and undesirable result may then be that US investors would be denied the opportunity to invest in non-US funds.”

“As stated in our Response, we will be sending copies of it to regulatory authorities in other relevant, non-US jurisdictions. We will await the SEC’s decision on whether to accept the proposals contained in the Staff Report. If that happens and detailed rules are proposed, we will consider making further representations on behalf of our members in the SEC’s consultation process that will follow.”

Executive Summary of AIMA’s Response

AIMA’s response to the SEC’s Staff Report has been made on behalf of the majority of its members who are not US based and who are already regulated in their own jurisdictions. Such members would very probably be affected if the proposals made in the Report, requiring registration of hedge fund managers or advisers by the SEC and with other consequent implications also, were to be approved. Almost all non-US based managers or advisers have US investor interests in the funds they manage; accordingly, the potential implications of the proposals for them would be significant.

AIMA has made specific representations to the SEC concerning the following matters:-

* A non-US manager or adviser is usually already subject to adequate and relevant regulation in his own domicile and, very often, also in any place in which he operates; he should not be required to submit to separate or additional regulation by the SEC.

* The requirements of those non-US jurisdictions are usually complementary. Conflicting, irreconcilable and “overlapping” regulatory requirements – which would arise if US regulation were also to be imposed – are to be avoided, as are duplicating regimes covering authorisation, compliance, investigation, discipline and enforcement. In its response, AIMA has set out in some detail particular and complex issues which would arise in respect of dual regulation by, e.g., the Financial Services Authority (FSA) in the UK and the SEC.

* In other, non-US, jurisdictions, the obligation to register is usually triggered by the provision of investment services, irrespective of the number of clients; many hedge fund managers or advisers start with just one fund.

* Those managers or advisers who are already subject to good and relevant regulation outside the US should be excluded from any US regulatory requirements, irrespective of the number of US investors in any fund managed or advised by them.

* An offering document is required of a non-US fund; a “Hedge Fund Brochure” would duplicate the information disclosed. Funds offered in Europe and elsewhere, whether with a stock exchange listing or not, are required to provide extensive disclosure. In the UK, where managers are regulated, all promotional documentation must comply with certain requirements, including that it must be clear, fair and not misleading.

* Outside the US, it is standard practice, and it may also be a requirement, that a fund’s securities are valued by an independent third part administrator, who will also verify prices and calculate NAV; this will address and often exceed the SEC’s concerns.

* Registration and regulation do not, of themselves, act as a deterrent to fraud.

* The imposition of a minimum threshold of USD 1.5 million for direct investment in some hedge funds would act as a trade barrier to non-US managers or advisers since that is significantly higher than requirements in most non-US jurisdictions.

* Regulation of non-US managers or advisers will not assist the SEC’s aim to obtain information on the US hedge fund industry and will add an onerous US layer of regulation without bringing any additional benefits beyond those already resulting from existing regulation.

* In contrast to comment referred to in the Report, a non-US manager or adviser faced with the cost and encumbrance of SEC registration would probably choose the alternative and forego having US investors in a fund – with the resultant disadvantage for US investors, who would be denied the opportunity to invest in the non-US fund.

For further information on the SEC meeting, contact Vivien Liu at the SEC on (202) 942-0719.

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