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U.S. Financial Reform Law: Key Changes for Non-U.S. Advisers and Certain Investors in Hedge and Private Equity Funds

July 28, 2010

On July 21, 2010, U.S. President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”) into law after it was approved in final form by the U.S. Senate on July 15‚ 2010 by a vote of 60 to 39.

The Act will require many investment advisers and fund managers with their principal office and place of business outside the U.S. (each, a “Non-U.S. Adviser”) to register with the U.S. Securities and Exchange Commission (the “SEC”) under the U.S. Investment Advisers Act of 1940, as amended (the “Advisers Act”), particularly those Non-U.S. Advisers that have previously relied on the “private adviser” exemption from SEC registration‚ which has been eliminated by the Act.1 The “private adviser” exemption was available to a Non-U.S. Adviser if‚ during the preceding 12 months, the Non-U.S. Adviser advised fewer than 15 clients resident in the United States (and, for this purpose, each fund advised by the Non-U.S. Adviser was viewed as a single client), and neither held itself out generally to the public in the U.S. as an investment adviser nor acted as an investment adviser to any investment company registered under the U.S. Investment Company Act of 1940‚ as amended (the “1940 Act”), or any entity electing to be treated as a business development company under the 1940 Act (each registered fund and business development company under the 1940 Act, a “1940 Act Fund”).

A Non-U.S. Adviser that registers with the SEC must observe, with respect to its U.S. clients, the full spectrum of SEC regulations that apply to registered investment advisers. These regulations include, for example, adopting and implementing compliance policies and procedures, making and maintaining certain books and records, making and maintaining publicly available filings with the SEC, accepting periodic SEC examinations, and adopting and enforcing detailed codes of ethics and personal trading rules for their personnel. The SEC, however, has permitted a “regulation lite” approach that registered Non-U.S. Advisers may observe with respect to their non-U.S. clients (including, without limitation, non-U.S. funds in which U.S. persons invest).2 It is reasonable to expect that the “regulation lite” regime will continue in some form for Non-U.S. Advisers.  

The Act will also impose new disclosure and recordkeeping requirements on many Non-U.S. Advisers, including Non-U.S. Advisers exempt from SEC adviser registration because, for example, they rely on certain new exemptions from Advisers Act registration established by the Act. Although these new disclosure and recordkeeping requirements to a large extent have yet to be specified, the Act authorizes the SEC to adopt such requirements as it deems “necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk.”3

Below is a summary of the Advisers Act registration implications for Non-U.S. Advisers that now rely on the “private adviser” exemption from Advisers Act registration, as well as a summary of certain of the Act’s principal changes affecting investors in funds managed by Non-U.S. Advisers.


Prior to the enactment of the Act, many Non-U.S. Advisers, including advisers to hedge funds, private equity funds and other private investment funds, were exempt from the Advisers Act requirements to register with the SEC. In particular, Non-U.S. Advisers relied on the “private adviser” exemption from registration under the Advisers Act. Non-U.S. Advisers were required to count only U.S. resident clients towards the 15 client threshold. For this purpose, each fund was viewed as a single client, and the adviser was not generally required to look through any U.S. or non-U.S. fund and count its underlying investors. Accordingly, based on the “private adviser” exemption, Non-U.S. Advisers could manage private investment funds with many U.S. investors without being required to register under the Advisers Act. 

Elimination of “Private Adviser” Exemption and Creation of Narrower “Foreign Private Adviser” and Other Exemptions from Advisers Act Registration

The Act eliminates the “private adviser” exemption from the registration requirements of the Advisers Act. As a result, within one year after the Act’s enactment, many previously exempt Non-U.S. Advisers of hedge funds, private equity funds and other private investment vehicles will be required to register with the SEC.

If you are a Non-U.S. Adviser currently relying on the “private adviser” exemption and are ineligible for another exemption from Advisers Act registration, you must under the Act register with the SEC unless you qualify for the “foreign private adviser” exemption by meeting all of the following tests:

  • you do not have a place of business in the U.S.; and
  • you do not have U.S. $25 million or more (or such higher amount as the SEC may specify in a rule) of aggregate assets under management attributable to clients in the U.S. and to investors in the U.S. in funds excluded from the definition of "investment company" by operation of Section 3(c)(1) or 3(c)(7) of the 1940 Act ("Private Funds") you manage; and
  • you have fewer than 15 clients and investors in the U.S. in Private Funds you advise; and
  • you do not hold yourself out generally to the public in the U.S. as an investment adviser or act as an investment adviser to a 1940 Act Fund. 

As a practical matter‚ many Non-U.S. Advisers that currently rely on the “private adviser” exemption will not qualify for the “foreign private adviser” exemption because they manage funds with U.S. $25 million or more invested by U.S. investors or have 15 or more U.S. clients or U.S. investors in Private Funds they manage.

Non-U.S. Advisers that are not able to rely on the “foreign private adviser” exemption should consider whether they are eligible for another exemption from Advisers Act registration. Certain new exceptions are provided by the Act. These include exemptions for advisers solely to (a) Private Funds if these advisers have assets under management in the U.S. of less than U.S. $150 million or (b) “Venture Capital Funds”, which is to be defined by the SEC by July 2011. 

The SEC may consider raising the asset threshold for determining “foreign private adviser” status from U.S. $25 million to U.S. $150 million in the case of a Non-U.S. Adviser that advises only Private Funds in order to address the discrepancy between the U.S. $25 million threshold for qualifying as a "foreign private adviser" and the assets under management registration threshold for an adviser solely to Private Funds.4 However, there can be no assurance that the SEC will take any such action.

Reporting and Recordkeeping Requirements Relating to Private Funds

The Act authorizes the SEC to require registered investment advisers to maintain such records and file such reports with the SEC regarding Private Funds advised by the investment adviser that the SEC deems “necessary or appropriate in the public interest or for the protection of investors” or to provide the Financial Stability Oversight Council (the “Council”) with the data necessary to monitor systemic risk issues.5

The Act also specifies that each registered investment adviser must maintain the following records and provide the following reports to the SEC with respect to its Private Funds: (a) the amount of assets under management and use of leverage (including off-balance sheet leverage)‚ (b) counterparty credit risk exposure‚ (c) trading and investment positions‚ (d) valuation policies and practices of the fund, (e) types of assets held, (f) side arrangements or side letters providing favorable terms for certain investors, (g) trading practices, and (h) all other information that the SEC determines, in consultation with the Council, to be “necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk...based on the type or size of private fund being advised.”6

The Act stipulates that the records and reports of a Private Fund advised by a registered investment adviser shall be deemed to be the records and reports of the investment adviser.7 In this way, the Act shifts regulatory responsibility for these records to the registered investment adviser, which is subject to the provisions of the Advisers Act.

The Act also directs the SEC to conduct periodic examinations (the schedule of such examinations is to be established by the SEC) of all records of Private Funds maintained by a registered investment adviser and provides the SEC with ample discretion to conduct such additional or special examinations as the SEC may prescribe as “necessary and appropriate in the public interest, or for the assessment of systemic risk.”8

It is presently unclear whether the SEC may adopt any “registration lite” limitations on these recordkeeping and reporting requirements for Non-U.S. Advisers that register under the Advisers Act.

Information Sharing; Requirement of Confidentiality for Private Fund Information

Pursuant to the Act, the SEC is required to make available to the Council copies of the reports, documents, records and information filed with or provided to the SEC by an investment adviser with respect to a Private Fund. The Act provides that neither the SEC nor the Council may be compelled to disclose this information. However, this confidentiality requirement does not authorize the SEC or the Council to withhold such information from Congress.9 The confidentiality requirement also requires the SEC and the Council to comply with requests for information from any other U.S. federal department or agency, or any self-regulatory organization or an order of a U.S. court in an action brought by the U.S. government or the SEC. Note that the Act imposes the same confidentiality requirements as are applied to the SEC and the Council on such other U.S. federal departments and agencies and such self-regulatory organizations, and exempts the SEC, the Council and other recipients of Private Fund information from the Freedom of Information Act in relation to Private Fund information. Further, the Act states that any “proprietary information” of an investment adviser obtained by the SEC shall be subject to the same limitations on public disclosure as the facts the SEC ascertains during an examination of an adviser (as provided under Section 210(b) of the Advisers Act). “Proprietary information” of an investment adviser as defined by the Act includes sensitive, non-public information regarding: (a) the investment or trading strategies of the investment adviser, (b) analytical or research methodologies, (c) trading data, (d) computer hardware or software containing intellectual property and (e) any additional information the SEC determines to be proprietary. Finally, the Act provides that the SEC may require the disclosure of the identity, investment or affairs of any of an investment adviser's clients "for purposes of assessment of potential systemic risk."

Other Provisions of Interest

Limitation of Investment by Banking Entities and Nonbank Financial Companies in Hedge Funds and Private Equity Funds. Section 619 of the Act (the “Volcker Rule”) adds a new Section 13 to the Bank Holding Company Act of 1956 that generally prohibits a “banking entity”10 from, among other things, acquiring or retaining ownership interests in “hedge funds” and “private equity funds”11 or from sponsoring such entities (e.g. serving as their general partner or managing member). However, the acquisition, retention and sponsorship of hedge funds and private equity funds by banking entities that engage in such activities "solely" outside the U.S. is permitted if (a) the relevant funds are not offered to U.S. persons, and (b) the banking entity is not directly or indirectly controlled by a banking entity organized under the laws of the U.S. or one or more states.

Another important exception to the general prohibitions of the Volcker Rule provides that a banking entity may organize and offer (including sponsor) a private equity or hedge fund to which it provides bona fide trust, fiduciary or investment advisory services provided that such fund is organized and offered only in connection with the provision of such services and only to persons who are customers of such services of the banking entity and so long as the banking entity does not acquire or retain an equity interest, partnership interest or other ownership interest in the fund apart from a “de minimis investment.”12 “De minimis investments” include: (a) the banking entity’s “seed investment” in the fund and (b) other investments in the fund provided that the banking entity: (i) actively seeks third party investment to dilute its investment, (ii) reduces its investment in the fund to 3 percent or less of the fund's total ownership interests within one year after the fund’s establishment,13 (iii) makes an investment that is “immaterial”14 to the banking entity and (iv) the aggregate of all the banking entity's de minimis investments does not exceed 3 percent of its “Tier I” (core) capital.

Banking entities must comply with the applicable hedge and private equity fund ownership provisions of the Volcker Rule within two years after the effective date of the relevant divestiture provisions (that may be up to two years after the effective date of the Act). This compliance period may be extended by up to three one-year periods by the Board of Governors of the Federal Reserve System (the “Fed”), which may also grant a one time five-year extension for the divestiture of “illiquid funds”15 held by subject banking entities. As a result of these provisions, many banking entities may be required to divest themselves of a substantial portion of their holdings in hedge funds and private equity funds in the future. Advisers to such funds should examine their organizational documents and fund-related contracts (including private “side letter” agreements with their investors in such funds) to determine the applicable procedures to facilitate the redemption, sale and/or transfer of fund interests currently held by investors that are banking entities regulated by the Fed.

The Fed is required to impose additional quantitative limits on the investment in hedge and private equity funds by the nonbank financial companies16 the Fed regulates. Nonbank financial companies regulated by the Fed must comply with the applicable hedge and private equity fund ownership provisions of the Volcker Rule within the earlier of: (a) two years after the effective date of the relevant divestiture provisions (that may be up to two years after the effective date of the Act) and (b) two years after the date on which an entity or company becomes a non-bank financial company regulated by the Fed. This compliance period may also be extended by up to three one-year periods by the Fed. As a result, many nonbank financial companies regulated by the Fed may also be required to divest certain of their hedge and private equity fund holdings in the future.17

A banking entity may act as investment manager to a hedge fund or private equity fund so long as it does not enter into “covered transactions” (as defined in Section 23A of the Federal Reserve Act) with such fund, and the banking entity acts in accordance with Section 23B of the Federal Reserve Act as if such entity was a member bank and such fund was an affiliate. Similar restrictions apply to banking entities that sponsor or organize and offer hedge funds or private equity funds.

Changes to the Definition of “Accredited Investor”. Rules 215 and 501(a) under the Securities Act define “accredited investors” to include, among others, individual investors with a net worth, or joint net worth with their spouse, that exceeds $1 million. It appears that, effective when the Act became law, individuals were no longer permitted to include the value of their primary residence in determining whether they have sufficient net worth, or joint net worth with their spouse, to meet this test. The Act directs the SEC to maintain the net worth threshold at $1 million exclusive of the value of the investor's primary residence for four years after enactment of the Act and authorizes the SEC to review the definition of “accredited investor” as it applies to natural persons, and to make any adjustments or modifications necessary for the protection of investors, in the public interest and in light of the economy at least once within every four year period, starting four years after the enactment of the Act.18 Advisers should examine offering and subscription documents for Private Funds they manage to ensure that the value of an individual's primary residence is excluded from the calculation of the $1 million net worth threshold.19

Adjustment of “Qualified Client” Test for Inflation. Section 205(a) of the Advisers Act generally prohibits registered investment advisers from charging performance fees or similar fees based on the appreciation of the value of assets under management. Rule 205-3 provides an exemption from this prohibition that generally permits registered investment advisers to charge performance fees to “qualified clients.” The rule defines “qualified clients” to include natural persons or companies (a) with at least $750,000 under management with the adviser immediately after entering into such advisory relationship, (b) with a net worth of more than $1.5 million (including assets held jointly with a spouse), and (c) that are “qualified purchasers” under the 1940 Act (generally individuals with at least $5 million and companies with at least $25 million in “investments” as defined in Rule 2a51-1 under the 1940 Act). The Act amends Section 205(e) of the Advisers Act to require the SEC to adjust for inflation the $750,000 assets under management and $1.5 million net worth thresholds for determining a client’s status as a “qualified client” within one year after the date of the Act's enactment and every 5 years thereafter. This change may increase the suitability requirements for many Private Funds managed by an SEC registered adviser and must be reflected in the subscription and offer documents for Private Funds upon effectiveness. However, this change will not require an increase in the suitability standards for Private Funds that require their investors to be “qualified purchasers” as defined in the 1940 Act because “qualified purchasers” are automatically qualified clients.


Non-U.S. Advisers currently relying on the “private adviser” exemption should consider whether they are required to register under the Advisers Act by July 2011. Although the SEC may issue further guidance with respect to special requirements or exemptions for Non-U.S. Advisers within the next year, it is prudent for Non-U.S. Advisers that do not fall in one of the exemptions set forth in, or provided for by, the Act to assume they will be required to register with the SEC under the Advisers Act and comply with the regulations applicable to registered investment advisers under the Advisers Act. In addition, advisers to hedge funds and private equity funds should consider whether the Volcker Rule may trigger redemptions from these funds by banks and other financial institutions subject to regulation by the Fed. Advisers to Private Funds offered in the United States to accredited investors should adjust the “accredited investor” wording in their offer and subscription materials in order to require individual investors to exclude their primary residences when determining if they meet the $1 million net worth accredited investors test. 

The obligations of Non-U.S. Advisers under the Advisers Act may evolve as the SEC and other regulators provide guidance and issue rules implementing the Act. We will be monitoring the rulemaking process closely and will discuss further developments in future alerts. 

Please direct questions to any of the listed attorneys or to any other Bingham attorney with whom you ordinarily work on related matters:

Steven Giordano, Partner, Investment Management
steven.giordano@bingham.com, 617.951.8205

Anne-Marie Godfrey, Partner, Investment Management
anne-marie.godfrey@bingham.com, 852.3182.1705

Richard A. Goldman, Partner, Investment Management
rich.goldman@bingham.com, 617.951.8851

Thomas John Holton, Partner, Investment Management
john.holton@bingham.com, 617.951.8587

Amy Natterson Kroll, Partner, Broker-Dealer Group
amy.kroll@bingham.com, 202.373.6118

Paul B. Raymond, Partner, Investment Management
paul.raymond@bingham.com, 617.951.8567 

Stephen C. Tirrell, Partner, Investment Management
stephen.tirrell@bingham.com, 617.951.8833

Richard J. Welch, Partner, Private Equity
rick.welch@bingham.com, 213-229-8510

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area
roger.joseph@bingham.com, 617.951.8247

Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area
edwin.smith@bingham.com, 617.951.8615

Authored by: Paul B. Raymond


1For additional discussion regarding changes to the U.S. regulatory regime governing investment advisers and private funds please see our alert U.S. Financial Reform Law: Key Changes for Private Fund Managers Under the U.S. Investment Advisers Act and Changes to Certain Investor Eligibility Qualifications, dated June 30, 2010 as supplemented on July 28, 2010.
2 Under the “regulation lite” regime, a Non-U.S. Adviser is permitted to treat each non-U.S. fund as its “client” for all purposes of the Advisers Act, except for Sections 203, 204, 206(1) and 206(2) thereof.  As a result, most of the substantive provisions of the Advisers Act would not apply to a Non-U.S. Adviser’s dealings with a non-U.S. fund, even if the investors in the fund included U.S. persons.  For example, a Non-U.S. Adviser would not be required to comply with the following rules under the Advisers Act as to non-U.S. clients: (a): Rule 206(4)-7 (the “compliance” rule), (b) Rule 206(4)-2 (the “custody” rule) and (c) Rule 206(4)-6 (the “proxy voting” rule).
4Generally, many U.S. advisers with between U.S. $25 million and U.S. $100 million in assets under management that do not otherwise qualify for SEC registration will be required to register with one or more U.S. states. It is also possible that the SEC may consider raising the threshold for qualification as a “foreign private adviser” from U.S. $25 million to U.S. $100 million in order to address the discrepancy in these SEC registration thresholds.
The Act also requires the SEC to report annually to Congress on how the SEC has used the data it has collected to monitor the markets for the protection of investors and the integrity of the markets (§406).
10 “Banking entity” is defined in §619 to include: (a) any insured bank, savings association or nonbank entity corporation deemed to be operating in substantially the same manner as a savings association jointly by such entity and the Director of the Office of Thrift Supervision, (b) any company that controls an entity described in (a), (c) a company that is treated as a bank holding company under Section 8 of the International Banking Act of 1978, and (d) any affiliate or subsidiary of any entity in (a)-(c). These may include non-U.S. entities.
11“Hedge funds” and “private equity funds” are defined in §619 to include Private Funds or such similar funds as the appropriate U.S. federal banking agencies, the SEC and the U.S. Commodity Futures Trading Commission (“CFTC”) may determine by rule.
12The banking entity and/or its affiliates will also need to comply with additional restrictions set forth in the Volcker Rule. These restrictions include: (a) a ban on guarantees by the banking entity of the obligations or performance of the fund, (b) certain trading restrictions between the banking entity and the fund, (c) written disclosure by the banking entity that the fund’s investors (and not the banking entity) are responsible for the losses of the fund, (d) a prohibition on the use of the same name (or a variant thereof) by the banking institution and the fund and (e) a prohibition on the ownership of equity interests in the fund by directors or employees of the banking entity (except for those who are directly engaged in providing investment advisory or other services to the fund).
13 This divestiture requirement may be extended for a period of two years by the Board of Governors of the Federal Reserve System if it determines that such extension is consistent with safety and soundness and in the public interest.
14 Such term shall be defined under the Act by the applicable federal banking agencies, the SEC and/or the CFTC.
15 The Volcker Rule defines “illiquid fund” as a hedge fund or private equity fund that, as of May 1, 2010, was principally invested in (or contractually committed to invest in) illiquid assets (undefined) such as portfolio companies, real estate investments and venture capital investments and makes all investments pursuant to, and consistent with, an investment strategy to principally invest in illiquid assets.
16 “Nonbank financial companies” is defined in §102 to include U.S. and non-U.S companies (excluding bank holding companies, national securities exchanges and such other entities described in §102) that derive 85 percent or more of their gross revenues (directly or indirectly) from “activities that are financial in nature” (as such phrase is defined Section 4(k) of the Bank Holding Company Act of 1956) or from the ownership or control of one or more insured depository institutions. These may include non-U.S. entities.
17 Although not part of the Volcker Rule, §113 of the Act grants the Council the authority to require supervision of a non-U.S. nonbank financial company if two-thirds of the voting members of the Council determine that, among other things, material financial distress at the non-U.S. nonbank financial company or its activities pose a threat to the financial stability of the U.S. 
18 §413(b)
19 It appears that, subject to implementation of any new rules (or revisions to existing rules) adopted by the SEC as a result of the Act, any indebtedness secured by the primary residence (but only up to the fair market value of such residence) also my be excluded for purposes of the $1 million net worth test. Along those lines, it appears that any indebtedness secured by the investor's primary residence that exceeds the fair market value thereof should be treated as a liability and, accordingly, deducted for purposes of calculating the investor's net worth.

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