Hedge funds were a key subject of debate during the passage of Dodd-Frank. While the funds were not tied to the causes of the market crisis, they do represent large pools of assets which can impact the market. Regulators frequently note that they have inadequate information about the funds. Accordingly, the financial reform bill contains provisions focused on registration of the funds and record keeping.

For registration, the legislation sets a minimum asset threshold for state regulated investment advisers is $100 million. If however, the adviser is not subject to registration and examination in their home state, or would be otherwise required to register with fifteen or more states, the minimum is $25 million. The Act eliminates the private investment adviser exemption. It also eliminates the intrastate exemption for advisers with any private fund client.

All registered investment advisers will be required to appoint a chief compliance officer and establish compliance programs. In addition, they must adopt a code of ethics.

The burdens of registration and inspection may be eased for mid-sized registrants. The legislation requires the SEC to issue regulations to take into account the size, governance and investment strategy of these funds. The assessment is to focus on whether these funds pose a systemic risk. The registration and examination procedures are to be designed to reflect the results of the risk assessment. Mid-sized private funds is not a defined term.

The new legislation contains a number of exemptions from registration. These include:

• Venture capital funds. The SEC has one year to define this term. These advisers will be subject to the record keeping requirements.

• Small business. Small business investment companies are exempt from registration.

• Private fund advisers. The SEC is to provide an exemption from registration for an investment adviser that serves solely private funds and has assets under management in the U.S. of less than $150 million. Private fund is defined to be any fund that would be an investment company except for the exemptions contained in Sections 3(c)(1) or 3(c)(7) of the Investment Company Act.

• Family offices. Generally family offices are placed outside the Investment Advisers Act. The SEC is required to define the term taking into account several factors stated in the Act.

• Foreign private adviser. The legislation exempts from registration an investment adviser who: 1) has no place of business in the U.S.; 2) has fewer than fifteen clients and investors in the U.S. in private funds; and 3) has aggregate assets under management attributable to clients and investors in the U.S. in private funds of less than $25 million. The SEC is given authority to the dollar amount in the last requirement.

• CFTC registration. Generally, investment advisers registered with the CFTC as commodity trading advisers that advise private funds are exempt.

The legislation gives the SEC authority to conduct periodic inspections of private funds and review all of their records. The Commission is also authorized to conduct special examinations as it deems necessary. In addition, advisers are required to maintain specific records including those regarding: 1) the amount of assets under management, 2) the type of assets held; 3) the use of leverage; 4) counterparty exposure; 5) trading and investment positions; 6) valuation policies and practices; and 7) those deemed necessary by the SEC in consultation with the Counsel created by the Act. The Act requires certain information to be shared with the Council, although proprietary information is subject to enhanced confidentiality measures.

The SEC is required to report to Congress annually on the uses made of the data collected from registered advisers to monitor the markets for the protection of investors and the markets. The SEC and CFTC are also required, within one year, to have consulted with the Council and jointly issue rules regarding the form and content of reports to be filed with each agency by advisers registered with each. The provisions of this section of the Act are generally effective within one year.

Finally, as in other sections of the legislation, it directs that four studies be undertaken:

• Within one year the SEC must submit a study on the feasibility, benefits and costs of requiring the reporting of short sale positions in real time to the public or, alternatively only to the SEC and FINRA. The study is also to include a voluntary pilot program in which companies agree to have trades in their shares marked “short,” “market maker short,” “buy,” “buy-to-cover” or “long” and reported in real time through the consolidated tape.

• Within two years the SEC is to submit a study on the state of short selling after recent rule changes.

• Within three years the GAO is to furnish a study on the criteria for determining who is an accredited investor and the eligibility to invest in private funds. (The Act also requires the SEC to review the definition of accredited investor as it applies to individuals and four years after enactment make appropriate adjustments to the net worth requirements in view of economic conditions).

• Within three years the GAO is to complete a study regarding certain aspects of the custody rules and their impact.

Additional note: Yesterday’s article on the latest Dell settlements states that neither settling defendant relinquished his right to appear and practice before the Commission. Yesterday, the Commission posted the litigation release related to the two settlements (dated last Friday) which notes that Messrs. Davis and Imhoff agreed to be prohibited from practicing before the Commission as accountants in related administrative proceedings which will be filed. Mr. Davis has a right to apply for reinstatement after five years while Mr. Imhoff will have that right after three years. An addendum was added to yesterday’s article noting this important part of the settlement after I was notified about it by the staff. Thank you to the staff for the notification.