Obama Administration Introduces Legislation Regulating Hedge Fund Advisers

Following up on its plan for overhauling US financial regulation, the Obama Administration has proposed specific legislation requiring advisers to hedge funds and other private investment funds with more than $30 million under management to register with the SEC and be subject to significant disclosure and other requirements. Current law generally does not require private fund advisers to register with any federal financial regulator.

Once registered with the SEC, investment advisers to private funds will be subject to important requirements such as substantial regulatory reporting requirements with respect to the assets, leverage, and off-balance sheet exposure of their advised private funds. There will also be disclosure requirements to investors, creditors, and counterparties of their advised private funds. The legislation contains strong conflict-of-interest and anti-fraud prohibitions. Moreover, hedge funds and other private funds will be required to establish a comprehensive compliance program.

Specifically, the Private Fund Investment Advisers Registration Act would include confidential reporting of amount of assets under management, borrowings, off-balance sheet exposures, counterparty credit risk exposures, trading and investment positions, and other important information relevant to determining potential systemic risk and potential threats to our overall financial stability. The legislation would require the SEC to conduct regular examinations of such funds to monitor compliance with these requirements and assess potential risk. In addition, the SEC would share the disclosure reports received from funds with the Federal Reserve Board and the Financial Services Oversight Council.

This information would help determine whether systemic risk is building up among hedge funds and other private pools of capital, and could be used if any of the funds or fund families are so large, highly leveraged, and interconnected that they pose a threat to our overall financial stability and should therefore be supervised and regulated as what the Administration calls Tier 1 financial holding companies, which would be subject to oversight by the new federal systemic risk regulator.

The Administration’s proposed legislation dovetails with legislation recently introduced by Senator Jack Reed requiring advisers to hedge funds, private equity funds, and venture capital funds with $30 million under management to register as investment advisers with the SEC. The Private Fund Transparency Act, S 1276, sponsored by the Securities Subcommittee Chair would also authorize the SEC to collect information from the hedge fund industry and other investment pools, including the risks they may pose to the financial system. The legislation incorporates a confidentiality requirement. The SEC would also be authorized to require hedge funds and other investment pools to maintain and share with other federal agencies any information necessary for the calculation of systemic risk.

Hedge funds and other private funds are not currently subject to the same set of standards and regulations as banks and mutual funds, reflecting the traditional view that their investors are more sophisticated and therefore require less protection. According to Sen. Reed, this has enabled private funds to operate largely outside the framework of the financial regulatory system even as they have become increasingly interwoven with the financial markets. As a result, there is no data on the number and nature of these firms or ability to calculate the risks they pose to the broader markets and the economy.

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