Key House Committee Passes Legislation Regulating Hedge Fund Advisers

As part of the plan for overhauling US financial regulation, the House Financial Services Committee has reported out legislation requiring advisers to hedge funds and other private investment funds to register with the SEC if they have assets under management of at least $150 million 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. The $150 million assets under management threshold is significantly higher than the $30 million trigger proposed by the Obama Administration. The higher number also sets up a possible fight with the Senate, where proposed legislation by Securities Subcommittee Chair Jack Reed would set a $30 million assets under management trigger.

However, the Meeks-Peters-Garrett Amendment also requires hedge fund advisers covered by the exemption to maintain the required records and gives the SEC the discretion to require reports in the public interest or for investor protection. The House legislation also contains a registration exemption for advisers to venture capital funds.

The Private Fund Investment Advisers Registration Act, HR 3818, passed with bi-partisan support of 67-1, would mandate the registration of private advisers to private pools of capital so that regulators can better understand exactly how those entities operate and whether their actions pose a threat to the financial system as a whole. In addition, new recordkeeping and disclosure requirements for private advisers will give regulators the information needed to evaluate both individual firms and entire market segments that have until this time largely escaped any meaningful regulation, without posing undue burdens on those industries. Under the legislation, advisers to hedge funds, private equity firms, single-family offices, and other private pools of capital will have to obey some basic ground rules in order to continue to play in our capital markets. Regulators will have authority to examine the records of these previously secretive investment advisers.

The draft mandates the confidential reporting to the SEC 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.

An amendment by Rep. Garrett would require the US Comptroller General to conduct a study and report to Congress on the costs to the hedge fund industry of the legislation’s registration and reporting requirements. Another amendment offered by Rep. Kosmas would delay the effective date for one year, although advisers would have the discretion to register earlier with the SEC.

Senator Reed’s bill requires 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 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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