Private Fund Investment Advisers Act

On October 27, 2009, the House Committee on Financial Services approved by a vote of 67-1 the Private Fund Investment Advisers Act of 2009 (the “Act”). This proposed Act closely tracks draft legislation introduced by the Obama Administration in July this year with one important exception. The proposed Act provides an exemption from registration and reporting for “venture capital fund advisers.” The Securities and Exchange Commission (“SEC”) is charged with the responsibility of identifying and defining the “venture capital fund.” The venture capital fund exemption was included on the assumption that the venture capital industry does not pose systemic financial risk and registration would place a burden on small private equity firms aiming to create jobs in this difficult economy. A full House vote is expected in the coming weeks.

The proposed Act has various objectives. First, the proposed Act would replace the current registration exemption under the Investment Advisers Act of 1940 (the “Advisers Act”), which is available to advisers not holding themselves out to the public as investment advisers and who have fewer than fifteen (15) clients. Instead, the proposed Act would do away with the existing private investment exemption and require all advisers to private funds¹ to register with the SEC if their assets under management are greater than $30,000,000. The proposed Act would exempt non-U.S. investment advisers who have fewer than fifteen (15) clients and assets under management attributable to U.S. clients of less than $25,000,000.

Second, the SEC would be granted recordkeeping, reporting and inspection authority. The SEC would be authorized to require any investment adviser registered under the Advisers Act to maintain records of, and submit to the SEC, reports regarding private funds advised by the investment adviser as determined by the SEC to be necessary or appropriate and for the assessment of systemic risk by the Federal Reserve and the Financial Services Oversight Council, and to provide or make available to the Federal Reserve and the Financial Services Oversight Council such reports or records. The proposed Act provides a specific list of records and reports that would be required to be filed with the SEC, including but not limited to, the amount of assets under management, use of leverage (including off-balance sheet leverage), counterparty credit risk exposures, trading and investment positions and trading practices. Additionally, the proposed Act would require investment advisers registered under the Advisers Act to maintain records of private funds advised by the investment advisor for periods as the SEC, by rules and regulations, may prescribe as necessary or appropriate.

Third, the proposed Act would provide that the SEC may classify persons and matters within its jurisdiction and prescribe different requirements for different classes of persons or matters and ascribe different meanings to terms used in different sections of the Advisers Act, including the term “client,” as the SEC determines necessary. This provision was most likely crafted as an attempt to reverse the 2006 decision by the U.S. Court of Appeals for the D.C. Circuit, which vacated a SEC rule that construed the definition of “client” to include hedge fund advisers for purposes of investment adviser registration.

Finally, the proposed Act requires advisers to venture capital funds to maintain certain records and provide annual reports to the SEC, as the SEC may determine to be “necessary or appropriate in the public interest or for the protection of investors.”

National Venture Capital Association Chairman Terry McGuire testified on October 6, 2009 before the House Financial Services Committee, together with leaders of the private equity industry. Although McGuire, understandably, supports the exemption afforded to venture capital funds by the proposed Act, those in the buyout and hedge fund industries disagree, claiming that no category of private funds should be exempted. According to McGuire, however, the venture capital industry does not pose systemic financial risk and registration would place a burden on small private equity firms aiming to create jobs these days.²

Given the ease with which the Financial Services Committee approved the proposed Act, as well as the broad bipartisan support it received, the legislation may very well become law. If so, the big question that will remain is how the SEC would define “venture capital fund” if it is faced with such a task.

Should you have any questions regarding your own situation, please contact Frank T. Cannone, Cheryl A. Gorman or Pamela Lopata of our Corporate Department.