0. The Potential Impact Of Regulatory Reform On Investors
October 13, 2009
Ida Wurczinger Draim, Partner
Schulte Roth & Zabel LLP
1152 Fifteenth Street, NW, Suite 850 Washington, District of Columbia 20005 |
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2. Overview Backdrop of Proposed Legislation:
Availability of “private adviser” exemption under SEC Rule 203(b)(3) for advisers with fewer than 15 clients/year
2004: SEC adoption of “Hedge Fund Rule,” which re-defined “client” as “fund investor”
2006: Goldstein decision invalidating Hedge Fund Rule; Court holds fiduciary duty owed to funds (clients), not investors
Many funds halt SEC registration process or withdraw from registration

3. Overview Reform Proposals:
Hedge Fund Adviser Registration Act (Jan. 2009)
H.R. 711 (Reps. Capuano and Castle)
Eliminates fewer-than-15 clients exemption
Private Fund Transparency Act (June 2009)
S 1276 (Sen. Reed)
Removes exception for 15 or fewer clients/year
Introduces “foreign adviser” exemption
Private Investment Advisers Registration Act (July 2009)
Treasury Dept. proposal
“Foreign adviser” exemption
Fund disclosure/filing requirements

4. Overview Reform Proposals (continued):
Hedge Fund Transparency Act of 2009 (Jan. 2009)
S (Sen. Grassley)
Eliminates ICA 3(c)(1) and 3(c)(7) registration exemptions
Investment cos w/ $50 million or more must register
Investor Protection Act of (July 2009)
Treasury Dept. proposal
Enhanced regulation of IAs and BDs
Strengthened SEC Enforcement powers
Corporate and Financial Inst’n Comp Fairness Act (July 2009)
H.R (Rep. Frank)
Regulatory authority over financial institution compensation

5. Overview Conclusions: Managers rather than funds will have to register
There will be direct or indirect regulation of funds
“Investor” as “client” is not likely to resurface

6. Private Investment Advisers Registration Act
SEC registration for managers of hedge and private equity funds with $30 million under management
Elimination of “fewer than 15 clients” Exemption
Partial elimination of Commodity Trading Adviser Exemption
New Exemption for “Foreign Private Advisers”
New Fund Disclosure and Filing Requirements
Confidentiality of Fund Reports

7. Private Investment Advisers Registration Act
Ramifications for Investors:
Greater transparency regarding fund managers through Form ADV disclosures
Unfit advisory personnel pre-screened by manager/SEC and removed or restricted
SEC policing of manager’s disclosure and handling of conflicts of interest

8. Private Investment Advisers Registration Act
Ramifications for Investors (continued):
SEC scrutiny of best execution, handling of trade errors, trade allocations, valuation, front-running by personnel
Potential greater transparency regarding funds’ use of leverage (incl. off-balance sheet), counterparty credit risk, positions and trading practices
SEC scrutiny of side letter agreements and other differences in treatment of investors

9. Investor Protection Act of 2009
Broad Rule-Making authority to SEC on various aspects of relationship between investment professionals and clients
Uniform Fiduciary Duty Standard
New RIA/BD Disclosures re:Terms of Customer Relationship
Focus on Conflicts of Interest arising out of Compensation
New Point of Sale Disclosures
Limits on Mandatory Arbitration Agreements
Investor Advisory Committee and Consumer Testing

10. Investor Protection Act of 2009
Expanded SEC Enforcement Powers:
New aiding and abetting provision, Advisers Act Rule 209(f), is broadest to date
Collateral bars and suspensions could be extended across BD, RIA, MSD, NRSRO lines if requested by SEC
Whistleblower incentives and protection under which SEC could make monetary awards of up to 30% of fines collected over $1 million

11. Investor Protection Act of 2009
Ramifications for Investors:
Heightened focus on “Accredited Investor” Certification/Back-up Documentation
Less flexibility for investment professionals to vary terms of client relationship
Restrictions on incentive compensation could chill innovation of fund managers
Changes to Fund Offerings/Manner of Distribution

12. Corporate and Financial Institution Compensation Fairness Act of 2009
Enhanced compensation structure reporting requirements for “covered financial institutions”
Disclosure to appropriate Federal regulator of incentive-based compensation arrangements for purposes of risk analysis
Regulatory authority to prohibit compensation arrangements that “encourage inappropriate risks”
No reporting of actual compensation of individuals – just compensation terms and formulas
Exemption for financial institutions with assets of less than $1 billion

13. Corporate and Financial Institution Compensation Fairness Act of 2009
Ramifications for Investors:
Flight of large fund complexes overseas
Loss of talent to overseas complexes
Proliferation of under-$1billion fund complexes

14. QUESTIONS