Q&A: Hedge and Private Equity Funds Under Financial Reform Law

Date: Friday, July 23, 2010
Author: Sheri Qualters, law.com

The financial reform law signed into law by President Barack Obama on July 21 targets a sector that has previously escaped vigorous government scrutiny -- hedge funds and private equity funds. The Private Fund Investment Advisers Registration Act of 2010, which was enacted as part of the financial reform law (officially the Dodd-Frank Wall Street Reform and Consumer Protection Act), calls for most hedge fund and private fund advisers to register with the U.S. Securities and Exchange Commission. The law exempts investment advisers who manage only venture capital funds, but it's not clear which companies will be exempt from the rules because the SEC has a year to define what's a venture capital fund for purposes of the law.

More onerously, companies subject to the act will be required to adopt compliance programs, tap a chief compliance officer, craft a written code of ethics and implement policies to curb insider trading. Thomas Beaudoin, a partner in the Boston office of Wilmer Cutler Pickering Hale and Dorr who chairs the firm's fund formation practice group, discussed the types of companies that are subject to the law, what it means for overseas private advisers and the law's impact on attorneys. The Q&A has been edited for space and clarity

NLJ: The hedge fund and private equity sectors have always been considered lightly regulated compared with other segments of the financial services industry. Do you consider this the first significant regulation of these sectors?

TB: There was an attempt to regulate hedge funds by requiring them to register back in 2004 or so, but that ultimately failed. This is an attempt to get hedge funds and others, including private equity funds and non U.S. [investment advisers], to register with the SEC to keep a much closer eye on them. Today, they are very lightly regulated entities, and soon they will be highly regulated entities.

NLJ: The act exempts several categories of advisers, including those who solely manage venture capital funds or private funds that have less than $150 million in assets under management in the U.S. Given the exemptions, what kind of companies is the act really targeting?

TB: It's really targeting hedge funds and most private equity funds. It has that under $150 million [language] to exempt smaller buyout funds, but it's fair to say it's looking at virtually all buyout funds.

NLJ: What legal questions will these types of companies face going forward?

TB: [First], registering under the act. It's not a difficult process, but it's a process nonetheless. Also, developing rules and procedures around different aspects of your operations. [Companies now] might not have as robust a code of ethics or document-retention, conflicts-of-interest or insider-trading policy as will be required. They also need to appoint someone to be a chief compliance officer. That could be the [chief financial officer] or internal general counsel. [But if] it is a very complex organization that is not yet registered, that may mean they need to hire someone for that role.

NLJ: What does it mean for lawyers who advise these types of companies?

TB: Lawyers who represent hedge funds and private funds will have, at least at the outset, a significant amount of legal work to get their clients registered. On an ongoing basis, compliance is less intensive. Venture capital is a mystery as to how [the SEC is] going to define that. [But] many funds don't have narrowly defined investment strategies; they have more broadly defined strategies that may enable them to make investments the SEC may not consider venture capital investments. There may be a whole group of what we'd consider venture capital [companies that] will be required to register. The SEC seems inclined to have everyone register. They're likely to craft a definition that is very narrow. Law firms that do venture capital fund formation will have many of their clients being required to register.

NLJ: Does the law contain any surprises for the industry?

TB: Let's say I'm living in Russia and investing in Russian securities. If I have U.S. investors with $25 million, I'm going to have to register unless I come under an exception. That is going to be a real surprise to [private fund managers] who work outside the U.S. -- that the reach of U.S. laws is pretty vast.

NLJ: Will it be a challenge for the SEC to enforce that?

TB: I would think it would be. It will also be a big challenge for any non-U.S. based money manager subject to these requirements to register.

NLJ: Do non-U.S. money managers who have U.S. investors typically work with U.S. lawyers now?

TB: They should be, if they're taking U.S. money, they should be. Theoretically, they are at least interfacing with U.S. lawyers if they're conducting any kind of sales activity in the U.S. [But] if you're talking about someone managing $5 billion and taking in a few [U.S.] people [whose investments] add up to $30 million, there's a tendency on some of their parts to ignore U.S. law or not to get a U.S. lawyer involved.

NLJ: Is advising overseas fund managers a growing legal area?

TB: The appetite of U.S. investors for [foreign investment] products, whether we're talking a private equity fund that invests in Indian companies or a venture capital fund that invests in Chinese startups, there's a very large appetite from U.S. investors for those kinds of products. The role of U.S. lawyers in capital formation projects managed overseas and invested in overseas is becoming much more prominent than it was, say, 15 years ago.