The U.S. Securities and Exchange Commission proposed requiring hedge funds and private-equity funds to submit to inspections and new disclosure requirements, aiming to expand oversight as required by the Dodd-Frank law.
SEC commissioners voted 4-1 today to approve a preliminary rule requiring most hedge-fund managers, who currently operate with limited government scrutiny, to register with the agency.
The rules would improve what regulators know about the funds, including their size and the identity of key personnel, SEC Chairman Mary Schapiro said during a meeting at the agency’s Washington headquarters. Deeper background information, such as the name of an auditor, can “serve as a red flag to regulators,” she said.
Until now, the funds have been “out of sight and were unknown to financial regulators and the public,” Schapiro said.
The proposal will be subject to a comment period before final rules are adopted. The rules would revise the Investment Advisers Act of 1940, creating different tier to classify private investment pools by size. At the highest level, advisers managing more than $150 million in U.S. assets would have to register, requiring them to hire compliance officers and submit to periodic inspections by SEC examiners.
The funds also would face wider reporting requirements. They would be required to identify critical “gatekeepers,” including each fund’s auditors, prime brokers, custodians, administrators and marketers, in addition to reporting basic information about their operations, types of clients and business practices that could lead to conflicts of interest.
Some private funds would be exempt from registration: venture capital funds, foreign funds and those with assets of less than $150 million. Those would still have to share basic information, identities of owners and affiliates and any disciplinary history of the adviser.
The final tier specified under Dodd-Frank and detailed in the SEC proposal is an increased swath of smaller hedge fund advisers with less than $100 million in assets -- an adviser list the SEC estimates in the thousands -- which would be swept into regulation by state securities authorities.
Republican SEC Commissioner Kathleen Casey was the lone vote going against today’s proposal, arguing that the reporting requirement for the exempted advisers “collapsed a carefully wrought distinction between registered advisers and exempt advisers.”
Casey praised a grandfather clause within the proposed rules that would “minimize disruption” for established venture capital firms, letting them more easily seek exemption. Any fund that has represented itself as a venture capital fund could meet the rule’s exemption. Otherwise, the definitions for an exempt venture capital firm are that it invests in private companies to primarily provide operating or expansion capital, it’s not leveraged, it lends managerial help and it doesn’t offer redemption rights to investors.
“It sounds as if the definition of venture capital fund is now relatively narrow, as I expected it would be,” said Barry Barbash, a former director of the SEC’s division of investment management and now a partner at Willkie Farr & Gallagher in Washington. “The SEC never appeared to be all that thrilled with an exemption for venture capital funds in the first place.”
Democratic Commissioner Elisse Walter said the grandfather provision was “written quite broadly.” She said it leaves her with a “degree of nervousness” about funds seeking exemptions that bear “no resemblance” to genuine venture capital funds.
This isn’t the first time the SEC has tackled hedge fund registration, although the agency is now backed up by Dodd-Frank. Its earlier effort in 2004 fell short when a U.S. appeals court agreed with hedge-fund manager Phillip Goldstein, who filed a lawsuit, that the agency lacked authority to impose the rule.
In separate votes today, SEC commissioners also unanimously proposed requiring security-based swap data repositories to register with the agency, as well as a rule describing how such swap transactions should be reported and publicly disseminated.