Many Hedge Fund Managers May Now Deregister under the Advisers Act

On August 7, 2006, Securities and Exchange Commission (“SEC”) Chairman Christopher Cox announced the SEC’s decision not to seek a rehearing of the decision of the U.S. Court of Appeals vacating the so-called Hedge Fund Rule (the “Rule”). The Rule had required most hedge fund managers to register under the Investment Advisers Act of 1940 (the “Advisers Act”). As a result of the SEC’s decision not to seek a rehearing, any adviser wishing to do so may now actively consider deregistration. Advisers that wish to avoid SEC audits should not plan on waiting to file an application for deregistration until after the SEC commences na audit of the adviser with the expectation of being able to forestall the audit.

Before deregistering, an adviser should first confirm that it satisfies the requirements of the Section 203(b)(3) exemption from registration under the Advisers Act. That exemption is available to na adviser that has had 14 or fewer clients in the last 12 months and that is not holding itself out to the public as an investment adviser. Each hedge fund counts as one client toward the limit of 14 as long as the adviser provides advice based on the investment objectives of the fund rather than the individual investment objectives of the investors in the fund. An adviser may also need to consider whether registration under the Advisers Act is helpful or necessary for purposes of achieving QPAM status under ERISA, or whether SEC registration may be desirable for other purposes (such as to satisfy preferences of current and prospective investors).

Additionally, advisers should be aware that any adviser that deregisters under the Advisers Act may be required to register as an investment adviser under one or more state laws unless exemptions are available. State examination requirements may also apply. Before the adviser terminates its registration under the Advisers Act, it may be necessary for registration with one or more states to become effective. Requirements of foreign jurisdictions in which the adviser has clients or in which it trades in securities or other financial instruments may also need to be considered in deciding whether an adviser should deregister.

Furthermore, any fund managed by an adviser that adopted a lockup of more than two years in order to avoid “private fund” status, and therefore, the requirement of adviser registration under the Rule, may now issue securities that are not subject to such a lockup. Subject to the requirements of each fund’s organizational documents, such an adviser may also now seek to amend such fund’s organizational documents to reduce or eliminate the lockup on previously-issued securities.

Advisers considering deregistration should also be aware that the SEC may propose a new rule or that Congress may enact certain legislation or amend the Advisers Act in such a way as to subject them to registration in the future. In fact, Rep. Barney Frank, D-Mass., has already introduced legislation to reinstate the Rule. The SEC may also propose rules that would provide incentives for advisers to remain registered under the Advisers Act. It seems likely, however, that any new rules, legislation or amendments would provide sufficient notice to take appropriate action.

In his August 7 announcement, Chairman Cox indicated that, instead of seeking a rehearing of the U.S. Court of Appeals decision, the SEC intends to focus aggressively on rulemaking to address the legal consequences from the invalidation of the Rule. Among the new SEC rulemaking proposals announced by Chairman Cox is an anti-fraud rule under the Advisers Act that would have the effect of “looking through” a hedge fund to its investors. This proposed rule would establish that the anti-fraud provisions of the Advisers Act apply directly to the adviser’s dealings with investors in the hedge fund, not just with the fund itself.

According to Chairman Cox, the SEC is also considering whether it should increase the minimum asset and income requirements for investors in hedge funds. Other SEC initiatives announced by Chairman Cox include the grandfathering, transition and other miscellaneous relief necessitated by the vacating of the Rule, which are designed to eliminate disincentives for voluntary registration and to enable hedge fund advisers that are already registered to remain registered. Finally, Chairman Cox emphasized that the SEC would continue to vigorously enforce the federal securities laws against hedge funds and hedge fund advisers who violate those laws.

Nicholas S. Hodge
617.261.3210
[email protected]
Kay Gordon
212.536.4038
[email protected]
Girish S. Kashyap
617.951.9124
[email protected]

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If you have questions or would like more information about K&LNG’s Hedge Fund Practice, please contact one of our lawyers listed below, or send general inquiries via e-mail to [email protected].

BOSTON
Mark P. Goshko 617.261.3163 [email protected]
Nicholas S. Hodge 617.261.3210 [email protected]

LONDON
Philip J. Morgan +44.20.7360.8123 [email protected]

LOS ANGELES
William P. Wade 310.552.5071 [email protected]

NEW YORK
Beth R. Kramer 212.536.4024 [email protected]
Richard D. Marshall 212.536.3941 [email protected]

SAN FRANCISCO
David Mishel 415.249.1015 [email protected]
Mark D. Perlow 415.249.1070 [email protected]

WASHINGTON
Cary J. Meer 202.778.9107 [email protected]
Robert H. Rosenblum 202.778.9464 [email protected]

Kirkpatrick & Lockhart Nicholson Graham LLP - United States