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Grassley and Levin Propose the Hedge Fund Transparency Act

January 29, 2009

With the backdrop of the financial crisis, Senator Carl Levin, a Michigan Democrat, and Charles Grassley, an Iowa Republican, introduced a bill yesterday that, if passed, would dramatically change the requirements currently applicable to unregistered  private investment  funds by subjecting them to the Investment Company Act, requiring certain private investment funds to register with the Securities and Exchange Commission (the "SEC"), establish anti-money laundering programs and report suspicious transactions.

While introducing the bill on the Senate floor, Senator Levin made it clear that he thinks the time has come for Congress to establish clear authority for federal regulation and oversight of hedge funds.  Senator Levin stated, "the problem is that hedge funds have gotten so big and are so entrenched in U.S. financial markets, that their actions can now significantly impact market prices, damage other market participants, and can even endanger the U.S. financial system and economy as a whole."

Under current law, hedge funds and other private investment funds rely on exclusions from the definition of "investment company" to avoid registration under the Investment Company Act and accordingly, SEC oversight. Private investment funds most commonly rely upon Sections 3(c)(1) and 3(c)(7) of the Investment Company Act. Section 3(c)(1) provides an exclusion for any fund whose outstanding securities are beneficially owned by not more than 100 persons, and that is not making or proposing to make a public offering of its securities. Section 3(c)(7) provides an exclusion for any fund whose outstanding securities are owned exclusively by "qualified purchasers" (generally, persons owning not less than $5 million in certain investments), and that is not making or proposing to make a public offering of its securities.

The Hedge Fund Transparency Act, if passed, would include private investment funds formerly relying on Sections 3(c)(1) and 3(c)(7), in the definition of "investment company", thereby subjecting them to the Investment Company Act and SEC oversight absent an exemption. The bill essentially re-categorizes the exclusions in Sections 3(c)(1) and 3(c)(7) as exemptions in new Sections 6(a)(6) and 6(a)(7), without making substantive changes to their text. However, the bill does add conditions on the new exemptions for certain large investment funds. Investment funds with assets, or assets under management, of not less than $50,000,000, can avail themselves of the new exemptions only if they:

  • Register with the SEC;
  • File, at least annually, an information form with the SEC;
  • Maintain such books and records as the SEC may require; and
  • Cooperate with any request for information or examination by the SEC.

The information form, which will be freely available to the public in an electronic, searchable format, must include:

  • The name and current address of each beneficial owner of the investment company, any company with an ownership interest in the investment company, and the primary accountant and primary broker used by the investment company;
  • An explanation of the structure of ownership interests in the investment company;
  • Information on any affiliation the investment company has with another financial institution;
  • A statement of any minimum investment commitment required of a limited partner, member, or other investor;
  • The total number of any limited partners, members, or other investors; and
  • The current value of the assets of the investment company and any assets under management by the investment company.

The bill also authorizes the SEC to require additional information it deems appropriate.
To safeguard against the financing of terrorist organizations and money laundering, the bill also requires investment companies exempt under new Sections 6(a)(6) or 6(a)(7) to establish, within one year of the enactment of the Act, anti-money laundering programs and report suspicious transactions. The Treasury Secretary must establish a rule within 180 days of the enactment of the Act establishing the minimum policies, procedures and controls required for the anti-money laundering programs. The rule must require exempted investment companies to “use risk-based due diligence policies, procedures, and controls that are reasonably designed to ascertain the identity of and evaluate any foreign person...that supplies funds or plans to supply funds to be invested with the advice or assistance of such investment company.” The rule must also require exempted investment companies to comply with the same requirements as other financial institutions for producing records requested by a federal bank regulator no later than 120 hours after receiving such request.  The rule also may incorporate elements of the Bush administration's 2002 proposed anti-money laundering rule for investment funds that was never finalized.

If the bill is passed, the SEC must issue forms and guidance to carry out the Act within 180 days after its enactment. The bill also authorizes the SEC to make a rule to carry out the Act.