Record Keeping Requirements for Advisers to Private Funds
The Dodd-Frank Wall Street Reform and Consumer Protection Act requires certain investment advisers to “private funds” to maintain certain records and file reports with the SEC for the purpose of providing the SEC and the Financial Stability Oversight Council with an opportunity to identify potential systemic risk in the system and to address those risks before they result in a major market disruption A private fund is defined as an entity that would fall within the definition of an “investment company” under the Investment Company Act but for reliance on one of two exemptions from that definition. An “investment company” is broadly defined to include those entities which hold themselves out as being primarily engaged in investing in securities. The first exemption from the definition of an “investment company” referred to in Dodd-Frank is available when an issuer has less than 100 beneficial owners of its securities. The second exemption applies when all of the issuers owners are “qualified purchasers,” meaning certain entities that have significant invested amounts. Many private equity funds and hedge funds may fall within the definition of a private fund and be subject to these provisions of the Dodd-Frank Act.
Advisers to Private Funds Registered With the SEC
Section 404 of the Dodd-Frank Act, which amends Section 204 of the Investment Advisers Act of 1940, sets forth the general rules for advisers to private funds that are registered with the SEC. It provides the SEC may require any investment adviser to a private fund registered with the SEC:
- to maintain such records of, and file with the SEC such reports regarding, private funds advised by the investment adviser, as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk by the Financial Stability Oversight Council; and
- to provide or make available to the Council those reports or records or the information contained therein.
Under the Dodd-Frank Act the records of private funds that are advised by investment advisers subject to Section 404 are deemed to be the records of the investment adviser. Presumably, this will have the effect of subjecting new types of information on private funds to existing record keeping requirements applicable to investment advisers.
In addition, Section 404 of the Dodd-Frank Act requires investment advisers to maintain certain records and information relating to clients, subject to inspection by the SEC. These records and information include, for each private fund advised by the investment adviser, a description of:
- the amount of assets under management and the use of leverage, including off-balance-sheet leverage;
- counterparty credit risk exposure;
- trading and investment positions;
- valuation policies and practices of the fund;
- types of assets held;
- side arrangements or side letters, whereby certain investors in a fund obtain more favorable rights or entitlements than other investors;
- trading practices; and
- such other information as the SEC, in consultation with the Financial Stability Oversight Council, determines is necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk, which may include the establishment of different reporting requirements for different classes of fund advisers, based on the type or size of private fund being advised.
A number of issues relating to these new record-keeping requirements have not yet been resolved, and will be the subject of forthcoming rules to be developed by the SEC. For example, the SEC will promulgate rules relating to how long records must be retained by investment advisers, how often investment advisers will be subject to regular record inspections, and the conditions pursuant to which the SEC may conduct non-scheduled record inspections “as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk.” Forthcoming rules will also specify the form and content of new reports that investment advisers will be required to file relating to their work with private funds.
Confidentiality of Information Relating to Private Funds
The Dodd-Frank Act requires the SEC to share information it collects on private funds with the Financial Stability Oversight Council, and allows for information sharing with other departments and agencies. One concern relating to the additional record keeping, reporting, and inspection provisions applicable to advisers to private funds is that compliance with these new rules and the sharing of information among regulators will lead to the disclosure of highly confidential and proprietary information that has traditionally been closely guarded by private funds. The Dodd-Frank Act attempts to address this concern by providing that the Financial Stability Oversight Council and any other department or agency that receives information relating to private funds must maintain the same level of confidentiality with respect to that information as was maintained by the SEC.
The SEC has the authority to maintain a high level of confidentiality with respect to sensitive information, and is exempt from the public disclosure requirements contained in the Freedom of Information Act (Title 5, Section 552 of the United States Code). The Dodd-Frank Act identifies a subclass of “proprietary information” collected by the SEC for special treatment. Proprietary information included in reports to the SEC is subject to the same limitations on disclosure as are provided in Section 210(b) of the Investment Advisers Act, which amongst other things, prohibits the disclosure of such information to anyone not a member, officer, or employee of the SEC without the approval of the SEC. Proprietary information is defined to include sensitive, nonpublic information regarding:
- the investment or trading strategies of the investment adviser;
- analytical or research methodologies;
- trading data;
- computer hardware or software containing intellectual property; and
- any additional information that the SEC determines to be proprietary.
Exempt Advisers to Private Funds
Investment advisers with assets under management of less than $150,000,000 that solely act as advisers to private funds are exempt from registration as investment advisers under the Dodd-Frank Act. These exempt advisers to private funds are not subject to the record keeping requirements described above. Exempt advisers will still be subject to some level of record keeping requirements and to some form of reporting, but the specifics of these obligations are left to the discretion of the SEC. The Dodd-Frank Act requires the SEC, when promulgating rules applicable to exempt advisers, to take into account the size, governance, and investment strategy of such funds to determine whether they pose systemic risk, and to match the administrative burden of the new rules with the level of systemic risk posed by such funds.