Battle of the bills

A side-by-side comparison of the House and Senate draft legislation for the regulation of US private investment funds, by Nathan Greene and Jesse Kanach of law firm Shearman & Sterling.

On Tuesday, Christopher Dodd, Chairman of the US Senate Committee on Banking, Housing, and Urban Affairs, unveiled wide-ranging proposed legislation concerning US financial regulation. Deep within the 1,100 page draft bill, a 14-page portion corresponds to last month’s US House of Representatives draft bill concerning private adviser registration under the Investment Advisers Act of 1940. The following summary points out significant differences between the House and Senate drafts, including which private advisers would be exempt from registration under each draft.  
Sen. Dodd has said that he hopes to mark up the bill in the first week of December, but parts of the Senate legislation, most of which are unrelated to investment advisers, are reported to be controversial and may slow the pace at which the legislation proceeds. 
Exemptions from registration
Private equity fund advisers
House draft: Required to register. 
Senate draft: Exempt from registration, but subject to recordkeeping and US Securities and Exchange Commission reporting obligations.
Venture capital fund advisers
House draft: Exempt from registration, but subject to recordkeeping and SEC reporting obligations. 
Senate draft: Exempt from registration.
Family offices    
House draft: Required to register. 
Senate draft: Exempt from registration; excluded from the definition of “investment adviser.” If exempted from registration, private equity and venture capital fund advisers would apparently no longer have to count clients for purposes of determining registration requirements, as both draft bills would remove the “14-or-fewer client” rule from the Advisers Act. Such investment advisers would, however, remain subject to the fiduciary duty and anti-fraud obligations imposed under the Advisers Act.
The specific details about each of the above exemptions, including the definitions of relevant terms, would be determined by SEC rulemaking.
Independent custody of client assets
The Senate draft would provide that a registered investment adviser must use an “independent custodian” to hold client assets. The SEC would be directed to issue rules in this regard. The summary accompanying the Senate draft remarks that this provision is “to prevent Madoff-type frauds.” This provision appears stricter than the US Investment Company Act of 1940's provisions governing who may hold custody of US registered funds' assets, and may even affect many of those funds. The House draft has no similar provision on custody.
Non-US advisers with US clients
Each draft would create a “foreign private adviser” exemption from registration that is significantly more limited than exemptions currently available to non-U.S. advisers.  Part of the test for this exemption concerns the number of U.S. clients and amount of assets attributable to them.  Unlike the Senate draft, the House draft counts the number of clients and the amount of assets during the preceding 12 months.  Neither draft mitigates the likely extraterritorial effect of the proposed legislation.
Specific items to be included in private fund reports
The House draft sets out a list of items to be included in private fund reports to the SEC, such as fund asset size, use of leverage, investment positions and trading practices. The Senate draft makes the following additions to that list of required items: valuation methodologies; types of assets held; and side arrangements or side letters whereby certain investors in a fund obtain more favorable rights or entitlements than other investors.
Increased regulation by states
The Senate draft would increase the assets under management threshold for federal regulation from $25 million to $100 million.  Smaller advisers would be subject to state regulation.  A similar provision arises in a different House bill, the Investor Protection Act of 2009.
SEC examinations emphasised
The House draft authorises SEC examinations. The Senate draft, on the other hand, requires the SEC to conduct examinations according to a schedule to be established by the SEC, plus special examinations as appropriate.
Accredited investor standard
Under the Senate draft, the dollar amounts associated with the accredited investor standard under Regulation D under the US Securities Act of 1933 would increase every five years to reflect inflation. This change would affect the drafting of many private funds' offering and subscription documents.
Studies on investor eligibility standards, a private funds SRO, and short selling
The Senate draft calls for the US Comptroller General to conduct studies on (i) appropriate accredited investor and hedge fund investor eligibility standards; (ii) the feasibility of forming a self-regulatory organization for hedge funds, private equity funds and venture capital funds; and (iii) the state of short selling in the market. The House draft of the Investor Protection Act calls for certain more general studies, such as with respect to the organizational structure of the SEC.