Will Asian hedge fund managers with US investors have to register with the SEC?
Goldstein: The new SEC rules will require an offshore hedge fund manager to register with the SEC if it has 15 US clients or more. The new rules will be effective from February 2006. In the past, most hedge funds have escaped SEC registration because of the exemption for funds with less than 15 US clients. What the new rules have changed is the definition of a 'client.' Before, each private fund invested with an investment advisor was counted as one client. The new rules now require non-U.S. investment advisors to look through any non-U.S. private funds and count each US investor in the fund as a client for the purposes of registration.
For example if a fund of hedge funds is the investor in an Asian hedge fund, each US resident investor in the fund of hedge funds is considered as one client for the purposes of registration.
If US institutions invest in Asian hedge funds through offshore entities, will they still be counted as a US client?
The look through provision means that you have to trace beyond the offshore entity to the final investor. If US investors invest through offshore private fund vehicles they will still be counted as US clients.
Can Asian managers with 15 or more US clients avoid registration by creating separate sub funds and including less than 15 US clients in each fund?
They cannot avoid registration simply through creating separate funds. The new SEC rules apply an integration principle so all of an investment advisor's funds are added together to find the number of US clients.
What impact will the registration requirements have on offshore hedge funds?
Apart from the cost of complying, which could be quite a burden for managers of small and mid-sized funds, one of the practical difficulties that overseas managers are facing is the requirement that all books and records must be maintained in English. This is a big problem for German, French and Japanese managers, for example. Advisors of funds will also have to disclose the ownership structure of the enterprise, which some firms prefer not to be a matter of public record. The advisor would also have to reveal past disciplinary events.
Beyond this, the major impact of registration for non-U.S. managers is that it will to some extent also affect its dealings with offshore non-US clients. The SEC applies a 'conduct and effects' test, which means that if a manager's dealings with its non-U.S. clients are judged to have an impact on its US clients or markets the SEC will exercise jurisdiction over these dealings. For example, under the new regulations, antifraud provisions would apply to dealings between non-US advisors and non-US clients, such as its non-U.S. funds. This would apply even if the fund and dealings with investors was in line with local legal regulations.
One way for managers to avoid the SEC having jurisdiction over the advisor's dealings with non-US investors is to set up separate funds for non-US investors. Then, in order for the integration principle not to apply, the advisor would have to establish separate advisory operations for each group of funds, those with U.S. investors and those without U.S. investors. Avoiding the SEC's integration analysis is very technical and the SEC's positions have taken many years to evolve. Clearly, though, this suggestion only works to the extent that a particular advisor has the resources to do this and such a split of operations would have no real impact on the advisor's business.
What feedback have you gotten from Asian hedge fund managers who have US investors, are they willing to register with the SEC?
The registration requirements will not be too much of a burden for institutional funds, which have the knowledge, experience and resources internally that are necessary to comply with on-going Advisers Act requirements. Those that will struggle are the mid-sized boutique and emerging managers. Several of these managers have told me that they will look to limit the US investors in their fund to less than 15. One manager told me that he will retain the top 14 US investors in his fund, and return money to those US investors will smaller allocations. If more successful Asian hedge fund managers take this approach, this will give them increased bargaining power with US investors, who will need to allocate larger amounts of capital to make it into a fund's top 14 list.
Most Asian hedge funds can find significant amounts of capital from Europe or Japan, and don't necessarily need to attract US investors if it means registering with the SEC.
How will the SEC enforce overseas? Will they come to Asia to visit managers personally?
The SEC has not been made clear yet. But personally, I suspect that they will not seek to be adversarial in their enforcement. The early stages will be cooperative. I expect the SEC would initially correspond with overseas managers in writing, conduct telephone interviews and send out questionnaires. Eventually they will make a trip down to individual countries to conduct on-site inspections.
What should Asian hedge funds managers be doing now to prepare themselves for the new rules?
Asian hedge fund managers with more than 14 US clients have to decide whether these investors are significant enough to make registration worthwhile.
If they decide to maintain more than 14 US clients, they will need to undertake the registration process and should start learning about, and preparing for, the on-going compliance requirements. They should also consider the option of separating their operations to create a totally separate fund to give advise to their non-US investors so that these investors are not effected by the requirements of the new registration rules.
My impression from talking to many overseas managers is that they have not drilled down and found out how the new details will impact their operations. Those that have, have already began preparing. Although the implementation date is February 2006, I would recommend that a manager understand whether and how it will be impacted sooner rather than later.