K&LNG
DECEMBER 2006
Alert
Hedge Funds
SEC Proposes Rules Prohibiting Fraud by Managers
of Hedge Funds and Revising the Criteria for
Accredited Investors in Hedge Funds
company but for the exclusions in Sections
3(c)(1) or 3(c)(7) of the Investment Company
Act of 1940 (“1940 Act”).
On December 13, 2006, the Securities and Exchange
Commission (“SEC”) proposed several new rules
that are intended to provide additional protections to
investors in hedge funds and other pooled investment
vehicles. The SEC proposed the rules in response to
the D.C. Circuit Court of Appeals’ decision in
Goldstein vs. Securities and Exchange Commission
(“Goldstein decision”), which vacated the SEC rule
requiring most hedge fund managers to register as
investment advisers under the Investment Advisers
Act of 1940 (“Advisers Act”).
The proposals include the following:
■
1
The provision, which the SEC crafted to
withstand judicial scrutiny, is intended to
clarify the ambiguity that arose following the
Goldstein decision by expressly recognizing
the authority the SEC believes it has to regulate
fraud committed by advisers against investors.
It would not, however, give rise to a private
right of action for investors.
■
Anti-Fraud Provision under the Advisers
Act. Under the proposed provision, an
investment adviser to a pooled investment
vehicle would commit a fraudulent, deceptive
or manipulative act, practice, or course of
business prohibited under Section 206(4) of the
Advisers Act if, at any time, it makes
materially false or misleading statements to, or
otherwise materially defrauds, investors or
prospective investors in that pool. The rule
would apply to all investment advisers to
pooled investment vehicles, regardless of
whether the adviser is registered under the
Advisers Act. For purposes of the new
provision, “pooled investment vehicles” would
include any investment company and any
company that would be an investment
Amendments to Private Offering Rules
under the Securities Act of 1933 (“1933
Act”). The proposal would increase the
requirements for a natural person to be
considered an “accredited investor” who may
invest in securities issued by hedge funds and
other pooled investment vehicles that rely on
the exclusion from registration in Section
3(c)(1) of the 1940 Act. The new definition of
accredited investor would include any natural
person who meets the current net worth or
income standards specified in Rule 215 or Rule
501(a) under the 1933 Act,1 as applicable, and,
in addition, owns at least $2.5 million in
investments, as defined in the proposal. (An
investor’s personal residence would not be
considered an “investment” for purposes of the
new criterion.) An investor would be required
Rule 501(a) of Regulation D under the 1933 Act and Rule 215 under the 1933 Act define an “accredited investor,” in part, as any natural person whose
individual net worth, or joint net worth with that person’s spouse, at the time of the purchase exceeds $1,000,000 or any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of
those years and has a reasonable expectation of reaching the same income level in the current year.
Kirkpatrick & Lockhart Nicholson Graham LLP |
DECEMBER 2006
to satisfy the new criterion at the time of
purchase; therefore, an investor who does not
own $2.5 million in investments would not be
affected with regard to any investments in
hedge funds made prior to the effective date of
the rule. The proposal includes an inflation
adjustment that would first be triggered in
2012. It also includes a joint asset test to
account for the designation of assets between
spouses that is similar to the test used by hedge
funds relying on the exclusion in Section
3(c)(7) of the 1940 Act. The proposal would
generally not apply to investors in venture
capital funds.
The proposal reaches beyond a simple update
of the current standard for “accredited
investors” to account for inflation; it instead
establishes an additional criterion with a much
tougher threshold for individual investors to
meet than they currently must meet. The SEC
2
estimates that the proposal would reduce the
number of households eligible to invest as
accredited investors by 88%.
Comments on these proposals should be received by
the SEC within 60 days of their publication in the
Federal Register. The SEC indicates that the full text
of the detailed release concerning the proposals will
be posted to its web site as soon as possible. We will
circulate the detailed release when it is posted and
will keep you apprised of all developments as they
occur. The proposed changes will not impact
registered funds of hedge funds.
Cary J. Meer
202.778.9107
cmeer@klng.com
Jill L. Ehrlich
202.778.9168
jehrlich@klng.com
Kirkpatrick & Lockhart Nicholson Graham
LLP
|
DECEMBER 2006
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 hedgefunds@klng.com.
BOSTON
Mark P. Goshko
Nicholas S. Hodge
George Zornada
LONDON
Philip J. Morgan
LOS ANGELES
William P. Wade
617.261.3163 mgoshko@klng.com
617.261.3210 nhodge@klng.com
617.261.3231 gzornada@klng.com
+44.20.7360.8123 pmorgan@klng.com
SAN FRANCISCO
David Mishel
Mark D. Perlow
415.249.1015 dmishel@klng.com
415.249.1070 mperlow@klng.com
WASHINGTON
Cary J. Meer
202.778.9107 cmeer@klng.com
Robert H. Rosenblum 202.778.9464 rrosenblum@klng.com
310.552.5071 wwade@klng.com
NEW YORK
Bruce Kahne
212.536.4019 bkahne@klng.com
Beth R. Kramer
Richard D. Marshall
212.536.4024 bkramer@klng.com
212.536.3941 rmarshall@klng.com
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