IA Regulatory News
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	SEC Adopts Anti-Fraud Rule for Advisers to Hedge Funds
	The SEC unanimously voted to adopt an Anti-Fraud Rule which broadens the Commission’s ability to bring enforcement actions under the Adviser Act against investment advisers who defraud investors or prospective investors in hedge funds or other pooled investment vehicles. The Goldstein decision clarified the definition of “client” as only including the pooled investment vehicle advised by the adviser and not an investor in the pooled vehicle. Under the new Rule, statements deemed to be false or misleading need not have been made to “clients” as defined under the act, and further clarified by Goldstein, but to any investor or prospective investor in the pooled investment vehicle. The Rule will apply to investment advisers, whether registered or unregistered with the SEC, and will not distinguish among types of pooled investment vehicles, and therefore is intended to include hedge funds, private equity funds, venture capital funds and other types of private pooled investment vehicles that invest in securities, as well as investment companies that are offered to the public. Furthermore, the Rule will apply to false and misleading statements whether or not those statements are made in connection with the sale, purchase or redemption of securities and therefore would include, for example, statements made in quarterly newsletters, etc. Finally, the Rule does not require scienter, and therefore advisers are cautioned to exercise great care before disseminating information received from third parties. For more information contact Barry Hollander, Senior Consultant – New York at 212.537.6555
	SEC No-Action Letter on Hedge Clauses
BACKGROUND: On February 12, 2007, the SEC issued a response to a request for no action by an investment adviser with regard to the use of a certain “hedge clause” accompanied by a “non-waiver” disclosure. The Adviser sought the views of the SEC with regard to use of certain language in its agreements and requested either no-action or interpretive assurance that the Commission would not recommend an enforcement action under the anti-fraud provisions of Section 206 (1) and (2) of the Advisers Act if such language was used. FACTS: A number of affiliated advisors used the following hedge clause language in their Investment Management Agreements (“IMA”): Client Indemnification: Client shall indemnify and hold harmless Manager and its affiliates and their respective directors, managers, officers, agents and employees, from and against any and all losses, claims, demands, actions, or liability of any nature, including but not limited to attorneys’ fees, expenses and court costs, arising out of or in connection with this Agreement, except to the extent based upon, arising out of or in connection with Manager’s grossly negligent, reckless, willfully improper or illegal conduct in its performance or failure to perform under this Agreement, actions outside the scope of Manager’s authority or other material breach under this Agreement, by Manager, its directors, managers, officers, employees and agents. The IMA had the following non-waiver disclosure: Non-Waiver of Rights: Notwithstanding the foregoing, nothing contained in this paragraph or elsewhere in this Agreement shall constitute a waiver by Client of any of its legal rights under applicable U.S. federal securities laws or any other laws whose applicability is not permitted to be contractually waived. The adviser further stated that all clients were sophisticated persons, with the resources and experience to understand the IMA and in certain cases had the right to dictate the terms of such IMA. SEC ANALYSIS: Section 206 (1) and (2) of the Advisers Act make it unlawful for any investment adviser to employ any device, scheme or artifice to defraud or to engage in any transaction, practice or course of business that operates as a fraud or deceit on clients or prospective clients. The SEC maintains the position that the use of hedge clauses which may lead clients to believe that they may have waived certain non-waivable rights of action against the adviser may be a violation of the antifraud provision of Section 206. For example, a hedge clause which purports to limit the liability of an adviser to gross negligence or willful malfeasance is likely to mislead a client who is unsophisticated in the law into believing that that he or she has waived his non-waivable rights even if the hedge clause explicitly provides that rights under federal or state law cannot be relinquished. The SEC stated that in order to determine the applicability of the anti-fraud provisions to any particular language in an IMA, they will look to all surrounding facts and circumstances on a case by case basis. Among the factors the Commission will take into account will be: • Form and content of the hedge clause (e.g., is it in plain English?) • Any oral or written communications between the investment adviser and the client about the hedge clause • The level of sophistication of the client • The presence and sophistication of any intermediary assisting the client in his dealings with the investment adviser and the extent of that assistance CONCLUSION While the SEC did not find that the use of the language referenced above would constitute a per se violation of Rule 206 (1) and (2), because of the fact-intensive nature of the inquiry necessary to determine the Rule’s applicability, it did not provide the adviser with any guidance with regard to any hedge clause language employed. SCA RECOMMENDATION In light of the SEC response, it is important to review any hedge clauses and any non-waiver disclosures in IMAs for content and clarity. In addition, it is important for all advisers to evaluate the level of sophistication of their clients to determine whether changes are necessary in the IMAs so as to take into account the facts and circumstances which may be subject of any inquiry by the Commission when reviewing these agreements. For more information contact Barry Hollander, Senior Consultant – New York at 212.537.6555
	Hedge Fund Registration Rule Struck Down

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On Friday, June 23, 2006, the District of Columbia Circuit Court of Appeals struck down the SEC’s recently adopted “Hedge Fund Rule” which had established a “look through” provision into the operative definition of a “client”. The Court determined the SEC’s reinterpretation of the term “client” to include the respective investors within pooled investment funds, rather than just the fund itself, to be “arbitrary.” The fallout of the ruling is that most hedge fund managers will no longer be required to register with the SEC as stipulated by the Investment Advisers Act of 1940. In the absence of a “look through” provision, that is, most hedge funds’ fall below regulatory threshold set by the Advisors Act under which firms are exempt from registration (i.e. 15 clients).

Looking forward, the SEC has essentially three options. It could (1) ask the Court for a rehearing; (2) appeal the decision to the U.S. Supreme Court; or (3) appeal to the Congress to amend to the Advisers Act to explicitly enumerate a “look through provision” in the definition of a “client.” At the present time, the latter appears to be the most likely and effectual of the three possibilities. On July 5th, Massachusetts Congressman Barney Frank, the ranking Democrat on the House Financial Services Committee, introduced a bill (HR 5712) which, if enacted, would amend section 203 of the Advisers Act by adding language that would reinstitute a client “look through” provision.

Despite remaining threads of uncertainty regarding the fate of the SEC’s “Hedge Fund Rule,” hedge fund managers may wish to review the desirability of their regulatory status at this time. If resources have already been invested to register and set up compliance procedures, then it may be wise to maintain one’s registered status. In addition, registration with the SEC may attract clients such as pension funds and other institutional investors who might not otherwise invest with a hedge fund. If the decision is made to de-register, one should first inquire whether the firm is subject to any mandatory state registration.

How and When Should You Conduct Your Annual Review If You Are An IA?

By Cheryl Young, CRCP

SCA offers specific Investment Adviser compliance programs for Hedge Fund Managers