AN ACT CONCERNING HEDGE FUNDS.

This bill requires investment advisers to private investment funds to comply with the disclosure requirements of Rule 204-3 of the Investment Advisers Act of 1940, regardless of whether the adviser is registered with the Securities and Exchange Commission (SEC) (see BACKGROUND). This requirement applies to funds that meet the bill's criteria. The bill specifies that this does not require disclosure of any information other than the adviser's “material conflicts of interest. ” Neither the bill nor the rule define this term.

However, these requirements cannot be imposed unless the banking commissioner adopts regulations. The bill allows the commissioner to adopt regulations if federal regulations or changes to the Investment Advisers Act of 1940 to regulate investment advisers to private investment funds are not adopted by December 31, 2009. The bill does not specify what type of federal regulations or changes are required.

*Senate Amendment “A” (1) eliminates language that would have made any investment adviser without a place of business in the state exempt from registering with the banking department; (2) eliminates provisions on hedge funds and replaces them with similar provisions on “private investment funds” with references to disclosures under Rule 204-3; (3) adds the contingency regarding federal law; and (4) changes the effective date.

EFFECTIVE DATE: January 1, 2010, except for the provision on possible changes in federal law, which is effective on passage.

The bill defines the term “private investment fund” as any investment company, as defined under the Investment Company Act of 1940:

1. that claims an exemption under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940;

2. whose offering of securities is exempt under the private offering safe harbor criteria in Rule 506 of Regulation D of the Securities Act;

3. that offers or sells securities in this state or is located in this state; and

4. that meets any other criteria the banking commissioner establishes in the regulation he adopts to implement the bill.

A private investment fund is located in the state if it has an office in this state where employees regularly conduct business on the fund's behalf.

Rule 204-3 requires an investment adviser, registered or required to be registered under the Investment Advisers Act, to provide each advisory client and prospective advisory client with a written disclosure statement.

This can be a copy of Part II of their Form ADV, which investment advisers use to register with the SEC, or a document that contains the information required by Part II of the ADV. Part II of the ADV requires information on advisory services and fees; types of clients; types of investments; methods of analysis, sources of information, and investment strategies; education and business standards; education and business background; other business activities; other financial industry activities or affiliations; participation or interest in client transactions; conditions for managing accounts; review of accounts; investment or brokerage discretion; and additional compensation.

These investment advisers must deliver the statement (1) not less than 48 hours before entering into any written or oral investment advisory contract with the client or prospective client or (2) at the time of entering into any such contract, if the advisory client has a right to terminate the contract without penalty within five business days after entering into it. Generally, the adviser must annually deliver or offer in writing to deliver upon written request to each of its advisory clients the information for free.

If an investment adviser renders substantially different types of investment advisory services to different advisory clients, any information required by Part II of Form ADV may be omitted from the statement furnished to an advisory client or prospective advisory client if it is applicable only to a type of investment advisory service or fee which is not rendered or charged, or proposed to be rendered or charged, to that client or prospective client.

Under Section 3(c)(1) of the federal Investment Company Act, an issuer (1) whose outstanding securities are beneficially owned by 100 or fewer persons and (2) who does not plan to make public offerings is exempt from registering as an investment company.

There is also a “sophisticated investor” exemption under Section 3(c)(7) of the Investment Company Act. Issuers are exempt from registering under this section if (1) their outstanding securities are owned by “qualified purchasers” and (2) they do not make a public offering of securities. A “qualified purchaser” is defined as an (1) individual who owns $ 5 million worth of investments and (2) certain entities that own $ 25 million worth of investments.

Since hedge fund interests are considered securities under the Securities Act of 1933, they would ordinarily be subject to SEC regulation. However, the 1933 act provides an exception to the registration requirements if the interests are not sold in a “public offering. ” Under federal regulations, offers and sales of securities by an issuer that satisfy certain conditions are deemed to be transactions not involving any public offering (and therefore, exempt from registration requirements. )

To meet the commonly used “safe harbor” in Regulation D, hedge funds may sell their interests to an unlimited number of “accredited investors. ” This term includes:

1. a natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $ 1 million at the time of the purchase;

2. a natural person with income exceeding $ 200,000 in each of the two most recent years, or joint income with a spouse, exceeding $ 300,000 for those years and a reasonable expectation of the same income level in the current year;

3. institutional investors (corporations and other corporate entities must have $ 5 million in assets); and

4. an officer of the company selling the securities. Regulation D also allows an issuer to sell its interests to a limited number of non-accredited investors (up to 35) if they have sufficient financial knowledge.

Yea

Nay

(03/10/2009)