On June 23, 2006, the U.S. Court of Appeal for the District of Columbia Circuit handed down its decision in Phillip Goldstein, et. al. v. Securities and Exchange Commission ("Goldstein v. SEC")1. The Court of Appeal’s decision vacated the Securities and Exchange Commission ("SEC" or the "Commission") regulations under the Investment Advisers Act of 1940 (the "U.S. Advisers Act") that required most hedge fund advisers to register under such legislation as of February 1, 2006 (the "Registration Rule"). However, the Court of Appeal’s decision does not come into effect immediately and the SEC has a period of 45 days (until August 7, 2006) to challenge the decision. Although it is not yet clear how the SEC will respond, the decision will undoubtedly affect a large number of hedge fund managers, including Canadian advisers with U.S.- based clients, who are currently registered or would need to register with the SEC under the existing Registration Rule.
How did we get to this Point?
The SEC adopted the Registration Rule after a lengthy review of the hedge fund market in 2004. The Registration Rule required advisers to count each individual investor in a private fund as a separate "client" (rather than counting only the private fund as the entity receiving the investment advice). Prior to implementation of the Registration Rule, most hedge fund advisers relied on an exemption to the U.S. Advisers Act, which excluded advisers of fewer than 15 clients (counted as the number of private funds advised on a rolling 12 month basis) from the requirement to register as an adviser.
The Court of Appeal in Goldstein v. SEC found that the SEC’s revised definition of the term "client" for the purposes of the Registration Rule was arbitrary and unreasonable. The court stated that the SEC’s "interpretation of the word "client" comes close to violating the plain language of the [U.S. Adviser’s Act]. At best it is counterintuitive to characterize the investors in a hedge fund as the "clients" of the adviser." The decision continues, "That the [SEC] wanted a hook on which to hang a more comprehensive regulation of hedge funds may be understandable. But the Commission may not accomplish its objective by a manipulation of meaning."
What will the SEC do now?
The Chairman of the SEC has indicated that the Court of Appeal’s decision will require the Commission to re-evaluate its approach to the regulation of the hedge fund industry. The SEC has yet to announce whether it will file a petition for rehearing by the Court of Appeal or appeal the decision to the U.S. Supreme Court. It is also possible that the U.S. Senate Banking Committee will conduct further hearings on the hedge fund industry in light of Goldstein v. SEC.
It is too soon to determine how hedge fund advisers, including those based outside the U.S., will be affected by Goldstein v. SEC. The Alternative Investment Management Association (AIMA), a global trade association for the hedge fund industry, has re-iterated its position that non-U.S. based managers, who are already regulated in their own jurisdiction, should not be subject to dual registration and have submitted that these types of foreign-based managers who have already complied with the Registration Rule should be permitted to de-register with the SEC.
What should Canadian Advisers do now?
Until the matter has been definitively determined, Canadian hedge fund advisers may wish to adopt a "wait and see" approach. If you are currently registered as an adviser in the United States or are considering registration with the SEC, you may wish to consider delaying any steps toward de-registration or registration (as applicable) until the SEC’s response to the Court of Appeal’s ruling is known.
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