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- 23 February, 2009 -
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State to Increase Regulation of Hedge Funds
(www.hedgefundlawblog.com) Connecticut, home of many of the biggest hedge funds in the world, may begin regulating hedge funds in a heavy handed manner. Recently state lawmakers have introduced three bills (Raised Bill No. 953, Raised Bill No. 6477 and Raised Bill No. 6480) which would greatly increase oversight of hedge funds which have a presence in Connecticut. This article provides an overview of the three raised bills and provides reprints the actual text of these bills.
Raised Bill No. 953
The largest of the three bills, No. 953 has the following central features:
- Definitions certain terms (including the term “Hedge Fund”) which are used throughout the bill.
- Provides that, starting in 2011, hedge funds may not have individual investors who do not have $2.5 million in “investment assets” (different than net worth)
- Provides that, starting in 2011, hedge funds may not have institutional investors who do not have $5 million in “investment assets”
- Provides that funds must disclose certain conflicts of interest of the manager
- Provides that funds must disclose the existence of side letters
- Requires an annual audit (beginning in 2010)
The above provisions would apply to those funds which have an office in Connecticut where employees regularly conduct business on behalf of the fund. It is currently unclear whether there will be any sort of grandfathering provisions for those funds which currently have investors who do not meet the “investment assets” threshold. Another interesting part of the bill is that it defines a hedge fund with reference to Section 3(c)(1) and Section 3(c)(7) of the Investment Company Act. The recently proposed Hedge Fund Transparency Act would actually eliminate these sections and add new Section 6(a)(6) and Section 6(a)(7).
Raised Bill No. 6477
The next bill is No. 6477 which would require hedge funds to be regulated by the Connecticut Banking Commission. The bill requires hedge funds to purchase a $500 license issued by the Connecticut Banking Commissioner prior to conducting business in Connecticut. The license would need to be purchased each year. The bill also provides the Banking Commission with authority to adopt regulations.
This bill is interesting because it is fundamentally different from most hedge fund regulations which seek to regulate the management company through investment advisor registration. This bill regulates the fund entity (as opposed to the management company) and does so through the power of the state to regulate banking. Right now it looks like this bill will apply to all hedge funds, even those who do not utilize leverage. It is not currently clear why or how the Banking Commission has jurisdiction non-banking private pools of capital, especially for those funds which do not utilize any sort of leverage.
It is also interesting to note that No. 6477 would apply regardless of the registration status of the fund’s management company. This means that a fund could be subject to SEC oversight and may also be subject to direct oversight by the Connecticut Department of Banking (“DOB”), which means the DOB could presumably conduct audits of the fund. Of course, this could potentially greatly increase operational costs for hedge funds with an office in Connecticut.
Raised Bill No. 6480
The final bill is No. 6480 which would require Connecticut based hedge funds with Connecticut pension fund investors to disclose detailed portfolio information to such pension funds upon request. It goes without saying that this bill is likely to receive a considerable amount of scrutiny from the Connecticut hedge fund community.
Conclusion
The hedge fund industry continues to be a major focus of both state and federal lawmakers who are anxious to start regulating these vehicles. Unfortunately we are witnessing a patchwork approach to regulation where there is little communication between the states and the federal lawmakers. If other states follow Connecticut’s lead then we face the potential situation where funds in each state will need to follow state specific laws enacted by quick-to-legislate, out-of-touch lawmakers. Efficiency in the securities markets is undercut by overlapping and unnecessary regulations – both managers and investors would be better served by a comprehensive effort to revise the securities laws at the federal and state levels.
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Raised Bill No. 953
January Session, 2009
Referred to Committee on Banks
Introduced by: (BA)
AN ACT CONCERNING HEDGE FUNDS.
Be it enacted by the Senate and House of Representatives in General Assembly convened:
Section 1. (NEW) (Effective October 1, 2009) (a) As used in this section:
(1) “Hedge fund” means any investment company, as defined in Section 3(a)(1) of the Investment Company Act of 1940, located in this state (A) that claims an exemption under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940; (B) whose offering of securities is exempt under the private offering safe harbor criteria in Rule 506 of Regulation D of the Securities Act; and (C) that meets any other criteria as may be established by the Banking Commissioner in regulations adopted under subsection (f) of this section. A hedge fund is located in this state if such fund has an office in Connecticut where employees regularly conduct business on behalf of the hedge fund;
(2) “Institutional investor” means an investor other than an individual investor including, but not limited to, a bank, savings and loan association, registered broker, dealer, investment company, licensed small business investment company, corporation or any other legal entity;
(3) “Investment assets” includes any security, real estate held for investment purposes, bank deposits, cash and cash equivalents, commodity interests held for investment purposes and such other forms of investment assets as may be established by the Banking Commissioner in regulations adopted under subsection (f) of this section;
(4) “Investor” means any holder of record of a class of equity security in a hedge fund;
(5) “Major litigation” means any legal proceeding in which the hedge fund is a party which if decided adversely against the hedge fund would require such fund to make material future expenditures or have a material adverse impact on the hedge fund’s financial position;
(6) “Manager” means an individual located in this state who has direct and personal responsibility for the operation and management of a hedge fund; and
(7) “Material” means, with respect to future expenditures or adverse impact on the hedge fund’s financial position, more than one per cent of the assets of the hedge fund.
(b) On or after January 1, 2011, no hedge fund shall consist of individual investors who, individually or jointly with a spouse, have less than two million five hundred thousand dollars in investment assets or institutional investors that have less than five million dollars in assets.
(c) The manager shall disclose to each investor or prospective investor in a hedge fund, not later than thirty days before any investment in the hedge fund, any financial or other interests the manager may have that conflict with or are likely to impair, the manager’s duties and responsibilities to the fund or its investors.
(d) The manager shall disclose, in writing, to each investor in a hedge fund (1) any material change in the investment strategy and philosophy of the fund and the departure of any individual employed by such fund who exercises significant control over the investment strategy or operation of the fund, (2) the existence of any side letters provided to investors in the fund, and (3) any major litigation involving the fund or governmental investigation of the fund.
(e) On January 1, 2010, and annually thereafter, the manager shall disclose, in writing, to each investor in a hedge fund (1) the fee schedule to be paid by the hedge fund including, but not limited to, management fees, brokerage fees and trading fees, and (2) a financial statement indicating the investor’s capital balance that has been audited by an independent auditing firm.
(f) The Banking Commissioner may adopt regulations, in accordance with chapter 54 of the general statutes, to implement the provisions of this section.\
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Raised Bill No. 6477
January Session, 2009
Referred to Committee on Banks
Introduced by: (BA)
AN ACT CONCERNING THE LICENSING OF HEDGE FUNDS AND PRIVATE CAPITAL FUNDS.
Be it enacted by the Senate and House of Representatives in General Assembly convened:
Section 1. (NEW) (Effective October 1, 2009) (a) No person shall establish or conduct business in this state as a hedge fund or private capital fund without a license issued by the Banking Commissioner. Applicants for such license shall apply to the Department of Banking on forms prescribed by the commissioner. Each application shall be accompanied by a fee of five hundred dollars. Such license shall be valid for one year and may be renewed upon payment of a fee of five hundred dollars and in accordance with the regulations adopted pursuant to subsection (b) of this section.
(b) The Banking Commissioner shall adopt regulations in accordance with the provisions of chapter 54 of the general statutes for purposes of this section.
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Raised Bill No. 6480
January Session, 2009
Referred to Committee on Banks
Introduced by: (BA)
AN ACT REQUIRING THE DISCLOSURE OF FINANCIAL INFORMATION TO PROSPECTIVE INVESTORS IN HEDGE FUNDS AND PRIVATE CAPITAL FUNDS.
Be it enacted by the Senate and House of Representatives in General Assembly convened:
Section 1. (NEW) (Effective October 1, 2009) Any hedge fund or private capital fund that is (1) domiciled in the state, and (2) receiving money from pension funds domiciled in the state shall disclose to each prospective pension investor in such funds, upon request, financial information including, but not limited to, detailed portfolio information relative to the assets and liabilities of such funds.
Re CT Bill 953:
How does the CT legislature plan to get around the pre-emption provisions of the National Securities Market Improvement Act of 1996, which prohibits a state from restricting an offering that complies with Reg. D? Unless I’m missing something, this law looks dead on arrival.
[...] A bill was recently introduced into the Connecticut General Assembly which would require investment advisers to hedge funds to provide an overview of any conflicts of interests of such investment adviser with respect to its duties to the fund (or its investors). This new bill comes about a year after another bill was proposed (but not passed) in Connecticut (see New Connecticut Hedge Fund Laws Proposed). [...]