Hedge Funds See Holes in Dodd-Frank Rulemaking

Rulemaking under the US Dodd-Frank Wall Street Reform and Consumer Protection Act that aims to tighten restrictions on foreign fund investment in the US leaves some holes in its specifics, according to Manhattan-based hedge fund manager, Viking Global Investors.

The Dodd-Frank Act changes the exemption for private investment advisors, namely hedge funds, so that the 15 clients or less threshold under which foreign advisors need not register with the US Securities and Exchange Commission (SEC) will no longer encompass both funds and individuals, says Eric Komitee, general counsel at Viking Global Investors. "They did away with the distinction between client-as-fund and client-as-individual," he says. "It's fewer than 15 regardless of which definition you apply."

Foreign fund managers may also remain unregistered if they do not maintain a "place of business" in the US, according to Komitee. "Place of business sounds like physical office space," he says. "You can't have an office at which you regularly provide investment advisory services or conduct meetings to market the fund. To the extent that foreign private investors are engaging a placement agent in the US to go places on their behalf, as long as they're not providing physical office space to that person, that's a key component in compliance with the rule."

For investment groups with both US and foreign-based units, the SEC will conduct a "separateness analysis," observes Komitee. "You may be part of a group that has US contacts or US advisors in other parts of the group but you're taking the position that you're able to conclude you don't have those in your own particular entity within that group," he says. "How to define separateness is a facts and circumstances test. The US provisions in Dodd-Frank are essentially the mirror image of third-party provisions in AIFMD [the Alternative Investment Fund Managers Directive, newly issued by the European Commission], in that if you can establish that there's one manager for US purposes and you're separate from that manager, you can avoid registration as a sub-advisor."

BST's analysis: The Dodd-Frank Act, as it currently stands, appears to leave private investment advisors or hedge funds plenty of ways to avoid following the spirit of the Act. Conceivably, an advisor or fund could bundle as many individuals as it wants into a fund to stay under the 15-client threshold. A multinational fund or advisory firm with smart lawyers could structure itself to technically comply with the requirements so that it appears US professionals are not involved in parts of its business.