Despite what many had hoped, SEC registration, and consequent regulation, is here to stay and many UK hedge fund managers now need to pull their heads out of the sand and accept that extra territorial regulation by the SEC is imminent.
Another danger is that firms are using inexperienced advisers to assist with their SEC registration. Because only a handful of law firms in the UK are sufficiently experienced to offer the requisite advice and guidance on SEC registration and in particular, assistance with identifying the applicable rules and regulations, and drafting a compliance manual, there are all sorts of inexperienced firms claiming to be experts in this area. Many of these have no experience of US regulation whatsoever and some are even unaware that the development of policies and procedures is a key part of the SEC registration process. We have already had to assist firms who have been badly advised or who know little about the need for registration or its consequences.
Those Advisers subject to full scope regulation (broadly those with a direct US client relationship such as a managed account on behalf of a US person or entity, or an onshore US fund in a master feeder fund structure) will have to contend with some peculiar new requirements, such as the requirement to retain all emails received and sent either internally or externally. Even those subject to what has become known as "regulation light" will need to get their mind around things like enhanced personal account dealing requirements and anti-fraud provisions. In addition, managers will also need to make amendments to their existing offering documents and marketing materials. However, too many hedge funds still think SEC registration is about filling in a simple tick-the-box form. One hedge fund who contacted us recently was not aware of the need to complete ADV Part II, believing it was not necessary as it does not need to be filed with the SEC! Not strictly true. Part II is not filed directly with the SEC, but under the rules, Part II must be filed internally, and such action is deemed to constitute a filing with the SEC. This way, if the form is not complete, or is misleading or inaccurate in any way, the SEC can take action for failing to file Part II or for misleading information.
Firms need to take care to properly understand the requirements of SEC registration and the impact of SEC regulation. They should take great care to hire advisers who are experienced and can demonstrate considerable knowledge and experience of the Investment Advisers Act, the rules and regulations made under it, and US securities laws generally. Ignorance of the law and the requirements is no excuse and as the SEC has stated it will be carrying out visits to UK hedge funds in 2006, the correct professional approach now could save a few tears, or perhaps even handcuffs, later.
On a final note, managers who have fewer than 15 US investors, the trigger for SEC registration, need to note that the 15 investor test also applies on a look-through basis to fund of fund investors. Managers who do not register will therefore be prohibited from taking a fund of fund investor which itself has more than 15 underlying US investors. A lot of managers have not yet thought this through.