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SECURITIES AND EXCHANGE COMMISSION17 CFR Parts 275 and 279[Release No. IA-2266; File No. S7-30-04]RIN 3235-AJ25Registration Under the Advisers Act of Certain Hedge Fund AdvisersAGENCY: Securities and Exchange Commission (the "Commission"). ACTION: Proposed rule. SUMMARY: The Commission is proposing for comment a new rule and rule amendments under the Investment Advisers Act of 1940. The proposed new rule and amendments would require advisers to certain private investment pools ("hedge funds") to register with the Commission under the Advisers Act. The rule and rule amendments are designed to provide the protections afforded by the Advisers Act to investors in hedge funds, and to enhance the Commission's ability to protect our nation's securities markets. DATES: Comments should be received on or before September 15, 2004. ADDRESSES: Comments may be submitted by any of the following methods: Electronic comments:
Paper comments:
All submissions should refer to File Number S7- 30-04. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for public inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, NW, Washington, DC 20549. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT: Vivien Liu, Senior Counsel, Jamey Basham, Branch Chief, or Jennifer L. Sawin, Assistant Director, at 202-942-0719 or IArules@sec.gov, Office of Investment Adviser Regulation, Division of Investment Management, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0506. SUPPLEMENTARY INFORMATION: The Commission is requesting public comment on proposed new rule 203(b)(3)-2 [17 CFR 275.203(b)(3)-2], proposed amendments to rules 203(b)(3)-1 [17 CFR 275.203(b)(3)-1], 204-2 [17 CFR 275.204-2], 205-3 [17 CFR 275.205-3], and 206(4)-2 [17 CFR 275.206(4)-2],1 and Form ADV [17 CFR 279.1] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] (the "Advisers Act" or "Act"). TABLE OF CONTENTS
TEXT OF PROPOSED RULE, rule amendments and form amendments I. BACKGROUNDThe Commission regulates the nation's money managers under the Investment Advisers Act of 1940. These include investment advisers to mutual funds, pension funds, private funds, corporations, trusts, endowments, charities, as well as advisers to individuals and families. The approximately 8,000 investment advisers registered with us under the Advisers Act manage more than $23 trillion of client assets.2 Advisers registered with us engage in a wide variety of asset management styles. They represent perhaps every different view and approach to managing money, including indexing, quantitative analysis, and numerous styles of fundamental analysis. Some assemble simple portfolios of stocks and bonds. Others employ sophisticated hedging strategies that seek to reduce volatility or other risks. Still others use futures contracts or derivatives to leverage client holdings in hopes that, by assuming greater risk, they will capture greater profits. Some manage cash holdings that provide safety and liquidity for a portion of client portfolios while others help clients speculate in distressed securities, options, merger arbitrage or other risky investment strategies. Many do not manage money at all but, instead, provide financial planning services. The clients of these advisers include small investors and the largest of national and international financial institutions. A number of advisers registered with us manage client portfolios through mutual funds or other collective investment vehicles organized as corporations, trusts, limited partnerships or limited liability companies.3 Many advise only individual accounts,4 while others report to us that they advise only institutional or high net worth individuals.5 There may be few areas of the financial services industry more diverse than the Commission's registered investment advisers.6 Yet the Advisers Act accommodates them all. Instead of prescribing a set of detailed rules, the Act contains a few basic requirements, such as registration with the Commission, maintenance of business records, and delivery of a disclosure statement ("brochure"). Most significant is a provision of the Act that prohibits advisers from defrauding their clients, a provision that the Supreme Court has construed as imposing on advisers a fiduciary obligation to their clients.7 This fiduciary duty requires advisers to manage their clients' portfolios in the best interest of clients, but not in any prescribed manner. A number of obligations to clients flow from this fiduciary duty, including the duty to fully disclose any conflicts the adviser has with clients,8 to seek best execution for client transactions,9 and to have a reasonable basis for client recommendations.10 Not all advisers must register with the Commission. The Act exempts an adviser from registration if it (i) has had fewer than fifteen clients during the preceding 12 months, (ii) does not hold itself out generally to the public as an investment adviser, and (iii) is not an adviser to any registered investment company.11 Advisers taking advantage of this "private adviser exemption" must nonetheless comply with the Act's antifraud provisions,12 but do not file registration forms with us identifying who they are, do not have to maintain business records in accordance with our rules, do not have to adopt or implement compliance programs or codes of ethics, and are not subject to Commission oversight. We lack authority to conduct regular examinations of advisers exempt from the Act's registration requirements.13 There is no legislative history that explains why the private adviser exemption was enacted. We do know, however, that it was not intended to exempt advisers to wealthy or sophisticated clients. They were the primary clients of many advisers in 1940 when the provision was included in the Act.14 While provisions of the Securities Act (and its rules) provide exemptions from registration under that Act for securities transactions with persons, including institutions, that have such knowledge and experience that they are considered capable of fending for themselves and thus do not need the protections of the applicable registration provisions,15 the Advisers Act does not. When a client-even one who is highly sophisticated in financial matters-seeks the services of an investment adviser, he acknowledges he needs the assistance of an expert. The client may be unfamiliar with investing or the type of strategy employed by the adviser, or may simply not have the time to manage his financial affairs. The Advisers Act is intended to protect all types of investors who have entrusted their assets to a professional investment adviser. Today, thirty-nine percent of advisers registered with us report that they advise only institutional and wealthy clients.16 The private adviser exemption appears to reflect Congress' view that there is no federal interest in regulating advisers with only a small number of clients, many of whom are likely to be friends and family members.17 Today, however, a growing number of investment advisers take advantage of the private adviser exemption to operate large investment advisory firms without Commission oversight. Instead of managing client money directly, these advisers pool client assets by creating limited partnerships, business trusts or corporations in which clients invest. Because our rules generally have permitted advisers to count each partnership, trust or corporation as a single client, many of these advisers have been able to avoid our oversight even though they manage large amounts of client assets and, indirectly, have a large number of clients.18 One significant group of these advisers provides investment advice through a type of pooled investment vehicle commonly known as a "hedge fund." There is no statutory or regulatory definition of hedge fund, although many have several characteristics in common. Hedge funds are organized by professional investment managers who frequently have a significant stake in the funds they manage and receive a management fee that includes a substantial share of the performance of the fund.19 Advisers organize and operate hedge funds in a manner that avoids regulation as mutual funds under the Investment Company Act of 1940, and they do not make public offerings of their securities.20 Hedge funds were originally designed to invest in equity securities and use leverage and short selling to "hedge" the portfolio's exposure to movements of the equity markets.21 Today, however, advisers to hedge funds utilize a wide variety of investment strategies and techniques designed to maximize the returns for investors in the hedge funds they sponsor.22 Many are very active traders of securities.23 The Commission has long been concerned about hedge funds and their managers, and the impact their investment activities can have on investors and the securities markets. As early as 1969, the Commission investigated hedge funds, responding to their rapid growth and concerns about their use of trading techniques such as leverage and short selling.24 In 1971 we conducted an economic study of institutional investors in which we described the activities of hedge funds, noted the serious conflicts of interest that hedge fund advisers have, and noted their growth.25 In 1992, in response to a Congressional inquiry, the Commission developed and provided to Congress detailed information about the regulatory treatment of hedge funds under the federal securities laws.26 Seven years later we participated in the President's Working Group on Financial Markets in the wake of the near-collapse of Long Term Capital Management, Inc., ("LTCM").27 LTCM was a large, highly leveraged hedge fund the unraveling of which threatened the stability of international capital markets.28 Recently, our staff assisted officials of the Treasury Department to prepare proposed rules that would require hedge funds to implement anti-money laundering programs.29 In 2002, we requested that our staff again examine the activities of hedge funds and hedge fund advisers. First, we were aware that the number and size of hedge funds were rapidly growing and that this growth could have broad consequences for the securities markets for which we are responsible. Second, we were bringing a growing number of enforcement cases in which hedge fund advisers defrauded hedge fund investors, who typically were able to recover few of their assets. Third, we were concerned that the activities of hedge funds today might affect a broader group of persons than the relatively few wealthy individuals and families who had historically invested in hedge funds.30 We directed the staff to develop information for us on a number of related topics, and advise us whether we should exercise greater regulatory authority over the hedge fund industry. In connection with the staff investigation, we held a Hedge Fund Roundtable on May 14 and 15, 2003, and invited a broad spectrum of hedge fund industry participants to participate. Information developed at the Roundtable, and a large number of additional submissions we subsequently received from interested persons, contributed greatly to the staff's investigation and our understanding of hedge funds and hedge fund advisers.31 In September 2003, the staff published a report entitled Implications of the Growth of Hedge Funds.32 The 2003 Staff Hedge Fund Report describes in detail the operation of hedge funds and raises a number of important public policy concerns. The report focused on investor protection concerns raised by the growth of hedge funds. In contrast, the principal focus of the President's Working Group's 1999 report was the stability of financial markets and the exposure of banks and other financial institutions to the counterparty risks of dealing with highly leveraged entities such as the LTCM hedge fund. Because the two reports had different purposes, the recommendations of the two reports are also quite different. The 2003 Staff Hedge Fund Report confirmed and further developed several of our concerns regarding hedge funds and hedge fund advisers. A. Growth of Hedge FundsSince 1993, the estimated assets in U.S. hedge funds have increased fifteenfold to at least $795 billion,33 and the number of hedge funds has increased more than fivefold to 7,000.34 Although hedge funds remain a relatively small portion of the U.S. financial markets,35 the rate of growth of hedge funds has been substantially greater than that of other sectors,36 and hedge fund assets have been projected to grow to over a trillion dollars by the end of 2004.37 In addition, hedge funds play a growing role in our securities markets as large and frequent traders of securities. One recent article portrayed a single hedge fund manager as responsible for an average of five percent of the daily trading volume of the New York Stock Exchange.38 Another reported hedge funds dominate the market for convertible bonds.39 B. Growth in Hedge Fund FraudThe growth in hedge funds has been accompanied by a substantial and troubling growth in the number of our hedge fund fraud enforcement cases. In the last five years, the Commission has brought 46 cases in which we have asserted that hedge fund advisers have defrauded hedge fund investors or used the fund to defraud others in amounts our staff estimates to exceed $1 billion. These frauds involved advisers that:
Since the staff report, a new species of hedge fund fraud has been uncovered. Advisers to hedge funds have been key participants in the recent scandals involving mutual fund late trading and inappropriate market timing.43 Many of our enforcement cases involved hedge funds that sought to exploit mutual fund investors for their own gain. Some entered into arrangements with mutual fund advisers under which the advisers waived restrictions on market timing in return for receipt of "sticky assets" from the hedge fund, i.e., placement of other assets in other funds managed by the mutual fund adviser. Others sought ways to avoid detection by mutual fund personnel by conspiring with intermediaries to conceal the identity of the hedge funds. While our investigation is ongoing, the frequency with which hedge funds appear in these cases and continue to turn up in the investigations is alarming. Our staff counts as many as forty different hedge funds involved in these cases, including hedge funds managed by Canary Investment Management, LLC.44 In a lawsuit against Canary, the New York Attorney General has alleged that Canary obtained its late trading and market timing "capacity" from mutual fund managers and intermediaries.45 In return, Canary often would leave millions of dollars in the fund managers' selected funds on a long-term basis as "sticky assets."46 Canary borrowed from the parent companies of the fund managers or intermediaries to finance its late trading and market timing schemes. As a result, Canary reaped tens of millions of dollars in profits from these schemes,47 the fund managers collected lucrative management fees from the "sticky assets," the intermediaries received huge commissions,48 and parent companies of the fund managers or intermediaries acting as lenders earned interest at a significant premium, while long-term investors in the mutual funds targeted by Canary lost tens of millions of dollars.49 C. "Retailization" of Hedge FundsThe third development of significant concern is the growing exposure of smaller investors, pensioners, and other market participants, directly or indirectly, to hedge funds. Hedge fund investors are no longer limited to the very wealthy. We note three developments that we have observed that contribute to our concern. First, some hedge funds today are expanding their marketing activities to attract investors who may not previously have participated in these types of risky investments.50 Many hedge funds maintain very high minimum requirements, and many of the hedge fund participants at our Roundtable expressed no interest in attracting "retail investors." Our staff observed, however, that many hedge funds' minimum investment requirements have decreased over time.51 In developed markets outside the United States, hedge funds have sought to market themselves to smaller investors, and we can expect similar market pressures to develop in the United States as more hedge funds enter our markets.52 Second, the development of "funds of hedge funds" has made hedge funds more broadly available to investors.53 Today there are 40 registered funds of hedge funds that offer or plan to offer their shares publicly.54 Most funds of hedge funds are today offered only to institutional investors, but there are no limitations on the public offering of these funds. Finally, and perhaps most significantly, in the last few years, a growing number of public and private pension funds,55 as well as universities, endowments, foundations, and other charitable organizations, have begun to invest in hedge funds or have increased their allocations to hedge funds.56 Press reports indicate that more of these institutions have also recently begun to consider these alternative investments.57 Hedge funds are thus today being purchased by entities that are not traditional hedge fund investors, including pension plans that have millions of beneficiaries. As a result of the participation by these entities in hedge funds, as well as other sophisticated investment strategies, the assets of these entities are exposed to the risks of the hedge fund. Losses resulting from hedge fund investments, as with any other investment loss, may affect the entities' ability to satisfy their obligations to their beneficiaries or pursue other intended purposes. II. DISCUSSIONA. Need for Regulatory ActionOur responsibilities to protect investors and the nation's securities markets do not permit us to ignore these developments. Our current regulatory program for hedge funds and hedge fund advisers is inadequate — it relies almost entirely on enforcement actions brought after the fraud has occurred and investor assets are gone.58 We have no oversight program that would provide us with the ability to deter or detect fraud by unregistered hedge fund advisers at an early stage. We lack basic information about hedge fund advisers and the hedge fund industry, and must rely on third party data that often conflict and may be unreliable.59 Hedge fund growth and the evolution of hedge fund ownership have resulted in both more significant and broader market and investor protection concerns, and have convinced us that we should consider taking steps to provide for greater oversight of hedge fund advisers. As the 2003 Staff Hedge Fund Report outlines, numerous institutions on which individual investors, savers, and pensioners depend today have a substantial exposure to the risks of hedge funds and the activities of hedge fund advisers. One survey reports that pension fund exposure to hedge funds has grown from $13 billion in 1997 to $72 billion today, an increase of 450 percent.60 Hardly a week passes in which industry publications do not announce a decision by a public pension plan, endowment, foundation or other charitable organization to invest in hedge funds.61 The growing demand for hedge funds has resulted in asymmetries of information: even institutional investors are often unable to acquire information on an ongoing basis about the hedge fund adviser, its operations and conflicts.62 The recent rapid growth of hedge fund investments also concerns us because of its potential impact on the behavior of hedge fund advisers. As substantial inflows chase absolute returns, hedge fund managers will have powerful incentives to pursue riskier strategies in order to generate substantial absolute returns under all market conditions. The capacity of hedge fund advisers to generate large absolute returns is limited because the use of similar financial strategies by other hedge fund advisers narrows spreads and decreases profitability.63 We are also concerned that some hedge fund advisers may be pursuing strategies that may be inconsistent with disclosures provided regarding the advisers, or may be improper or unlawful, as we have seen with hedge funds pursuing late trading and market timing strategies. Hedge funds present unique risks to the securities markets and investors that concern us and should concern all market participants. Unregistered hedge fund advisers operate largely in the shadows, with little oversight, are subject to the pressures of performance fee arrangements,64 and in many cases are expected to generate positive returns even in down markets. While these conditions can stimulate a tremendous amount of investment creativity and profit, they are also a perfect medium for the germination and growth of frauds. As we have seen, hedge fund advisers are capable of serious transgressions that can harm ordinary citizens who in many cases are now their ultimate beneficiaries. Our concern is and must be the protection of investors and the suppression of fraud. But we must also recognize the important role that hedge funds play in our markets. Hedge funds contribute to market efficiency and liquidity.65 They play an important role in allocating investment risks by serving as counterparties to investors who seek to hedge risks.66 They provide their investors with greater diversification of risk by offering them exposure uncorrelated with market movements.67 Therefore, in evaluating alternative courses we might take, we have paid particular attention to the extent to which our actions might encumber the operation of hedge funds and thus damage the very markets we seek to protect. B. Matters Considered by the CommissionWe are proposing a new rule the effect of which would be to require hedge fund advisers to register under the Advisers Act. Registration under the Act would address several of our concerns described above while imposing only minimal burdens on hedge fund advisers. 1. Census InformationHedge fund adviser registration would provide the Commission with important information about this growing segment of the U.S. financial system. Collecting information about the nation's investment advisers has been one aim of the Advisers Act since it was enacted in 1940.68 However, just as data on all advisers was lacking before 1940, today there are no comprehensive data on hedge fund advisers currently available.69 We have only limited indirect information about these firms and their trading practices, and we are hampered in our ability to develop regulatory policy regarding hedge fund advisers and their funds. Registering hedge fund advisers would permit us to collect information about the number of hedge funds that advisers manage, the amount of assets in hedge funds, the number of employees and types of clients these advisers have, other business activities they conduct, and the identity of persons that control or are affiliated with the firm.70 Although there may be other piecemeal sources for some of the information the Commission would obtain when a hedge fund adviser files Form ADV, much of the information is not readily available without substantial forensic efforts on the part of our staff. We need information that is reliable, current, and complete, and we need it in a format easily susceptible to analysis by our staff. 2. Deterrence and Early Discovery of FraudRegistration under the Advisers Act gives us authority to conduct examinations of the adviser's hedge fund activities.71 Our examinations permit us to identify compliance problems at an early stage, identify practices that may be harmful to investors, and provide a deterrent to unlawful conduct.72 They are a key part of our investor protection program. The prospect of an SEC examination increases the risk of getting caught, and thus will deter wrongdoers.73 During an examination, our staff reviews the advisory firm's internal controls and procedures; they examine the adequacy of procedures for valuing client assets, for placing and allocating trades, and for arranging for custody of client funds and securities. Examination staff also review the adviser's performance claims and delivery of its client disclosure brochure. Each of these operational areas presents a greater opportunity for misconduct if it is not open to examination. Our examinations bring limited sunlight to advisory activities that are kept from sight from clients for competitive and other reasons. Examinations may be a particularly appropriate form of sunlight because of the highly proprietary nature of many hedge fund advisers' activities.74 Examination of hedge fund advisers should serve the same deterrent role that it does with respect to other types of advisers.75 There is nothing unique about hedge fund advisers or the types of frauds they have committed that suggests that our examination program would not or could not play the same effective role. The fraud actions we have brought against unregistered hedge fund advisers have been similar to the types of fraud actions we have brought against other types of advisers, including misappropriation of assets,76 portfolio pumping,77 misrepresentation of portfolio performance,78 falsification of experience, credentials and past returns,79 misleading disclosure regarding claimed trading strategies80 and improper valuation of assets.81 Improper valuation of hedge fund assets by hedge fund advisers is a matter of serious concern to us. A recent study of hedge funds identified valuation problems as playing a primary or contributing role in 35 percent of hedge fund failures, and fraud as the underlying cause for more than half of them.82 The authors attribute these failures, in part, to a lack of regulatory oversight: "Put these natural, inherent difficulties in pricing complex or illiquid investments [in which hedge funds invest] together with a powerful financial incentive [on the part of the adviser] to show (or hide weak) performance, and then situate these factors in an environment with minimal regulatory oversight, or without strict discipline and internal controls (still far too typical in the hedge fund industry), and there is potential for trouble." 83 Valuation problems arise in many cases when hedge fund advisers overstate assets in order to cover trading losses or to "buy time" until performance improves.84 Registered investment advisers are not required to follow any particular valuation methodology, but our examiners consider whether the adviser's procedures for valuing the managed assets are effective, whether the adviser's actual practices in valuing client assets follow the procedures they have established, and how the adviser discloses, mitigates and manages the conflicts of interest that can arise with respect to valuation.85 3. Keeping Unfit Persons from Using Hedge Funds to Perpetrate FraudsRegistration with the Commission permits us to screen individuals associated with the adviser, and to deny registration if they have been convicted of a felony or had a disciplinary record subjecting them to disqualification.86 Several of the hedge fund frauds appear to have been perpetrated by unscrupulous persons using the hedge fund as a vehicle to defraud investors. These persons appear to never have intended to establish a legitimate hedge fund, but used the allure of a hedge fund to attract their "marks."87 We are concerned that these individuals may have been attracted to hedge funds because they could operate without regulatory scrutiny of their past activities. Our lack of oversight may have contributed to the belief that their frauds would not be exposed. Our ability to screen individuals and, in some cases, to block their entrance into the advisory profession should serve to discourage unscrupulous persons from using hedge funds as vehicles for fraud.88 4. Adoption of Compliance ControlsRegistration under the Advisers Act would require hedge fund advisers to adopt policies and procedures designed to prevent violation of the Advisers Act, and to designate a chief compliance officer.89 Because our examination staff resources are limited, we cannot be at the office of every adviser at all times. Compliance officers serve as the front line watch for violations of securities laws, and provide protection against conflicts of interests. Hedge fund advisers have substantial conflicts of interest, both with their hedge funds and with their investors. These conflicts arise from management strategies, fee structures, use of fund brokerage and other aspects of hedge fund management. To protect against the adverse consequences of these conflicts, a hedge fund adviser must make compliance considerations a part of its business plan. While the 2003 Hedge Fund Staff Report indicated that many unregistered hedge fund managers had strong compliance controls, others had very informal procedures that appeared to be inadequate for the amount of assets under their management.90 Application of our recent rule requiring more formalized compliance policies administered by an employee designated as a chief compliance officer should serve to better protect hedge fund investors.91 5. Limitation on RetailizationRegistration under the Advisers Act would have the salutary effect of requiring all direct investors in most hedge funds to meet minimum standards of rule 205-3 under the Advisers Act.92 Rule 205-3 requires that each investor generally have a net worth of at least $1.5 million or have at least $750,000 of assets under management with the adviser.93 Many hedge fund advisers will rely on rule 205-3 to continue charging a "performance fee" to the funds they manage. 6. Imposition of Minimal BurdensWhile it furthers these five important objectives, registration under the Advisers Act would meet another important objective of the Commission by imposing only minimal additional burdens on hedge fund advisers. As we discussed above, the Act does not require or prohibit an adviser to follow any particular investment strategies, nor does it require or prohibit specific investments. Its most significant provision, which requires full disclosure of conflicts of interest and prohibits fraud against clients, applies regardless of whether the adviser is registered under the Act.94 Many advisers registered with us today currently advise hedge funds,95 and none has reported to us that registration made their hedge funds less competitive with other hedge funds.96 Although some panelists on our Roundtable argued against requiring hedge fund advisers to register under the Act, none identified any impediment under the Advisers Act to managing a hedge fund.97 Thus, registration under the Advisers Act should not interfere with the important functions that hedge funds play in our financial markets. We request comment on the burdens our proposal would impose, and whether those burdens could be alleviated in some manner that also meets our objectives in proposing these rules.
7. CFTC RegulationSome have argued that registering hedge fund advisers under the Advisers Act is unnecessary because many may already be registered with the Commodity Futures Trading Commission ("CFTC") as commodity pool operators ("CPOs") and examined by the National Futures Association ("NFA"), a self-regulatory organization.106 These examinations, however, necessarily focus more on the area of futures trading — that is, the activities of most concern to the CFTC and NFA.107 Moreover, the CFTC is withdrawing its oversight of certain hedge fund advisers. The CFTC recently adopted rules that may permit most hedge fund advisers to now avoid registering as CPOs or commodity trading advisors ("CTAs").108 New entrants to the industry have an opportunity to structure their activities so as to avoid CFTC registration, and existing hedge fund advisers may deregister with the CFTC.109 8. Proper Administration of the Advisers ActAs we discussed above, many hedge fund advisers currently avoid registration under the Advisers Act by qualifying for the "private adviser" exemption that section 203(b)(3) provides to advisers that have had fourteen or fewer clients during the preceding twelve months and that do not hold themselves out generally to the public as investment advisers. The Act does not define the term "client," and for many years it was unclear whether the Act required an adviser that served as a general partner to a limited partnership holding investment securities to count each limited partner as a client, because the pooled investment vehicle served primarily as a vehicle through which the adviser/general partner provided investment advice.110 If advisers to hedge funds were viewed as providing investment advice to one client-the fund-then they would not be required to register under the Act (assuming they advised no more than fourteen funds and did not hold themselves out to the public as investment advisers). If they were viewed as advising each partner of a partnership having more than fourteen partners, they would be required to register (assuming no other exemption were available). In 1985, the Commission addressed this issue by adopting rule 203(b)(3)-1, which permits an adviser to treat a limited partnership as the "client" for purposes of the private adviser exemption if, among other things, the advice provided to the limited partnership is based on the investment objectives of the partnership rather than those of the various limited partners.111 When we adopted rule 203(b)(3)-1, we concluded that when an adviser manages a group of client accounts on the basis of the investment objectives of the pool, it would be appropriate to view the pool (rather than each participant in the pool) as the client.112 We acknowledged, however, that a different approach could be followed.113 But since 1985, circumstances have changed. Hedge fund assets have continued to grow,114 the number of hedge funds has increased, the types of investors have changed and funds of hedge funds have emerged. Moreover, this growth has occurred in an environment where hedge fund advisers have not been required to register. Commensurate with this growth, fraud in the hedge fund industry has increased. It is clear that the implications of our 1985 decision have also grown. Today, advisers to hedge funds manage multiple hedge funds having hundreds of investors, and tens of millions of dollars of assets, without registering with the Commission. We are concerned that rule 203(b)(3)-1 may no longer be consistent with the underlying purposes of section 203(b)(3), which, as we noted above, seems intended to exempt from registration advisers that have only a few clients and whose clients are likely to be friends, associates or family members.115 In 1996, Congress amended the Advisers Act to allocate regulatory responsibility over advisers between the SEC and state regulatory authorities.116 In doing so, Congress established a threshold for federal interest in advisers by requiring advisers to register with the Commission (unless they were otherwise exempt) if they have more than $25 million of assets under management.117 While such a later amendment of the Act would not serve to expand or contract the scope of section 203(b)(3),118 we believe it should inform our administration of the section. In this regard, rule 203(b)(3)-1 may provide too broad a safe harbor in light of the 1996 Congressional determination that there is a federal interest in the oversight of advisers that manage significant amounts of client assets. In suggesting this conclusion, we are mindful of section 208(d) of the Act, which prohibits advisers from doing indirectly, or through or by another person, what they are prohibited from doing directly.119 Rule 203(b)(3)-1 may thus be viewed to permit advisers to manage assets for more than fourteen clients "through or by" a hedge fund and remain unregistered. C. Proposed Rule 203(b)(3)-2Proposed rule 203(b)(3)-2 would require investment advisers to count each owner of a "private fund" as a client for purposes of determining the availability of the private adviser exemption of section 203(b)(3) of the Act. As a result, an adviser to a "private fund," which is defined in the rule and discussed below, could no longer rely on the private adviser exemption if the adviser, during the course of the preceding twelve months, advised a private fund that had more than fourteen investors. And an adviser that advised individual clients directly would have to count those clients together with the investors in any private fund it advised in determining its total number of clients. 1. Minimum Assets Under ManagementThe new rule would not alter the minimum assets under management that an investment adviser must have in order to be eligible to register with the Commission.120 Thus, hedge fund advisers with assets under management of less than $25 million would continue generally not to be eligible for Commission registration (unless they also advise a registered investment company or qualify for registration under one of our exemptive rules).121 Hedge fund advisers with assets under management between $25 and $30 million would be eligible, but not required, to register with the Commission.122
2. Funds of Hedge FundsThe new rule would contain a special provision for advisers to hedge funds in which a registered investment company invests.124 Hedge fund advisers would be required to count the investors in the registered fund as clients.125 Without this provision, a hedge fund adviser could provide its services to thousands of mutual fund investors through fourteen or fewer mutual funds, each of which could invest in the private fund, and each of which would count as a single client.
3. Offshore Advisersa. Counting Clients of Offshore AdvisersThe proposal would require hedge fund advisers located offshore to look through the funds they manage, whether or not those funds are also located offshore, and count investors that are U.S. residents as clients. An adviser to any hedge fund that, in the course of the previous twelve months, has more than fourteen investors (or other advisory clients) that are U.S. residents would generally have to register under the Advisers Act.126 Offshore advisers to hedge funds would, therefore, be treated in the same manner as any other type of offshore adviser providing advice to U.S. residents.127
b. Advisers to Offshore Publicly Offered FundsWe do not want to require advisers to offshore publicly offered mutual funds or closed-end funds to register with us simply because more than fourteen of their investors are now resident in the United States.129 Therefore, we have included in the proposed rule an exception to the definition of "private fund" for a company that has its principal office and place of business outside the United States, makes a public offering of its securities outside the United States, and is regulated as a public investment company under the laws of a country other than the United States.130
c. Advisers to Offshore Private FundsWe are also proposing to limit the extraterritorial application of the Advisers Act that would otherwise occur as a result of these amendments. We do not apply most of the substantive provisions of the Act to the non-U.S. clients of an offshore adviser.131 As a result, offshore advisers registered with us must, for example, comply with our rules regarding the safekeeping of client assets only with respect to assets of their U.S. clients.132 If those client assets are pooled and held, for example, in a hedge fund, our custody rule would, as a practical matter, require the adviser to meet many of the requirements of the rule with respect to all assets of the fund even if most of the fund investors are not U.S. residents. It is not uncommon for U.S. investors to acquire interests in an offshore hedge fund that has few connections to the United States other than the investors (or the securities in which they invest). The laws governing such a fund would likely be those of the country in which it is organized or those of the country in which the adviser has its principal place of business. U.S. investors in such a fund generally would not have reasons to expect the full protection of the U.S. securities laws.133 Moreover, as a practical matter, they may be precluded from an investment opportunity in offshore funds if their participation resulted in the full application of the Advisers Act and our rules. Therefore, we propose to permit an offshore adviser to an offshore fund to treat the fund as its client (and not the investors) for all purposes under the Act, other than (i) determining the availability of the private adviser exemption (section 203(b)(3)), and (ii) those provisions prohibiting fraud (sections 206(1) and 206(2)).134 Such an adviser would register with us, but because the fund would not be a U.S. client, most of the substantive provisions of the Advisers Act would not apply to the adviser's dealings with the fund or other of its non-U.S. clients.135 We request comment on this provision.
D. Definition of "Private Fund"Advisers have many types of clients, some of which may be legal organizations such as trusts, partnerships, or corporations that have beneficial owners, e.g., beneficiaries, limited partners, or shareholders. It would not serve the purpose of this regulatory initiative or of the Act if we were to require advisers to "look through" each and every business or other legal organization they advised for purposes of determining the availability of the "private adviser" exemption. To identify those legal organizations whose advisers would be required to look through, the rule would contain a definition of "private fund." Our rule would define a "private fund" by reference to three characteristics shared by virtually all hedge funds. First, the private fund would be limited to a company that would be subject to regulation under the Investment Company Act of 1940 (the "Investment Company Act") but for the exception provided in either section 3(c)(1) (a "3(c)(1) fund") or section 3(c)(7) (a "3(c)(7) fund") of such Act.138 By limiting the scope of the look-through provision to those entities relying on these two sections of the Investment Company Act, we would exclude advisers to most business organizations, including insurance companies, broker-dealers, and banks, and include advisers to many types of pooled investment vehicles investing in securities, including hedge funds.139 Second, a company would be a private fund only if it permits investors to redeem their interests in the fund (i.e., sell them back to the fund) within two years of purchasing them.140 Hedge funds typically offer their investors liquidity access following an initial "lock-up" period,141 and thus most hedge fund advisers would be included within the rules. This "redeemability" requirement would, however, exclude persons who advise private equity funds,142 venture capital funds,143 and similar funds that require investors to make long-term commitments of capital. These funds are similar to hedge funds in some respects, but we have not encountered significant enforcement problems with advisers with respect to their management of these types of funds. In contrast, the Commission has developed a substantial record of frauds associated with hedge funds. A key element of hedge fund advisers' fraud in most of our recent enforcement cases has been the advisers' misrepresentation of their funds' performance to current investors,144 which in some cases was used to induce a false sense of security for investors when they might otherwise have exercised their redemption rights. Because hedge funds are where we have seen a recent growth in fraud enforcement actions, that is where we propose to focus our examination resources at this time. In addition, as the staff discussed in its 2003 Staff Hedge Fund Report, private equity funds typically are long-term investments providing for liquidation at the end of a term specified in the fund's governing documents. They provide for little or no opportunity for investors to redeem their investments,145 and moreover typically require investors to commit to invest an amount of money over the life of the fund, and make contributions in response to "capital calls." Periodic redemption rights offered by hedge funds, however, provide the hedge fund investors with a level of liquidity that allows the investor to withdraw a portion of his or her assets, controlled by the adviser, or to terminate the relationship with the hedge fund adviser and choose a new adviser. Given the association between these redeemability features and potential abuses that could harm investors in the fund, this element of the private fund definition will help promote the purposes of the Act. Third, interests in a private fund would be based on the ongoing investment advisory skills, ability or expertise of the investment adviser. In deciding whether to invest in a particular hedge fund, the adviser's history, experience, past performance with this or other client accounts, strategies, and disciplinary record, are likely important to investors, who rely on the adviser for the success of their investment. In that regard, hedge fund advisers emphasize the record of the manager and often provide prospective investors with information about the adviser and individual manager. This reliance by hedge fund investors implicates the need for the protections that the Advisers Act offers.146 Our approach to defining the scope of rule 203(b)(3)-2 is similar to that taken recently by the Department of Treasury in defining the scope of its proposed rule requiring "private investment companies" to adopt anti-money laundering programs.147 Like the Treasury Department, we have tried to keep the definition simple, and provide a "bright line" indicator of when an adviser must look though a client that is a legal organization. We have avoided alternative approaches that would turn on the nature of the investments made by the pooled investment vehicle because we do not want registration concerns to affect investment decisions of the adviser. We request comment on the proposal:
E. Amendments to Rule 203(b)(3)-1We propose to amend rule 203(b)(3)-1 to clarify that investment advisers may not count hedge funds as single clients under that safe harbor. As discussed earlier, many hedge fund advisers have avoided Advisers Act registration by relying on paragraph (a)(2)(i) of this rule, which permits advisers to count a legal organization, rather than its owners, as a single client.148 New paragraph (b)(6) would make it clear that advisers cannot rely on paragraph (a)(2)(i) with respect to private funds.149 F. Amendments to Rule 204-2We are proposing to provide relief from a recordkeeping requirement for hedge fund advisers that would be required to register with us under new rule 203(b)(3)-2. Under our rules, a registered investment adviser that makes claims concerning its performance "track record" must keep documentation supporting those performance claims.150 The supporting records must be retained for a period of five years after the performance information is last used.151 Thus, if a registered adviser promotes its 20-year performance record in 2004, it must continue to keep its supporting records for its 1984 performance through 2009 — five years after the last time that 1984 performance is included. While it is important for our examiners to be able to substantiate an adviser's performance claims, we recognize that hedge fund advisers, like other investment firms, need to communicate their performance history to their clients and prospective clients. We question, however, whether advisers that were not previously subject to our rules will necessarily have retained adequate records from prior periods. It is not our intention to put these new registrants at a competitive disadvantage in promoting the returns they have earned, in some instances over many years. Accordingly, we would require these new registrants to retain whatever records they do have that support the performance they earned prior to their registration with us, but would excuse them from our recordkeeping rule to the extent that those records are incomplete or otherwise do not meet the requirements of rule 204-2. Once a hedge fund adviser has registered with us, of course, it must comply with our recordkeeping rule going forward. We ask comment on this aspect of our proposal.
We are also proposing an amendment to rule 204-2 clarifying that, for purposes of section 204 of the Advisers Act, the books and records of a hedge fund adviser registered with us include records of the private funds for which the adviser acts as general partner, managing member, or in a similar capacity.152 Section 204 of the Act generally subjects records of investment advisers to examination by the Commission. To determine whether a hedge fund adviser is meeting its fiduciary obligations to a private fund under the Advisers Act and rules, our examiners require access to all records relating to the adviser's activities with respect to the fund, including records relating to the adviser's service as the fund's general partner. The general partners effectively control all the operations and assets of the hedge fund. Because many hedge fund advisers establish a separate special purpose vehicle to be named as the fund's general partner, the proposed amendment would also cover private funds for which a related person of the adviser (as defined in Form ADV) acts as general partner, managing member, or in a similar capacity. We ask comment on this aspect of our proposal.
G. Amendments to Rule 205-3We are proposing to amend rule 205-3 under the Advisers Act to avoid requiring certain hedge fund investors to divest their current interests in the funds. Most hedge fund advisers charge a fee based on their fund's capital gains or appreciation — a "performance fee." Rule 205-3 permits registered investment advisers to charge performance fees only to "qualified clients," and requires the adviser to a 3(c)(1) fund to look through the fund to determine whether all investors are qualified clients.153 Generally, to be a qualified client of a registered investment adviser an investor must place at least $750,000 under that adviser's management or have a net worth of $1.5 million.154 While many hedge fund advisers place these or even more stringent requirements on the investors in their funds, not all do so. Some hedge funds are marketed to "accredited investors,"155 and some may permit a small number of non-accredited investors. Accordingly, there may be some small number of investors in hedge funds that are not qualified clients. It may, therefore, be against our current rules for the adviser to continue receiving a performance fee from some current investors.156 While we would require hedge fund advisers to comply with our performance fee rules going forward, we do not believe it is necessary to disrupt existing arrangements with persons who have already invested in the hedge fund. Our proposed amendment to 205-3 would allow a hedge fund's current investors who are not qualified clients to retain their existing investment in that fund, and to add to that account. It would not give them an exemption to open new investment accounts in that hedge fund or other hedge funds. We request comment on this aspect of our proposal:
H. Amendments to Rule 206(4)-2We propose to amend rule 206(4)-2, the adviser custody rule, to accommodate advisers to funds of hedge funds. Our custody rule makes it clear that an adviser acting as general partner to a pooled investment vehicle it manages has custody of the pool's assets.157 Under the rule, advisers to pooled investment vehicles, including hedge funds, may satisfy their obligation to deliver custody account information to investors by distributing the pool's audited financial statements to investors within 120 days of the pool's fiscal year-end.158 Some advisers to funds of hedge funds have encountered difficulty in obtaining completion of their fund audits prior to completion of the audits for the underlying funds in which they invest, and as a practical matter will be prevented from complying with the 120-day deadline. We propose to extend the period for pooled investment vehicles to distribute their audited financial statements to their investors from 120 days to 180 days, so that advisers to funds of hedge funds may comply with the rule.159 We request comments on the proposed amendments.
I. Amendments to Form ADVWe propose to amend Form ADV to identify advisers to hedge funds. The current Form ADV collects information about advisers to pooled investment vehicles without distinguishing hedge fund advisers from other advisers. We would amend Item 7 B. of Part 1A and Section 7 B. of Schedule D to require advisers to "private funds" as defined in the proposed rule to identify themselves as hedge fund advisers in Part 1A and Schedule D of Form ADV. We request comment on this aspect of our proposal.
J. Compliance PeriodWe request comment on the length of time hedge fund advisers would need in order to register and revise their compliance systems so as to meet the requirements under the Advisers Act. Although many hedge fund advisers may be able to transition easily, we recognize that some firms may need to develop control policies and procedures in a number of areas.
III. GENERAL REQUEST FOR COMMENTThe Commission requests comment on the rule and amendments proposed in this Release, suggestions for other additions to the rule and amendments, and comment on other matters that might have an effect on the proposals contained in this Release. For purposes of the Small Business Regulatory Enforcement Fairness Act of 1996, the Commission also requests information regarding the potential impact of the proposed rule and amendments on the economy on an annual basis. Commenters should provide empirical data to support their views. IV. COST-BENEFIT ANALYSISWe are sensitive to the costs and benefits that result from our rules. Proposed rule 203(b)(3)-2 would require certain hedge fund advisers to register with us under the Investment Advisers Act of 1940. We are also proposing related recordkeeping and performance fee amendments to facilitate a smooth transition for hedge fund advisers, and amendments to the custody rule designed to facilitate a smooth transition particularly for advisers to funds of hedge funds. We have identified certain costs and benefits, which are discussed below, that may result from the proposed rule and amendments. We request comment on the costs and benefits of the proposed rule and amendments. We encourage commenters to identify, discuss, analyze, and supply relevant data regarding these or any additional costs and benefits. A. Benefits1. Benefits to hedge fund investorsAs discussed above in this Release, our proposal to require hedge fund advisers to register under the Advisers Act would benefit hedge fund investors, though these benefits are difficult to quantify. (a) Deter fraud and curtail losses. Our oversight may prevent or diminish losses hedge fund investors would otherwise experience as a result of hedge fund advisers' fraud. Registration would allow us to conduct regular examinations of hedge fund advisers, and our examinations provide a strong deterrent to advisers' fraud, identify practices that may harm investors, and lead to earlier discovery of fraud that does occur. 160 Registration would also permit us to screen individuals seeking to advise hedge funds, and to deny entry to those with a history of disciplinary problems.161 In the last five years, the Commission has brought 46 enforcement cases in which we assert hedge fund advisers have defrauded hedge fund investors or used the fund to defraud others. While 3 of these frauds were detected in time to prevent investor losses, this was the exception rather than the rule.162 In 35 of these cases, our staff estimates potential investor losses aggregate approximately $1.1 billion.163 Staff cannot at this time estimate the amount of losses in the remaining eight cases.164 We are concerned that individuals have targeted hedge fund investors and chosen hedge funds as a vehicle for fraud because these individuals could operate their funds without regulatory scrutiny of their activities. Only eight of the 46 cases involve investment advisers registered with the Commission, with over $75.7 million in estimated aggregate investor losses.165 The remaining 38 cases involve advisers that were not registered with us, with over $1 billion in estimated aggregate investor losses.166 While our regulatory oversight cannot guarantee hedge fund investors will never be defrauded, our oversight should reduce investor losses.167 (b) Provide basic information about hedge fund advisers. Form ADV information that hedge fund advisers would file in registering would aid hedge fund investors in evaluating potential managers.168 Filing Form ADV would require hedge fund advisers to disclose information about their business, affiliates and owners, and disciplinary history. Many investors currently lack good access to this information about their hedge fund managers.169 Although the information hedge fund advisers would provide on their Form ADV filings and to comply with our rules cannot substitute for an investor's due diligence, it would aid investors by providing a publicly accessible foundation of basic information.170 (c) Improve compliance controls. Hedge fund investors would benefit from their advisers' improved compliance controls. Once registered, hedge fund advisers would be required to have comprehensive compliance procedures and to designate a chief compliance officer.171 Specific procedures governing proxy voting172 and a code of ethics including requirements for personal securities reporting would also be required.173 In addition, our examinations and the obligation to commit to a program of compliance controls foster adherence to a culture of compliance by advisers.174 These compliance measures are the first line of defense in protecting investors against breaches of an adviser's fiduciary duties under the Act. 2. Benefits to mutual fund investorsMutual fund investors would benefit from hedge fund adviser registration to the extent that Commission oversight deters hedge funds and their advisers from illegal conduct that exploits mutual funds. Many of the market timers and illegal late traders involved in recent mutual fund scandals have been hedge funds.175 The 46 enforcement cases discussed earlier do not include 12 other actions we have brought to date against persons charged with late trading of mutual fund shares on behalf of hedge fund groups, and against mutual fund advisers or principals for permitting hedge funds to market time mutual funds contrary to the mutual funds' prospectus disclosure.176 Hedge fund advisers reaped huge profits for their funds over an extended period while costing our nation's retail mutual fund investors hundreds of millions of dollars.177 3. Benefits to other investors and marketsOther investors, and markets, would benefit from hedge fund adviser registration to the extent that SEC oversight eliminates opportunities for hedge funds and their advisers to engage in other types of unlawful conduct in the securities markets. The mutual fund scandals have shown us that hedge fund advisers' improper or illegal activities can cause harm beyond the hedge funds' own investors. There may be other fraudulent activities by hedge fund advisers of which we are unaware because we cannot examine these advisers regularly.178 Adviser registration, as discussed above, would lead to earlier discovery of fraudulent activities and thus would enhance protections to all investors in the securities markets. 4. Benefits to regulatory policyRegistration of hedge fund advisers would benefit all investors and market participants by providing us and other policy makers with better data. Better data would help us to form and frame appropriate regulatory policies regarding the hedge fund industry and its advisers, and to evaluate the effect of our policies and programs on this sector. We have limited information about hedge fund advisers and the hedge fund industry, and much of what we do have is indirect information extrapolated from other data. This hampers our ability to develop regulatory policy for the protection of hedge fund investors and investors in general.179 Hedge fund adviser registration would provide the Congress, the Commission and other government agencies with important information about this rapidly growing segment of the U.S. financial system.180 5. Benefits to hedge fund advisers(a) Curtail competitive disparities. Mandatory registration would provide a level playing field for hedge fund advisers. Many hedge fund advisers have already registered with us,181 and have organized their compliance procedures under the Advisers Act. Unregistered hedge fund advisers, however, vary substantially in their compliance practices.182 While many of them have adopted sound compliance practices, many others, against whom they and the registered advisers compete, have not allocated resources to implement an effective compliance infrastructure. Mandatory registration would ensure that all hedge fund advisers compete on the same basis in this regard. (b) Legitimize a growing and maturing industry. As discussed above, the hedge fund industry has been growing at an extraordinary pace in the past decade.183 Registration under the Advisers Act would bring hedge fund advisers to the same compliance level as other SEC-registered advisers, thus legitimizing a growing and maturing industry that is currently perceived as operating in the shadows. In addition, without appropriate regulatory oversight to check growing hedge fund fraud, investors' confidence in hedge fund advisers and the hedge fund industry could eventually erode. B. CostsRegistration of hedge fund advisers under the Advisers Act would not impede hedge funds' operations. The Act does not prohibit any particular investment strategies, nor does it require or prohibit specific investments. Instead of imposing specific procedures on registrants, the Advisers Act is principally a disclosure statute that requires registrants to fully inform clients of conflicts so that those clients can determine whether to give their consent. For the same reasons, registering hedge fund advisers should not impair the ability of hedge funds to continue their important roles of providing price information and liquidity to our markets.184 Registration, however, imposes certain additional costs as discussed below. 1. Registration costsHedge fund advisers would experience costs to register under the Advisers Act, but these costs would not be high. In order to register, advisers are required to file Part 1 of Form ADV (the registration form for advisers) electronically through the Investment Adviser Registration Depository ("IARD") and pay initial filing fees and annual filing fees to the IARD system operator.185 In addition to these filing fees, hedge fund advisers would also incur internal costs in connection with preparing Part 1, but these costs should be low because Form ADV readily accommodates registration by hedge fund advisers. Part 1 requires advisers to answer basic questions about their business, their affiliates and their owners, and Part 1 can be completed using information readily available to hedge fund advisers. Numerous hedge fund advisers have already registered with the Commission using Part 1, and none has reported to us that their business model presents any difficulty in using the form.186 Advisers must also complete Part II of Form ADV and deliver a copy of Part II or a disclosure brochure containing the same information to clients.187 Part II requires disclosure of certain conflicts of interest. We expect that hedge fund advisers would face relatively small internal costs in preparing a Part II, and would be likely to include their Part II information as part of their private placement memoranda for their hedge funds, reducing their overall costs even further. 2. Compliance infrastructure costsNew hedge fund adviser registrants would also face costs to bring their operations into conformity with the Advisers Act and the rules under the Act, and these costs would vary substantially across advisory firms. Registered advisers are required to comply with rules under the Advisers Act such as the books and records rule,188 the custody rule,189 the proxy voting rule,190 the compliance rule,191 and the code of ethics rule.192 Many unregistered hedge fund advisers have already built sound compliance infrastructure because their business compels it. These firms already have procedures designed to keep good records of all transactions, to keep their clients' assets safe, to provide fair and full disclosure of conflicts of interest, and to prevent their supervised persons from breaching fiduciary duties. These advisory firms would face little cost to modify their current compliance practices to comply with the Advisers Act rules. For other hedge fund advisers that have not yet established sound compliance programs, however, the costs would be higher. Based on discussions with industry, we estimate the costs to establish the required compliance infrastructure would be $20,000 in professional fees and $25,000 in internal costs including staff time.193 These estimates are averages. As stated above, the costs would likely be less for new registrants that have already established sound compliance practices and more for new registrants that do not yet have good compliance procedures. These costs should not represent a barrier to entry for new hedge fund advisers. More than 2,500 smaller advisory firms are currently registered with us.194 These firms have absorbed these compliance costs, notwithstanding the fact that their revenues are likely to be smaller than those of a typical hedge fund adviser.195 V. EFFECTS ON COMMISSION EXAMINATION RESOURCESThe proposed rule would also increase the workload of the Commission's investment adviser examination program, which is operated by our Office of Compliance Inspections and Examinations ("OCIE"). OCIE's examination program already covers a number of advisers to hedge funds. These advisers have registered with the SEC, either because they advise non-hedge fund clients for whom registration is required, or because they perceive SEC registration to be necessary to their business model. The proposed rule would increase the number of SEC-registered advisers by some amount, and increase our examination workload correspondingly. There are various options we could pursue to lessen the effect of this increase. Though OCIE's resources would be spread over an expanded pool of investment adviser registrants, we could develop risk assessment tools that enhance the efficiency of our examination program. In addition, we have recently adopted measures that require advisory personnel to be more accountable for the efficacy of compliance programs. By October of this year, advisers must comply with our new compliance rule, which requires all registered investment advisers to implement comprehensive policies and procedures for compliance with the Advisers Act, under the administration of a chief compliance officer.196 As advisers improve their own compliance regimes, we expect our examination program will enjoy increased efficiencies. Another option would be to increase the current threshold for SEC registration from $25 million of assets under management to a slightly higher amount, thereby reducing the number of smaller advisers overseen by the Commission (instead of state securities administrators). Or we could seek additional resources from Congress, if necessary. Our ability to estimate the size of the increase in our workload has been hampered by the absence of any reliable and comprehensive database of hedge funds or advisers to hedge funds. Our staff tentatively estimates that the addition of new hedge fund advisers to our current registrant pool of 8,300 advisers could increase the total size of this pool by 8 to 15 percent. Based on a review of the limited information available, our staff estimates that there are probably between 2,300 and 3,500 hedge fund advisers in the industry, advising approximately 7,000 funds.197 After examining various private databases of hedge fund information, staff further estimates that approximately 60 percent of these firms are likely to have at least $25 million in assets under management, making them eligible to register with the Commission instead of the states. Staff further estimates that approximately 40 to 50 percent of those eligible advisers are already registered with the Commission, with registration rates likely to be higher for larger firms and lower for smaller firms.198 Based on these estimates and assumptions:
We request comment on these estimates. We encourage commenters to identify, discuss, analyze, and supply relevant data regarding these or any alternative estimates. VI. PAPERWORK REDUCTION ACTProposed rule 203(b)(3)-2 contains no new "collection of information" requirements within the meaning of the Paperwork Reduction Act of 1995 (44 U.S.C. 3501 to 3520). The rules proposed to be amended contain several collection of information requirements, but the proposed amendments do not change the burden per response from that under the current rules. Proposed rule 203(b)(3)-2 would have the effect of requiring advisers to hedge funds to register with the Commission under the Advisers Act and would therefore increase the number of respondents under several existing collections of information, and, correspondingly, increase the annual aggregate burden under those existing collections of information. The Commission has submitted, to the Office of Management and Budget ("OMB") in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11, the existing collections for information for which the annual aggregate burden would likely increase as a result of rule 203(b)(3)-2. The titles of the affected collections of information are: "Form ADV," "Form ADV-W and Rule 203-2," "Rule 203-3 and Form ADV-H," "Form ADV-NR," "Rule 204-2," "Rule 204-3," "Rule 204A-1," "Rule 206(4)-2, Custody of Funds or Securities of Clients by Investment Advisers," "Rule 206(4)-3," "Rule 206(4)-4," "Rule 206(4)-6," and "Rule 206(4)-7," all under the Advisers Act. The existing rules affected by rule 203(b)(3)-2 contain currently approved collection of information numbers under OMB control numbers 3235-0049, 3235-0313, 3235-0538, 3235-0240, 3235-0278, 3235-0047, 3235-0596, 3235-0241, 3253-0242, 3235-0345, 3235-0571 and 3235-0585, respectively. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number. All of these collections of information are mandatory, and respondents in each case are investment advisers registered with us, except that (i) respondents to Form ADV are also investment advisers applying for registration with us; (ii) respondents to Form ADV-NR are non-resident general partners or managing agents of registered advisers; (iii) respondents to Rule 204A-1 include "access persons" of an adviser registered with us, who must submit reports of their personal trading to their advisory firms; (iv) respondents to Rule 206(4)-2 are only those SEC-registered advisers that have custody of clients' funds or securities; (v) respondents to Rule 206(4)-3 are advisers who pay cash fees to persons who solicit clients for the adviser; (vi) respondents to Rule 204(4)-4 are advisers with certain disciplinary histories or a financial condition that is reasonably likely to affect contractual commitments; and (vii) respondents to Rule 206(4)-6 are only those SEC-registered advisers that vote their clients' securities. Unless otherwise noted below, responses are not kept confidential. We cannot estimate with precision the number of hedge fund advisers that would be new registrants with the Commission under the Advisers Act if proposed rule 203(b)(3)-2 is adopted. As discussed earlier, our staff has estimated that between 690 and 1,260 hedge fund advisers would be new Advisers Act registrants under the proposed rules.199 For purposes of estimating the increases in respondents to the existing collections of information, we have used the midpoint of this estimated range, or 975 new respondents. We request comment on the number of hedge fund advisers that would be subject to the proposed rule and to the applicable collections of information. A. Form ADVForm ADV is the investment adviser registration form. The collection of information under Form ADV is necessary to provide advisory clients, prospective clients, and the Commission with information about the adviser, its business, and its conflicts of interest. Rule 203-1 requires every person applying for investment adviser registration with the Commission to file Form ADV. Rule 204-1 requires each registered adviser to file amendments to Form ADV at least annually, and requires advisers to submit electronic filings through the IARD. This collection of information is found at 17 CFR 275.203-1, 275.204-1, and 279.1. The currently approved collection of information in Form ADV is 102,653 hours. We estimate that 975 new respondents would file one complete Form ADV and one amendment annually, and comply with Form ADV requirements relating to delivery of the code of ethics. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under Form ADV by 28,958 hours200 for a total of 131,611 hours. B. Form ADV-W and Rule 203-2Rule 203-2 requires every person withdrawing from investment adviser registration with the Commission to file Form ADV-W. The collection of information is necessary to apprise the Commission of advisers who are no longer operating as registered advisers. This collection of information is found at 17 CFR 275.203-2 and 17 CFR 279.2. The currently approved collection of information in Form ADV-W is 500 hours. We estimate that 975 hedge fund advisers that would be new registrants would withdraw from SEC registration at a rate of approximately 16 percent per year, the same rate as other registered advisers, and would file for partial and full withdrawals at the same rates as other registered advisers, with approximately half of the filings being full withdrawals and half being partial withdrawals. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under Form ADV-W and rule 203-2 by 78 hours201 for a total of 578 hours. C. Rule 203-3 and Form ADV-HRule 203-3 requires that advisers requesting either a temporary or continuing hardship exemption submit the request on Form ADV-H. An adviser requesting a temporary hardship exemption is required to file Form ADV-H, providing a brief explanation of the nature and extent of the temporary technical difficulties preventing it from submitting a required filing electronically. Form ADV-H requires an adviser requesting a continuing hardship exemption to indicate the reasons the adviser is unable to submit electronic filings without undue burden and expense. Continuing hardship exemptions are available only to advisers that are small entities. The collection of information is necessary to provide the Commission with information about the basis of the adviser's hardship. This collection of information is found at 17 CFR 275.203-3, and 279.3. The currently approved collection of information in Form ADV-H is 10 hours. We estimate that the approximately 975 hedge fund advisers that would be new registrants would file for temporary hardship exemptions at approximately 0.1 percent per year, the same rate as other registered advisers.202 Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under Form ADV-H and rule 203-3 by 1 hour203 for a total of 11 hours. D. Form ADV-NRNon-resident general partners or managing agents of SEC-registered investment advisers must make a one-time filing of Form ADV-NR with the Commission. Form ADV-NR requires these non-resident general partners or managing agents to furnish us with a written irrevocable consent and power of attorney that designates the Commission as an agent for service of process, and that stipulates and agrees that any civil suit or action against such person may be commenced by service of process on the Commission. The collection of information is necessary for us to obtain appropriate consent to permit the Commission and other parties to bring actions against non-resident partners or agents for violations of the federal securities laws. This collection of information is found at 17 CFR 279.4. The currently approved collection of information in Form ADV-NR is 15 hours. We estimate that the approximately 975 hedge fund advisers that would be new registrants would make these filings at the same rate (0.2 percent) as other registered advisers. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under Form ADV-NR by 2 hours204 for a total of 17 hours. E. Rule 204-2Rule 204-2 requires SEC-registered investment advisers to maintain copies of certain books and records relating to their advisory business. The collection of information under rule 204-2 is necessary for the Commission staff to use in its examination and oversight program. Responses provided to the Commission in the context of its examination and oversight program are generally kept confidential.205 The records that an adviser must keep in accordance with rule 204-2 must generally be retained for not less than five years.206 This collection of information is found at 17 CFR 275.204-2. The currently approved collection of information for rule 204-2 is 1,537,884 hours, or 191.78 hours per registered adviser. We estimate that all 975 advisers that would be new registrants would maintain copies of records under the requirements of rule 204-2. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under rule 204-2 by 186,985.5 hours207 for a total of 1,724,869.5 hours. F. Rule 204-3Rule 204-3, the "brochure rule," requires an investment adviser to deliver or offer to prospective clients a disclosure statement containing specified information as to the business practices and background of the adviser. Rule 204-3 also requires that an investment adviser deliver, or offer, its brochure on an annual basis to existing clients in order to provide them with current information about the adviser. The collection of information is necessary to assist clients in determining whether to retain, or continue employing, the adviser. This collection of information is found at 17 CFR 275.204-3. The currently approved collection of information for rule 204-3 is 5,412,643 hours, or 694 hours per registered adviser, assuming each adviser has on average 670 clients. We estimate that all 975 advisers that would be new registrants would provide brochures to their clients as required by rule 204-3. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under rule 204-3 by 676,650 hours208 for a total of 6,089,293 hours. We note that the average number of clients per adviser reflects a small number of advisers who have thousands of clients, while the typical SEC-registered adviser has approximately 76 clients. We ask comment on the number of clients of the average hedge fund adviser. G. Rule 204A-1Rule 204A-1 requires SEC-registered investment advisers to adopt codes of ethics setting forth standards of conduct expected of their advisory personnel and addressing conflicts that arise from personal securities trading by their personnel, and requiring advisers' "access persons" to report their personal securities transactions. The collection of information under rule 204A-1 is necessary to establish standards of business conduct for supervised persons of investment advisers and to facilitate investment advisers' efforts to prevent fraudulent personal trading by their supervised persons. This collection of information is found at 17 CFR 275.204A-1. The currently approved collection of information for rule 204A-1 is 945,841 hours, or 117.95 hours per registered adviser. We estimate that all 975 advisers that would be new registrants would adopt codes of ethics under the requirements of rule 204A-1 and require personal securities transaction reporting by their "access persons." Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under rule 204A-1 by 115,001 hours209 for a total of 1,060,842 hours. H. Rule 206(4)-2Rule 206(4)-2 requires advisers with custody of their clients' funds and securities to maintain controls designed to protect those assets from being lost, misused, misappropriated, or subjected to financial reverses of the adviser. The collection of information under rule 206(4)-2 is necessary to ensure that clients' funds and securities in the custody of advisers are safeguarded, and information contained in the collections is used by staff of the Commission in its enforcement, regulatory, and examination programs. This collection of information is found at 17 CFR 275.206(4)-2. The currently approved collection of information for rule 206(4)-2 is 72,113 hours. We estimate that all 975 hedge fund advisers that would be new registrants would have custody. We are proposing to amend rule 206(4)-2 to make it easier for hedge fund advisers to distribute audited financial statements to their investors annually in lieu of quarterly account statements sent by either the adviser or a qualified custodian and we estimate that all 975 new respondents would use this approach and would not be required to undergo an annual surprise examination. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under rule 206(4)-2 by 326,625 hours210 for a total of 398,738 hours. I. Rule 206(4)-3Rule 206(4)-3 requires advisers who pay cash fees to persons who solicit clients for the adviser to observe certain procedures in connection with solicitation activity. The collection of information under rule 206(4)-3 is necessary to inform advisory clients about the nature of a solicitor's financial interest in the recommendation of an investment adviser, so the client may consider the solicitor's potential bias, and to protect investors against solicitation activities being carried out in a manner inconsistent with the adviser's fiduciary duties. This collection of information is found at 17 CFR 275.206(4)-3. The currently approved collection of information for rule 206(4)-3 is 10,982 hours. We estimate that approximately 20 percent of the 975 hedge fund advisers that would be new registrants would be subject to the cash solicitation rule, the same rate as other registered advisers. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under rule 206(4)-3 by 1,373 hours211 for a total of 12,355 hours. J. Rule 206(4)-4Rule 206(4)-4 requires registered investment advisers to disclose to clients and prospective clients certain disciplinary history or a financial condition that is reasonably likely to affect contractual commitments. This collection of information is necessary for clients and prospective clients in choosing an adviser or continuing to employ an adviser. This collection of information is found at 17 CFR 275.206(4)-4. The currently approved collection of information for rule 206(4)-4 is 10,118 hours. We estimate that approximately 17.3 percent of the 975 hedge fund advisers that would be new registrants would be subject to rule 206(4)-4, the same rate as other registered advisers. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under rule 206(4)-4 by 1,265 hours212 for a total of 11,383 hours. K. Rule 206(4)-6Rule 206(4)-6 requires an investment adviser that votes client securities to adopt written policies reasonably designed to ensure that the adviser votes in the best interests of clients, and requires the adviser to disclose to clients information about those policies and procedures. This collection of information is necessary to permit advisory clients to assess their adviser's voting policies and procedures and to monitor the adviser's performance of its voting responsibilities. This collection of information is found at 17 CFR 275.206(4)-6. The currently approved collection of information for rule 206(4)-6 is 103,590 hours. We estimate that all 975 hedge fund advisers that would be new registrants would vote their clients' securities. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under rule 206(4)-6 by 16,283 hours213 for a total of 119,873 hours. L. Rule 206(4)-7Rule 206(4)-7 requires each registered investment adviser to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act, review those policies and procedures annually, and designate an individual to serve as chief compliance officer. This collection of information under rule 206(4)-7 is necessary to ensure that investment advisers maintain comprehensive internal programs that promote the advisers' compliance with the Advisers Act. This collection of information is found at 17 CFR 275.206(4)-7. The currently approved collection of information for rule 206(4)-7 is 623,200 hours, or 80 hours annually per registered adviser. We estimate all 975 advisers that would be new registrants would be required to maintain compliance programs under rule 206(4)-7. Accordingly, we estimate the proposal would increase the annual aggregate information collection burden under rule 206(4)-7 by 78,000 hours214 for a total of 701,200 hours. M. Request for CommentPursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to:
Persons wishing to submit comments on the collection of information requirements should direct them to the Office of Management and Budget, Attention: Desk Officer for the Securities and Exchange Commission, Office of Information and Regulatory Affairs, Room 3208, Washington, DC 20503, and also should send a copy to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609 with reference to File No. S7-30-04. OMB is required to make a decision concerning the collections of information between 30 and 60 days after publication, so a comment to OMB is best assured of having its full effect if OMB receives the comment within 30 days after publication of this release. Requests for materials submitted to OMB by the Commission with regard to these collections of information should be in writing, refer to File No. S7-30-04, and be submitted to the Securities and Exchange Commission, Records Management, Office of Filings and Information Services, 450 Fifth Street, NW, Washington, DC 20549. VII. EFFECTS ON COMPETITION, EFFICIENCY AND CAPITAL FORMATIONSection 202(c) of the Advisers Act mandates that the Commission, when engaging in rulemaking that requires it to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.215 As discussed above, proposed rule 203(b)(3)-2 would, in effect, require hedge fund advisers to register with the Commission under the Advisers Act. The proposed rule is designed to provide the protection afforded by the Advisers Act to investors in hedge funds, and to enhance the Commission's ability to protect our nation's securities markets. We are also proposing rule amendments that would facilitate hedge fund advisers' transition to registration and improve the Commission's ability to identify hedge fund advisers from information filed on their Form ADV. The proposed rule and rule amendments may indirectly increase efficiency for hedge fund investors. Hedge fund adviser registration would provide hedge fund investors and industry participants with better access to important basic information about hedge fund advisers and the hedge fund industry. This improved access may allow investors to investigate and select their advisers more efficiently. We do not anticipate that the proposed rule would introduce any competitive disadvantages. The proposed rule may provide a level playing field with respect to advisers' compliance infrastructures. Many hedge fund advisers are already registered with us, either because their investors demand it or because they have other advisory business that requires them to register. These registered advisers must adopt compliance procedures under the Advisers Act and must provide certain safeguards to their clients, including their hedge fund investors. While some unregistered hedge fund advisers have adopted sound comparable compliance procedures, others have not. Mandatory registration would require that all hedge fund advisers compete with each other and with other investment advisers on the same basis in this regard. The proposed amendment to rule 204-2 is designed to prevent newly-registered hedge fund advisers from being at a competitive disadvantage with respect to the promotion of their previous performance records, and the proposed amendment to rule 206(4)-2 is designed to allow advisers to funds of hedge funds to use the same approach under the adviser custody rule as do advisers to other pooled investment vehicles. The proposed rule is unlikely to have a substantial effect on capital formation. To the extent that registration and the prospect of Commission examinations improves the compliance culture at hedge fund advisory firms, it may bolster investor confidence and investors may be more likely to entrust hedge fund advisers with their assets for investment. However, these assets may be diverted from other investments in the capital markets. The Commission seeks comment regarding the impact of the proposed rules on efficiency, competition, and capital formation. Commenters are requested to provide empirical data to support their views. VIII. REGULATORY FLEXIBILITY ACTA. CertificationPursuant to section 605(b) of the Regulatory Flexibility Act,216 the Commission hereby certifies that proposed rule 203(b)(3)-2 and the proposed amendments to rules 203(b)(3)-1, 204-2, 205-3 and Form ADV would not, if adopted, have a significant economic impact on a substantial number of small entities. Under Commission rules, for the purposes of the Advisers Act and the Regulatory Flexibility Act, an investment adviser generally is a small entity if it: (i) has assets under management having a total value of less than $25 million; (ii) did not have total assets of $5 million or more on the last day of its most recent fiscal year; and (iii) does not control, is not controlled by, and is not under common control with another investment adviser that has assets under management of $25 million or more, or any person (other than a natural person) that had $5 million or more on the last day of its most recent fiscal year.217 Proposed rule 203(b)(3)-2 and the amendment to rule 203(b)(3)-1 would remove a safe harbor and require certain advisers to private funds to register with the Commission under the Advisers Act by requiring them to count investors in the fund as clients for purposes of the Advisers Act "de minimis" exemption from registration. Notwithstanding the proposed rule, investment advisers with assets under management of less than $25 million would remain generally ineligible for registration with the Commission under section 203A of the Advisers Act.218 The proposed amendments to rules 204-2 and 205-3 would allow advisers affected by the proposed new rule to continue certain marketing practices and performance fees they now have in place. The proposed amendment to Form ADV would require advisers to private funds to identify themselves as such. No other entities would incur obligations from the proposed rules and amendments. Accordingly, the Commission certifies that proposed rule 203(b)(3)-2 and the proposed amendments to rules 203(b)(3)-1, 204-2, 205-3 and Form ADV would not have a significant economic impact on a substantial number of small entities. The Commission requests written comments regarding this certification. The Commission requests that commenters describe the nature of any impact on small businesses and provide empirical data to support the extent of the impact. B. Amendment to Rule 206(4)-2The Commission has prepared the following Initial Regulatory Flexibility Analysis ("IRFA") regarding the proposed amendment to rule 206(4)-2 in accordance with section 3(a) of the Regulatory Flexibility Act.219 1. Reasons for Proposed ActionWe propose to amend rule 206(4)-2, the adviser custody rule, to accommodate advisers to private funds of funds, including funds of hedge funds.220 Under the rule, advisers to pooled investment vehicles may satisfy their obligation to deliver custody account information to investors by distributing the pool's audited financial statements to investors within 120 days of the pool's fiscal year-end.221 Some advisers to private funds of funds (including funds of hedge funds) have encountered difficulty in obtaining completion of their fund audits prior to completion of the audits for the underlying funds in which they invest, and as a practical matter will be prevented from complying with the 120-day deadline. We propose to extend the period for pooled investment vehicles to distribute their audited financial statements to their investors from 120 days to 180 days, so that advisers to funds of hedge funds may comply with the rule. 2. Objectives and Legal BasisThe objective of the proposed amendment to rule 206(4)-2 is to make the rule requirements easier to comply with for advisers to private funds of funds such as funds of hedge funds. Section IX of this Release lists the statutory authority for the proposed amendment. 3. Small Entities Subject to RuleThe Commission estimates that as of June 30, 2004,222 approximately 490 SEC-registered investment advisers that would be affected by the amendment to the rule were small entities for purposes of the Advisers Act and the Regulatory Flexibility Act.223 4. Reporting, Record-keeping, and Other Compliance RequirementsThe proposed amendment would impose no new reporting, record-keeping or other compliance requirements. To the contrary, the proposed amendment would provide all advisers, big or small, that advise pooled investment vehicles with the opportunity to reduce the burdens they incur complying with the present rule's requirements to send pools' audited financial statements to their investors within 120 days. 5. Duplicative, Overlapping, or Conflicting Federal RulesThe Commission believes that there are no rules that duplicate, overlap, or conflict with the proposed amendment. 6. Significant AlternativesThe Regulatory Flexibility Act directs the Commission to consider significant alternatives that would accomplish the stated objective, while minimizing any significant adverse impact on small entities. In connection with the proposed rule, the Commission considered the following alternatives: (a) the establishment of differing compliance or reporting requirements or timetables that take into account the resources available to small entities; (b) the clarification, consolidation, or simplification of compliance and reporting requirements under the rule for such small entities; (c) the use of performance rather than design standards; and (d) an exemption from coverage of the amendment for such small entities. The overall impact of the proposed amendment is to decrease regulatory burdens on advisers, and small advisers, as well as large ones, will benefit from the proposed rule. Moreover, the proposed amendment achieves the rule's objectives through alternatives that are already consistent in large part with advisers' current custodial practices. For these reasons, alternatives to the proposed amendment are unlikely to minimize any impact that the proposed rule may have on small entities. The 180-day rule cannot be further clarified, or improved by the use of a performance standard. Regarding exemption from coverage of the rule amendment, or any part thereof, for small entities, such an exemption would deprive small entities of the burden relief provided by the amendment. 7. Solicitation of CommentsWe encourage written comments on matters discussed in this IRFA. Commenters are asked to describe the nature of any effect and provide empirical data supporting the extent of the effect. IX. STATUTORY AUTHORITYWe are proposing amendments to rule 203(b)(3)-1 and proposing rule 203(b)(3)-2 pursuant to our authority under sections 202(a)(17),224 203, 204, 206(4) and 211(a) of the Advisers Act.225 Section 211(a) gives us authority to classify, by rule, persons and matters within our jurisdiction and to prescribe different requirements for different classes of persons, as necessary or appropriate to the exercise of our authority under the Act.226 We are proposing amendments to rule 204-2 pursuant to our authority under sections 204, 206(4), and 211(a) of the Advisers Act. We are proposing amendments to rule 205-3 pursuant to the authority set forth in section 205(e) and 206A of the Advisers Act.227 We are proposing amendments to rule 206(4)-2 pursuant to our authority set forth in sections 206(4) and 211(a) of the Advisers Act. We are proposing amendments to Form ADV under section 19(a) of the Securities Act of 1933,228 sections 23(a) and 28(e)(2) of the Securities Exchange Act of 1934,229 section 319(a) of the Trust Indenture Act of 1939,230 section 38(a) of the Investment Company Act of 1940,231 and sections 203(c)(1), 204, and 211(a) of the Investment Advisers Act of 1940.232 |