By Victor Murray, May 2012

This is an update on the much-heralded U.S Financial Reform Bill/ Dodd- Frank Bill passed by the Senate on 16th  July 2010 and signed into law on 21st July 2010.  The financial reforms are wide reaching and will impact Cayman Islands hedge fund industry as this is the biggest change to financial supervision in the U.S. since the 1930s. The official name of the legislation is the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Act”). The Act incorporates the “Private Fund Investment Advisers Registration Act of 2010” which implements the revised rules on SEC registration by hedge fund managers and record and reporting requirements. The Act became effective in stages. The various regulatory bodies responsible for implementing the Act were tasked to prepare the detailed rules required to implement its terms.    This is no small feat compared to the overarching scope of the Act and the limited resources of the agencies involved.

In the context of Cayman Islands hedge funds the Act’s impact will be felt in a number of areas discussed below.


The Act generally removed many of the current exemptions from SEC registration relied upon by many hedge fund managers.


U.S. hedge fund managers with assets under management exceeding $150M were required to register as an adviser with the SEC, with the deadline being March 30, 2012. This amendment removes the prior exemption from SEC registration under the Advisers Act for Managers who do not hold themselves out to the public as an investment adviser and they have less than 15 clients (a fund would generally be considered as a “client” under the old rule). According to SEC announcements there are close to 4,000 registrants advising private funds, and 34% of those registrants registering with the SEC since the passing of the Act.


Known as a “Foreign Private Adviser” under the Act, a non-U.S hedge fund manager will be exempt from registration if they have:

1.         no place of business in the U.S.;
2.         less than 15 U.S. clients/ investors in private funds;
3.         does not hold itself out generally to the public in the U.S as an investment adviser;
4.         aggregate assets attributable to U.S clients less than $25M (the SEC may by rule increase this amount).

The Non-U.S. Manager will be required to register with the SEC if they do not meet this criteria.  The SEC reported that 7% of their registered advisors are in a foreign country, with the U.K being the country with the most foreign registrants.


One of the other key exemptions that was provided for in the new registration rules is the “family office exemption”.  A family office is a firm: 1) whose only clients are family clients; 2) is wholly owned by family clients and controlled by family members or family entities; and 3) does not hold itself out to the public as an investment advisor.  There are quite nuanced determinations to be made in in determining if the exemption applies.


An important element of the Act is detailed record keeping requirements for registered investment advisers.


SEC registered hedge fund managers are required to maintain reports and records for each of their funds.    The reports and records will be  subject  to  SEC inspection.  For each fund they will be required to keep details of (1) assets under management; (2) use of leverage; (3) counterparty credit risk exposure; (4) trading and investment positions; (5) valuation policies and trading practices; (6) types of asset; (7) side arrangements or side letters whereby certain private fund investors obtain more favourable rights than other investors.

The SEC will have the power to establish different reporting requirements for different classes of investment advisers according to the type or size of hedge fund they manage. In the offshore context, especially in considering the discharge of directors’ duties, it should be noted the preservation of side letters is now an express part of the SEC record keeping requirements.


The Act amends the Investment Advisers Act to allow the records of persons (not only advisers) having custody or use of the securities, deposits or credits of a client to be the subject of an examination, document request or inspection by the SEC as it considers necessary or appropriate in the public interest or for the protection of investors.  Therefore, this would give the SEC additional powers to request records directly from parties such as banks, brokers or other service providers.


The Act also amended the accredited investor standard with immediate effect.  The change required that the value of a person’s primary residence be excluded when determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1 million.


As a post-script to the Dodd-Frank implementation the JOBS Act requires to the SEC to publish rules relaxing the advertising and public solicitation restrictions under Regulation D, Rule 506 (private placement).  The industry eagerly awaits the form of the rules, which should allow some form of advertising to qualified investors.

Credit for this article should also be given to Anthony Murray, Attorney New York.