Hedge Fund Regulation – Roundup of Recent Developments

Client Advisory

October 26, 2012

With the continuing rollout of important new regulations arising from the 2008 financial crisis and the Dodd-Frank Wall Street Reform and Consumer Protection Act, the enactment of the Jumpstart Our Business Startups Act earlier this year, and proposed new reporting requirements under the Foreign Account Tax Compliance Act, hedge fund managers now are presented with a number of important new and pending regulatory obligations, as well as some new opportunities. Here are the highlights:


On August 29, 2012, the Securities Exchange Commission proposed to amend Regulation D to permit issuers to use general solicitation and advertising in private placements under Rule 506, provided that all purchasers are accredited investors.[1] Private funds almost universally rely on Rule 506 to place their interests with U.S. residents. Congress mandated this rule change in the JOBS Act.

The SEC has declined to specify the steps that an issuer must take in order to determine whether an investor is accredited. Instead, the SEC has proposed that an issuer will comply if the issuer takes objectively reasonable steps to make the determination. 

The comment period for the proposed rule ended on October 5, 2012. The SEC already has missed its deadline under the JOBS Act to issue its final rule. 

The JOBS Act also increased the thresholds for registration under Section 12(g) of the Securities Exchange Act. (This change was effective upon enactment of the JOBS Act and does not require SEC rulemaking.) An issuer that is registered under Section 12(g) generally must publicly file annual, quarterly and current reports with the SEC, among other requirements. Prior to the JOBS Act, larger hedge funds limited the number of investors to 499 to avoid these requirements. Registration now is required only if a company has a class of equity securities held by either (i) 2,000 persons or (ii) 500 persons who are not accredited investors (and, as before, has assets exceeding $10 million). For a hedge fund that relies on Section 3(c)(7) of the Investment Company Act of 1940, this change increased the limit on the number of its investors to 1,999.

Futures Regulation

On February 9, 2012, the Commodity Futures Trading Commission adopted rule amendments that, among other things, rescinded a widely used exemption from registration as a commodity pool operator.[2] The exemption, Regulation 4.13(a)(4), was available with respect to any pool that limited U.S. natural person investors to “qualified purchasers” (or met certain alternative criteria) and met certain other conditions.  The exemption was created in 2003 and a large number of hedge fund managers came to rely on it. By December 31, 2012, each of these fund managers must either (i) transfer out all U.S. investors (and accept no new U.S. investors), (ii) refrain from trading in swaps and exchange-traded futures contracts, (iii) secure an alternative exemption or (iv) register and become fully regulated as a commodity pool operator.

On August 13, 2012, the CFTC issued final rules that, among other things, defined the term “swap.”[3] Swaps, as now defined, include a broad range of financial instruments, that, prior to the Dodd-Frank Act, had been largely unregulated as between eligible contract participants. (For example, an arrangement using one of the International Swap Dealer Association master agreement forms typically is a swap.) As a result of the final rules, the manager of a hedge fund that transacts in swaps generally must register as a commodity pool operator, unless an exemption is available.

The rescission of Regulation 4.13(a)(4) will cause some fund managers to carefully analyze whether and how they may become eligible to rely instead on the exemption provided by Regulation 4.13(a)(3). For that exemption, among other conditions, the fund must limit commodity interests so that, as a proportion of the liquidation value of the fund’s portfolio, after taking into account unrealized gains and losses on such positions, either (a) the initial margin, premiums and security deposits will not exceed 5% or (b) the aggregate net notional value of such positions will not exceed 100%. On August 14, 2012, the CFTC staff issued FAQ guidance[4] that clarified, among other things, that for the purpose of these thresholds, swaps will be “commodity interests” starting December 31, 2012, and this will include all swaps entered into prior to that date.

A second option, for an offshore fund manager of an offshore fund that exclusively trades offshore futures, and limits participation by U.S. residents to no more than 10% of the fund, may be to rely on an exemption provided by CFTC Regulation 30.4(c).

A third option, under Regulation 4.7, provides a partial exemption from some of the more onerous CFTC requirements for commodity pools, but requires the fund manager to register and submit to regulation as a commodity pool operator, and is available only if all U.S. investors in the fund are “qualified eligible participants” (which, for a fund that relies on Investment Company Act Section 3(c)(1), would likely be a significant new investor eligibility restriction), among other requirements. Each “associated person” of a registered commodity pool operator must be registered, and the CFTC and National Futures Association interpret the term “associated person” expansively for this purpose. The CFTC staff and the NFA recently published significant relief that will be relevant for many fund managers that seek to rely on the Regulation 4.7 exemption:

  • As part of the August 14, 2012 FAQs, the CFTC staff clarified that a fund manager that transitions from the Regulation 4.13(a)(4) exemption can assume that existing natural person investors in the fund continue to meet the qualified eligible person standard for purposes of the Regulation 4.7 exemption.
  • On August 22, 2012, the NFA published an amendment to its by-laws that waives the Series 3 examination requirement for an associated person of a CPO that exclusively trades swaps or trades swaps and a de minimis amount of other commodity interests.[5]   
  • On October 11, 2012, the CFTC staff issued a letter stating that it would take no action against a CPO that is required to register by December 31, 2012 solely because of its swaps activities and fails to register by that deadline, provided that the CPO shall have submitted an application to register (and a fingerprint card for each of its associated persons and principals) by that deadline and from and after that deadline makes a good faith effort to comply with the Commodity Exchange Act and the Commission’s regulations applicable to its activities as a CPO.[6] 

A CPO that claims an exemption under Rule 4.13(a)(3) now must affirm the exemption no later than 60 days after each calendar year end (which in 2013 will fall on March 1).

Form PF

On October 31, 2011, the SEC and the CFTC adopted new rules that require, among other things, that registered private fund managers file new Form PF with the SEC.[7] The new rules were mandated by the Dodd-Frank Act and their stated purpose is to enable the Financial Stability Oversight Council to better evaluate the systemic risk posed by private funds and their advisers. 

The new rules specify when a private fund manager must file its initial Form PF, how frequently (quarterly or annually) the manager must file subsequent Forms PF, and the information to be included in a Form PF filing, and these factors vary depending on the size and type of the private fund. Generally the manager of a large hedge fund is required to file its initial Form PF earlier, file subsequent Forms PF more frequently and include a greater range of information in each filing, in each case in comparison to other types of private funds.

A private fund adviser that has less than $5 billion but more than $150 million of assets under management in its private funds must file its first Form PF no later than 60 days after the end of its first fiscal year or quarter on or after Dec. 15, 2012. (For a registered fund manager that has $5 billion or more of AUM in its private funds, the deadline for the first Form PF has passed -- 60 days after the end of their first fiscal year or quarter on or after June 15, 2012.)

The SEC is required to keep the information on Form PF confidential, but the SEC may share the information with other federal agencies and with self-regulatory organizations such as FINRA and the NFA.


On February 8, 2012, the Internal Revenue Service proposed regulations to implement the Foreign Account Tax Compliance Act.[8] FATCA targets income tax noncompliance by U.S. taxpayers holding financial accounts in foreign countries. Foreign financial institutions (“FFIs”), including hedge funds, are essentially coerced into becoming reporting and withholding agents of the IRS. If an FFI has not agreed to perform the required due diligence, U.S. issuers and others will be required to withhold 30% of U.S. source payments to the FFI. To avoid this, an FFI must enter into an FFI agreement with the IRS. Such an agreement will require the FFI to collect information to determine its investors’ US tax status. The procedures vary depending upon the size of the account, and whether the investor is new or “pre-existing.” The new rules require an FFI to ascertain not only direct but also indirect ownership of accounts. A revised Form W-8BEN-E (for use by investors that are foreign entities) has been published in draft form.[9] The FFI is required to report relevant information to the IRS, and also to withhold U.S. tax from payments to “recalcitrant” investors. 

It is clear that this law is not going away, as some have hoped. The U.S. has been in discussions with several European governments to utilize agreed standard procedures for FFIs in those countries, and has reached such an agreement with the United Kingdom. However, many details of the FATCA regime remain to be determined by the IRS in final regulations. Although the IRS still expects to issue final regulations by the end of this year, it has finally heeded concerns expressed by foreign banks that they need both (i) more time to implement the required due diligence procedures and (ii) uniform procedures in all jurisdictions in which they have affiliates. On October 24, the IRS announced a delay in the effective dates of certain aspects of FATCA.[10]

In general, offshore funds should plan to enter into FFI agreements before the end of 2013, and to implement the required due diligence procedures beginning January 1, 2014. Such funds should already be reflecting the requirement to comply with FATCA in their organizational documents and offering materials. This would mean, among other things: (1) disclosure of FATCA-related risks, (2) agreement of investors to provide all needed information, and to waive the benefit of any local bank secrecy laws, and (3) the right of the fund to redeem an investor if desirable under FATCA.

Questions regarding this advisory should be addressed to corporate partner Andris J. Vizbaras (212-238-8698, or tax partner Howard J. Barnet, Jr. (212-238-8606,


[6]CFTC No Action Letter 12-15 (October 11, 2012), available at

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