Wednesday, February 09, 2005

 

Loopholes to SEC HF RIA Reg (II 2/9/05)

February 9, 2005
Lawyers Spot Loopholes To Hedge Fund Registration

Hedge funds torn with the unappetizing choice of registering with the Securities and Exchange Commission by February 2006 or talking their clients into a two-year lockup are casting around for other loopholes. While it's unlikely most hedge funds will go to such lengths, Section 3 of the Investment Company Act of 1940 contains 12 exemptions besides the lock-up period that could offer an escape hatch. Some lawyers are also looking at the way the 40 Act defines "investment company" to see if this, too, can offer a way out.

One alternative is Section 3-c3, which exempts banks and insurance company pooled funds from SEC regulation. There are some lawyers who wonder why any hedge fund firm could not just adopt the guise of an insurance company in one of several states that regulate insurance very lightly. Robert Rosenblum, partner in Kirkpatrick & Lockhart, thinks that view is simplistic. But he does believe a large financial conglomerate, which already happens to own a bank or insurance company, could set up a common trust fund to function as a hedge fund.

The 1940 Act definition of what is an "investment company" subject to registration also raises possibilities. The SEC takes the position that futures are not securities so a hedge fund trading solely in futures would not be covered by either 40 Act registration or the new IAA rule. It would even be possible to put some portion of the portfolio into the spot market, since a company may trade in securities up to 40% of assets without being a registered investment company. Hedge funds concentrating on mortgages or taking title to real estate could use another exemption, Section 3-c5.


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