As of February 1, those qualifying as US-based ?private fund? advisers must be registered as investment advisers with the Securities Exchange Commission or else risk being subject to serious consequences, such as being barred from doing business. The new registration requirement primarily targets the hedge fund industry, and it was presented in the form of an amendment to the Investment Adviser's Act of 1940 passed by the Securities Exchange Commission at the beginning of last year.
Notable in the new rule – Rule 203(b)(3)-2 – is the exemption of private equity funds from the registration requirements. Private equity funds are excluded from the scope of the new rule through a loophole for funds with ?lock-up? periods for investors' capital commitments of at least two years.
While many hedge funds have already registered, a significant portion of hedge funds are circumventing the registration requirements by setting their own lock-up periods past two years. Traditionally, hedge funds have allowed quarterly or even monthly liquidity. By utilizing the lock-up loophole, hedge funds are not only able to excuse locking-in their investors, but they also save on the administrative costs and efforts necessary for meeting the registration requirements.
Despite the convergence of private equity and hedge funds, most advisors to private investment funds do not expect the SEC to herd private equity funds under the registration umbrella anytime soon.
According to legal experts, the divergent evolution of the hedge fund and private equity fund industries provides regulators with little incentive to expand the registration requirements to cover private equity funds as well. Hedge funds, with low barriers to entry, have more often been found to be fraudulent.
Private equity funds, on the other hand, are not favored by fast money, and tend to be governed by LP agreements that limit what the GPs can or cannot do. Whereas hedge fund managers have the flexibility to switch strategies in a relatively short timeframe, private equity GPs are subject to more restrictions against sudden changes in directions or going against what they had originally promised their LPs.
To date, the SEC has not officially responded to hedge funds escaping through the lock-up loophole. However, once the flurry of processing submitted registrations has abated, the SEC just might take a second look at how to further define the meaning of the term ?hedge fund.?
Government teases UK VCT sector
The UK venture capital trust (VCT) industry has been left on tenterhooks after the Labour Government's Pre-Budget Report on 5 December deferred for three months a decision on whether or not the sector will continue to benefit from a highly prized tax break. The Pre-Budget Report broadly outlines the thrust of the Government's financial plans in advance of more details to follow in the Budget, with the next one due to be delivered by Chancellor Gordon Brown in March 2006. Currently, investments into UK VCTs – which target investments in small, fastgrowing UK businesses – attract a range of tax incentives. Chief among them is 40 percent income tax relief, which was increased from 20 percent for a period of two years with a view to stimulating VCT fundraising – and which is due to expire on 6 April 2006. This is the incentive that the industry hopes above all to retain. In a statement, David Thorp, lead manager of the London-based Baronsmead stable of VCTs, views the deferral as unhealthy, saying: ?The private equity job market is highly competitive and it is important for management groups to have a sense of what the future VCT market will look like lest they need to further expand their teams. They won't know this for sure until the 2006 Budget which will be just weeks before the end of the financial year.? There may, however, be a silver lining to the cloud. Thorp adds that doubt over the future status of the income tax perk means demand should now be strong for VCTs currently raising funds.
FASB comes out swinging for fair value
In November, the Financial Accounting Standards Board issued a statement defining its stance on fair value accounting as a standard of financial reporting. The statement further brings in to sharp relief the contrast between what the accounting policy-setting board requires in reporting, and the hold-at-cost tradition still widely practiced in private equity. One section section of the opinion that may have the most immediate impact on how private equity firms report their holdings concerns stakes in publicly traded companies. Specifically, the FASB made no mention of a policy on ?blockage discounts,? a practice whereby large blocks of publicly traded shares are discounted in a report to acknowledge the ostensible difficulty a seller would have unloading these shares at current market price. In 2000, the FASB disallowed the use of blockage discounts, but allowed parties that had been applying these discounts previously to continue the practice. The recently issued FASB opinion does not mention blockage discounts, and some accounting and legal experts have taken this as a sign that the board takes a dim view of this practice.
BVCA backs greater IP commercialization
According to ?Creating success from university spin-outs,? a British Venture Capital Association report published in November, there is ?clear evidence [in the UK] of positive progress in the relationship between VCs and Technology Transfer Offices (TTOs), i.e. the university departments responsible for identifying, documenting, evaluating, protecting, marketing and licensing new technologies and IP. Fully 60 percent of the venture capitalists participating in the survey said relevant TTO skills were improving. Likewise, all 25 UK TTOs polled found venture capitalists' advice valuable, and close to 70 percent reported improvements in their dealings with VCs. This is despite the fact that TTOs are naturally sensitive about finding the right balance between protecting their IP and getting outside partners involved to develop it commercially
Provided this balance is in place, TTOs are definitely keen to work with venture funds, the study found. The BVCA made a number of suggestions for how UK tax law might be altered and networks enhanced to further facilitate the transfer of technology to the local venture capital industry.