The 'Foreign Private Adviser' Exemption : A Potential Gap in the New Systemic Risk Regulatory Architecture

Since the collapse of Long-Term Capital Management in 1998, policymakers have generally agreed that hedge funds can add to systemic risk in the U.S. economy. The Dodd-Frank Wall Street Reform and Consumer Protection Act (WSRCPA) aims in part to address this risk by granting regulators the authority to impose prudential requirements on hedge funds. Crucial to the effectiveness of this authority will be the ability of regulators to timely and accurately identify which funds should be subject to such requirements. The WSRCPA requires U.S. hedge fund managers to self-identify the funds they manage by registering with the Securities and Exchange Commission (SEC). In contrast, foreign hedge fund managers whose funds do not include a threshold number of U.S. investors or amount of capital managed on behalf of U.S. investors are not required to register. As a result, to fulfill their statutory responsibility to protect the U.S. economy from systemic risks, regulators will themselves need to identify which foreign funds could pose a risk to the U.S. economy. The scope and quality of public information and the potential unreliability of international cooperation make it unlikely that U.S. regulators can accurately, promptly, and efficiently identify such funds. Exempting foreign hedge fund managers from the registration requirement therefore frustrates the ability of U.S. regulators to manage systemic risk. To fill this gap, managers of foreign hedge funds that meet thresholds for holdings of U.S. assets and obligations to U.S. lenders should be made to register with the SEC. Although the opportunity to narrow the WSRCPA's "foreign private adviser" exemption has passed, an alternative vehicle for bringing about self-identification exists in the SEC's proposed Large Trader Reporting System rule