§ 13.03 Key Implications of Investment Company Act Registration

• Jurisdiction: United States
• Publication year: 2022

§ 13.03 Key Implications of Investment Company Act Registration

[1]—Investment Restrictions Under the Investment Company Act

Registered funds are subject to certain investment-related limitations that are imposed by the Investment Company Act. These include limitations that restrict investments in other registered funds, in securities of issuers engaged in securities-related businesses and in securities of insurance companies. (Section 12(d) of the Investment Company Act and various rules thereunder.) In addition, Section 18 of the Investment Company Act limits the use of leverage by imposing an asset coverage requirement applicable to borrowings and the issuance of "senior securities." Most hedge fund investment programs, other than certain highly leveraged strategies, can operate in compliance with applicable Investment Company Act requirements. However, the use of highly leveraged strategies by registered funds may be feasible if implemented through the use of derivatives.¹²

[2]—Prohibitions on Transactions with Affiliates

The Investment Company Act and the rules thereunder contain various provisions (e.g., Section 17(a) and Rule 17d-1) that generally prohibit any affiliated person of a registered fund, and any affiliated person of such a person, from engaging in any principal transaction, or participating in any joint enterprise or other joint arrangement, with the registered fund.

These provisions need to be considered carefully; particularly, in the context of managing a registered fund of hedge funds. Generally, a hedge fund will be an affiliated person of a registered fund of hedge funds where: (1) the adviser of the registered fund of hedge funds is affiliated with the general partner/adviser of the hedge fund; (2) the registered fund of funds owns 5% or more of the outstanding voting securities of the hedge fund; or (3) funds and other accounts managed by the adviser of the registered fund of hedge funds (including the registered fund) own, in the aggregate, 5% or more of the outstanding voting securities of the hedge fund. (Section 2(a)(3) of the Investment Company Act.)

[3]—"Corporate Governance" Requirements

The Investment Company Act imposes certain governance requirements that require registered funds to have "independent directors" and require that certain matters be approved by these directors (and sometimes also approved by shareholders of the funds).¹³ Generally, independent directors must make up a majority of a registered fund's...