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Connecticut Proposes Conflict-Of-Interest Disclosure Requirements For Managers To Private Investment Funds

Publisher: Day Pitney Alert
March 31, 2010
Day Pitney Author(s) R. Scott Beach

The Banks Committee of the Connecticut General Assembly voted on March 11, 2010, in favor of proposed Substitute Bill No. 5053, An Act Concerning Transparency and Disclosure (the "Bill"). The Bill broadens the scope of legislation proposed earlier this year concerning the regulation of private investment funds within Connecticut. If enacted, the Bill would require investment advisers to private investment funds to comply with certain conflict-of-interest disclosure requirements under federal law, regardless of whether such advisers are registered with the Securities and Exchange Commission.

The Bill would require any investment adviser to a "private investment fund" to comply with the disclosure requirements of Rule 204-3 under the Investment Advisers Act of 1940. Under current federal regulations, investment advisers registered with the SEC are required to provide clients with certain written disclosures regarding conflicts of interest, including, among other things, the adviser's other business activities, financial industry activities and affiliations, and participation or interest in client transactions. If enacted, this legislation would become effective on January 1, 2011. However, if federal regulations or changes to the Investment Advisers Act of 1940 are enacted prior to December 31, 2010, that result in the regulation of investment advisers to private investment funds, such advisers would not be required to comply with the Bill.

The disclosure requirements of the Bill would be applicable to advisers of not just hedge funds but of private investment funds generally. The Bill broadly defines a "private investment fund" to mean any investment company, as defined by Section 3(a)(1) of the Investment Company Act of 1940, that:
  • claims an exemption under Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940;
  • offers exempt securities under the safe harbor provisions in Rule 506 of Regulation D of the Securities Act of 1933;
  • offers or sells securities in Connecticut or is located in Connecticut; and
  • meets any other criteria as may be established in regulations by the Connecticut Banking Commissioner.

As a result, the Bill would cover advisers to various private investment funds, including hedge funds, private equity funds, real estate funds, venture capital funds and others. Previous proposed legislation increased regulation only on advisers to funds located within Connecticut; the Bill extends the disclosure requirements to all advisers of private investment funds that either have an office in Connecticut where employees regularly conduct business on behalf of such funds or that engage in the offer or sale of securities in Connecticut.

At the public hearing held by the Banks Committee on February 25, 2010, Attorney General Blumenthal submitted written testimony with respect to an earlier version of this proposed legislation. He reiterated many of his 2009 statements in support of similar legislative regulation of the hedge fund industry.[1] The Attorney General urged the Committee to "consider requiring adequate, accurate transparency as to how much risk, and in what forms, an investor can anticipate and whether controls exist to assure that risk strategies are followed and internally enforced." Further, the Attorney General suggested that the Committee (1) consider including a provision of an annual schedule of management and brokerage fees paid by funds, (2) require fund managers to make quarterly disclosures as to fund strategy and philosophy, and (3) require disclosure of any side letter that provides for preferential treatment of certain fund investors. However, these suggestions were not incorporated into the Bill. Notably, the Attorney General stated that "[n]ational standards and rules are appropriate" and "[p]otential state action is an impetus for federal initiatives." It would appear that the Banks Committee agrees with the Attorney General's assertion that federal regulation in this area is desirable by providing that if any federal legislation is enacted by year-end, the Bill will not be applicable.

In contrast, opponents of this proposed legislation have argued that existing anti-fraud provisions under federal and state laws that require all investment advisers (regardless of registration status) to fully disclose all material facts to investors, including conflicts of interest, are sufficient, and the passage of the Bill may result in duplicative requirements. Additionally, some have expressed concern that Connecticut's passage of such legislation could deter private investment funds and their advisers from locating their operations in Connecticut.

Day Pitney team members actively monitor legislation that affects our clients and will continue to monitor the progress of the Bill and proposed federal legislation in this area.

The full text of the Bill and the File Copy (containing appended reports from the Offices of Legislative Research and Fiscal Analysis) can be found by clicking on these links:

The full text of the Connecticut Attorney General's testimony can be found by clicking on this link:,%20Atty%20Gen-TMY.PDF

[1] In 2009, the Connecticut Senate passed a similar proposal, but that legislation ultimately died as the Connecticut House failed to act on that legislation prior to the end of the Connecticut General Assembly's 2009 legislative session.