UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION 

WASHINGTON. D.C. 20549 

DIVISION OF 

INVESTMENT MANAGEMENT 

August 10,2006 

Paul N. Roth, Chair, Subcommittee on Private Investment Entities 

American Bar Association 

Section of Business Law 

321 N. Clark Street 

Chicago, Illinois 606 10-4714 

Jeffrey E. Tabak, Vice Chair, Subcommittee on Private Investment Entities 

American Bar Association 

Section of Business Law 

321 N. Clark Street 

Chicago, Illinois 606 10-47 14 

Dear Messrs. Roth and Tabak: 

This is in response to your letter of July 3 1,2006 requesting our views on matters 

affecting investment advisers to certain private investment funds ("hedge fund advisers") 

that arise as a result of the decision of the United States Court of Appeals for the District 

of Columbia Circuit in Goldstein v. SEC (the "Goldstein opinion" or "Goldstein 

decision").' In the Goldstein decision, the Court of Appeals vacated rule 203(b)(3)-2 

under the Investment Advisers Act of 1940 ("Advisers Act" or "Act") as well as other 

related rule amendments. The Commission adopted the rule and the amendments in 2004 

in Investment Advisers Act Release No. 2333 (Dec. 2,2004) (the "Adopting Release"). 

The principal design of rule 203(b)(3)-2 was to require additional hedge fund advisers to 

register with the Commission under the Advisers Act. 

The issues you present arise because of the breadth of the Goldstein decision 

which, as you note, appears to vacate the entire rulemaking. As a result, the court may 

have vacated not only those provisions of the Commission rulemaking that required 

hedge fund advisers to treat hedge fund investors as "clients" for purposes of determining 

the availability of the exemption fiom registration under section 203(b)(3) of the Act, but 

1 Goldstein v. Securities and Exchange Commission, No. 04-1434,2006(D.C. Cir. June 

23,2006). 
Messrs. Roth and Tabak 

August 10,2006 

Page 2 

also other rules, interpretations, and transitional provisions designed to facilitate the 

ability of newly registered hedge fund advisers to conduct their operations in accordance 

with the Advisers Act and Commission rules. 

The statements in this letter represent the views of the Division of Investment 

Management. To the extent that we indicate in this letter that we would not recommend 

enforcement action to the Commission based on the facts and circumstances in your 

letter, our response expresses the Division's position on enforcement only and does not 

purport to express any legal conclusion on the issues presented. Because any such 

position is based on the facts and representations in your letter, you should note that any 

different facts and circumstances may require a different conclusion. 

Investment Advisers That Remain Registered 

A. Offshore Investment Advisers to Offshore Funds 

Question: In order to limit the extraterritorial application of the Act that would 

otherwise result from the new rule, rule 203(b)(3)-2(c) provided that an adviser having a 

principal office and place of business outside the United States (an "offshore adviser") 

may treat a private fund organized and incorporated in a country other than the United 

States (an "offshore fund") as its "client" for all purposes under the Advisers Act other 

than sections 203,204, and 206(1) and (2). Because the Commission does not apply 

most of the substantive provisions of the Act to a non-U.S. client, the substantive 

provisions of the Act generally would not apply to the offshore adviser's dealings with 

the offshore fund.2 Your letter requests confirmation that, except as outlined in the 

Adopting Release, offshore advisers that remain registered as investment advisers with 

the Commission will not be subject to the substantive provisions of the Act with respect 

to offshore private funds (or other non-U.S. clients). 

Answer: We agree that, under principles laid out in prior staff guidance and letters, the 

substantive provisions of the Act do not apply to offshore advisers with respect to such 

advisers' dealings with offshore funds and other offshore clients to the extent described 

in those letters and the Adopting Release. An offshore adviser registered with the 

Commission under the Advisers Act must, of course, comply with all of the Act and the 

Commission's rules thereunder with respect to any U.S. clients (and any prospective U.S. 

clients) it may have. 

B. Records Supporting Performance Information 

Question: Rule 204-2(a)(16) requires a registered investment adviser that makes use of 

performance information to keep certain records that "form the basis for or demonstrate 

the calculation of the performance or rate of return." In connection with the adoption of 

See, e.g., Uniao de Bancos de Brasileiros S.A., SEC Staff No-Action Letter (July 28, 

1992); Adopting Release, Section II.D.4.c. 

2 
Messrs. Roth and Tabak 

August 10,2006 

Page 3 

rule 203(b)(3)-2, the Commission amended rule 204-2 to add a new paragraph (e)(3)(ii), 

which created a limited "transition" exception for advisers to private funds. Under this 

exception, certain advisers to private funds were not required to maintain books and 

records meeting the requirements of rule 204-2(a)(16) to support the performance of any 

private fund or other account for any period ended prior to February 10,2005. The rule 

was designed to accommodate newly registered hedge fund advisers that may not have 

kept records meeting the requirements of the rule and to prevent them from being at a 

competitive disadvantage as a result of their inability to use their performance records if 

they had not maintained records sufficient to meet the requirements of rule 204-2(a)(16). 

You ask us to interpret paragraph (a)(16) of rule 204-2 as not applying to an investment 

adviser to a private fund on the same terms and conditions that were set forth in the 

vacated rule. 

Answer: The staff would not recommend enforcement action to the Commission under 

section 204 of the Act or rule 204-2(a)(16) if an investment adviser that registered as a 

result of the Commission's adoption of rule 203(b)(3)-2 does not maintain or preserve the 

books and records required by rule 204-2(a)(16), provided the adviser meets the terms 

and conditions of vacated rule 204-2(e)(3)(ii). 

C. Performance-Based Compensation Arrangements 

Question: Section 205(a)(l) of the Advisers Act prohibits advisers from receiving 

compensation on the basis of a share of a client's capital gain or appreciation 

("performance-based compensation"). Rule 205-3 under the Advisers Act provides an 

exemption from this prohibition with respect to persons that are "qualified clients" as 

defined in the rule. The Commission amended rule 205-3 to add new paragraphs (c)(2) 

and (3), which allowed investment advisers to private funds that registered with the 

Commission as a result of the adoption of rule 203(b)(3)-2 to continue receiving 

performance-based compensation from private funds with non-qualified investors and 

from other clients who are not "qualified clients" if those persons became equity 

investors in the private fund or entered into investment advisory contracts with the 

adviser before February 10,2005, the effective date of the amendments to rule 205-3. As 

you point out, without this amendment, newly registered hedge fund advisers that remain 

registered with the Commission may be required to terminate certain existing advisory 

contracts and fee arrangements that provide for performance-based compensation. You 

therefore request the staff to interpret the exemption provided by rule 205-3 as being 

available to certain hedge fund advisers notwithstanding their receipt of performancebased compensation fiom certain persons who are not qualified clients under the rule. 

Answer: The staff would not recommend enforcement action to the Commission under 

section 205(a)(l) of the Act against a hedge fund adviser registered with the Commission 

that receives performance-based compensation if and to the extent that the adviser would 

have been exempt fiom the prohibition on receiving such compensation under vacated 

rule 205-3(c)(2) or (3). 
Messrs. Roth and Tabak 

August 10,2006 

Page 4 

D. Custody Rule 

Question: Rule 206(4)-2 under the Advisers Act specifies certain procedures that must 

be followed by registered advisers that have custody of client funds or securities. Among 

other things, the rule requires that quarterly account statements be provided to advisory 

clients, and if the account statements are provided by the adviser, the adviser must engage 

an independent public accountant to annually verify all client funds and securities. In the 

case of a client that is a limited partnership (or other type of pooled investment vehicle), 

the quarterly account statements must be sent to all limited partners (or members or other 

beneficial owners). The rule provides an exception from these requirements for a pooled 

investment vehicle ("fund") if it is subject to an annual audit of its financial statements 

prepared in accordance with generally accepted accounting principles and the audited 

financial statements are distributed to all limited partners (or members or other beneficial 

owners) of the fund within 120 days of the end of the fund's fiscal year (the "annual audit 

e~ce~tion").~ 

When it adopted rule 203(b)(3)-2, the Commission also amended rule 206(4)-2 to 

extend the deadline from 120 to 180 days following a fiscal year end for delivery of 

audited financial statements of a ''fund of funds" as defined in the rule.4 As you point 

out, the amendment was designed to address the practical difficulties faced by advisers to 

funds of funds in obtaining completion of their final fund audits prior to completion of 

the audits for the underlying funds in which they in~est.~ You request that the staff 

interpret rule 206(4)-2 to permit an adviser to a fund of funds relying on the annual audit 

exception to distribute the required audited financial statements to investors in the fund of 

funds within 180 days following the end of the fund of fund's fiscal year. 

Answer: The staff would not recommend enforcement action to the Commission under 

section 206(4) of the Act or rule 206(4)-2 against an adviser to a fund of funds (as such 

term was defined in vacated rule 206(4)-2(c)(4)) relying on the "annual audit exception" 

of rule 206(4)-2 if the audited financial statements of the fund of funds are distributed to 

investors in the fund of funds within 180 days of the fund of fund's fiscal year end. 

3 Rule 206(4)-2(b)(3). 

4 A "fund of funds" was defined as a "limited partnership (or limited liability company, or 

another type of pooled investment vehicle) that invests 10 percent or more of its total 

assets in other pooled investment vehicles that are not, and are not advised by, a related 

person (as defined in Form ADV (17 CFR 279. I)), of the limited partnership, its general 

partner, or its adviser." 

5 See Section 1I.Hof Registration Under the Advisers Act of Certain Hedge Fund Advisers, 

Investment Advisers Act Release No. 2266 (July 20,2004). 
Messrs. Roth and Tabak 

August 10,2006 

Page 5 

Investment Advisers That Withdraw Their Registrations 

A. Continued Availability of Section 203(b)(3) 

Question: Before registering with the Commission, many hedge fund advisers relied on 

section 203@)(3) of the Act, which provides an exemption from registration for any 

investment adviser who during the course of the preceding twelve months has had fewer 

than fifteen clients and who does not hold himself out generally to the public as an 

investment adviser. During the period it has been registered with the Commission, a 

hedge fund investment adviser may have held itself out generally to the public as an 

investment adviser, or taken on additional clients so that it has had more than 14 clients 

(counting each private fund as a single client). You request that we confirm that such an 

adviser could withdraw from registration by a certain date and still be able to rely on 

section 203(b)(3) if it ceases holding itself out as an investment adviser and reduces the 

number of clients it has to fourteen or fewer by the date it withdraws. In order to give a 

hedge fund adviser time to determine whether it wishes to remain registered with the 

Commission, you suggest that advisers to private funds be able to rely on this staff 

position if they withdraw from registration by February 1,2007. 

Answer: The staff would not recommend enforcement action to the Commission under 

section 203(a) of the Act against a hedge fund adviser that registered as a result of the 

Commission's adoption of rule 203@)(3)-2 and that withdraws fiom registration in 

reliance on the exemption from registration provided by section 203(b)(3) without regard 

to whether the adviser (i) held itself out generally to the public while it was registered, 

and/or (ii) had more than fourteen clients while it was registered (counting each private 

fund as a single client). An adviser relying on this staff position must withdraw its 

registration with the Commission by no later than February 1,2007. For the first 12 

months following withdrawal from Commission registration, the adviser may, for 

purposes of assessing its eligibility for the 203(b)(3) exemption, determine the number of 

clients it has had (and thus the availability of the section 203(b)(3) exemption) by 

reference to a period of time beginning on the date of withdrawal, which may be a period 

of less than 12 months. 

B. Form ADV-W Balance Sheet Requirement 

Question: An investment adviser must file Form ADV-W to withdraw its registration 

under the Advisers ~ct.~ Form ADV-W is filed electronically through the Investment 

Adviser Registration Depository (IARD). Item 7 of Form ADV-W requires an adviser to 

complete a balance sheet prepared in accordance with generally accepted accounting 

principles if the adviser responds affirmatively to one of the items on Form ADV-W 

Rule 203-2. 6 
Messrs. Roth and Tabak 

August 10,2006 

Page 6 

involving custody, money owed to clients, or judgments and liens.7 Most hedge fund 

advisers have custody of client assets, but are no longer required to file a balance sheet 

with the Commission in connection with their annual update of their Form ADV 

registration form.' You state that as a matter of fairness, we should not require a balance 

sheet as a condition of withdrawing from Commission registration. 

Answer: We would not recommend enforcement action to the Commission if a hedge 

fund adviser that registered as a result of the Commission's adoption of rule 203(b)(3)-2 

and that withdraws from registration with the Commission in reliance on the exemption 

from registration provided by section 203(b)(3) (counting each private fund as a single 

client) by February 1,2007 does not provide the information required in a balance sheet 

on Form ADV-W, Schedule W2 as a result of a "yes" answer to Item 3 of Form ADV-W. 

Investment advisers that have a "yes" answer to Item 3 and that wish to rely on this relief 

must complete a Schedule W2 but may enter "0"for all entries on Schedule W2. 

Other Matters Not Raised by Letter 

We are also taking this opportunity to address two other matters not raised by your letter, 

but which we believe will be of interest to hedge fund advisers. 

A. Form ADV 

Question: In connection with the adoption of rule 203(b)(3)-2, the Commission made 

several changes to Part 1A of Form ADV and Schedule D, which require advisers to 

identify and provide certain information on the "private funds" they advise. The 

Goldstein decision appears to vacate these changes and, as a result, Form ADV will 

revert to the version of the form that was in effect immediately prior to adoption of the 

rule. How should a registered investment adviser or an applicant for registration 

complete Form ADV? 

Answer: Due to system and programming constraints, Form ADV as it appears on the 

IARD will continue to reflect these form changes. The Commission has directed our 

contractor to make the necessary changes to IARD programming. The staff will post, on 

the Commission's website at htt_p://www.sec.~ov/divisions/investment/iard.shtml, 

additional guidance on how SEC-registered advisers may complete Form ADV until 

these changes are implemented on the IARD. 

7 
 The items relating to custody, money owed to clients, and judgments and liens are Items 

3,4, and 6, respectively, of Form ADV-W; the balance sheet must be provided on 

Schedule W2 to Form ADV-W. 

8 See Section I1.E. of Custody of Funds or Securities of Clients by Investment Advisers, 

Investment Advisers Act Release No. 2176 (Sept. 25,2003) (amending Form ADV to 

eliminate the requirement that advisers with custody include an audited balance sheet in 

their brochures to clients). 
Messrs. Roth and Tabak 

August 10,2006 

Page 7 

B. Access to Records 

Question: When it adopted rule 203(b)(3)-2, the Commission also adopted an 

amendment to rule 204-2 that provided that the records of a private fund are records of 

the adviser (and thus subject to examination by the Commission staff), if the adviser or 

any related person acts as the private fund's general partner, managing member, or in a 

comparable capacity. Must registered hedge fund advisers provide these records to the 

Commission's examiners now that the rules have been vacated? 

Answer: A registered investment adviser must make records available for examination 

in accordance with section 204 of the Act. The adviser may not evade this requirement 

by holding records by or through any other person, including a related person or private 

fund. 

Sincerely, 

Robert E. Plaze 

Associate Director 
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website: www.ababusinesslaw.org 

July 3 1,2006 

Robert E. Plaze 

Associate Director 

Division of Investment Management 

Securities and Exchange commission 

100F Street, NE 

Washington, DC 20549 

Re: Interpretive Issues Raised by Goldstein v. SEC 

Dear Mr. Plaze: 

This letter is submitted by the undersigned Chair and Vice Chair of the 

Subcommittee on Private Investment Entities (the "Subcommittee") of the 

Committee on Federal Regulation of Securities (the "Committee"), Section of 

Business Law (the "Section") of the American Bar Association (the "ABA") to 

request that the staff (the "Staff") of the Securities and Exchange Commission (the 

"Commission") address various interpretive issues affecting certain investment 

advisers of private investment funds ("hedge fund advisers") that arise as a result of 

the decision of the United States Court of Appeals for the District of Columbia 

Circuit (the "DC Circuit") in Goldstein v. Securities and Exchange Commission (the 

"Goldstein opinion").' In the Goldstein Opinion, the DC Circuit vacated the 

regulatory framework for hedge fund advisers established by the Commission 

through its adoption of Rule 203(b)(3)-2 and amendment of Rule 203(b)(3)-1, and 

its amendment of other rules that had the effect of requiring many such advisers to 

register with the Commission as investment advisers under the Investment Advisers 

Act of 1940 (the "Advisers ~ct").~ 

We are requesting that the Staff address the interpretive issues that arise as a 

result of the Goldstein Opinion that are set forth below. These issues, and 

' Goldstein v. Sec. and Exch. Comm'n, NO. 04-1434 (D.C. Cir. June 23,2006). 

'See Registration Under the Advisers Act of Certain Hedge Fund Advisers; Final Rule, 69 Fed. Reg. 

72,054 (Dec 10,2004) (to be codified at 17 C.F.R. pts. 275,279). 
comments and suggestions contained herein, were identified by certain 

S ubcommi ttee members. 

The comments expressed in this letter have not been approved by the House 

of Delegates or Board of Governors of the ABA and, therefore, do not represent the 

official position of the ABA. In addition, this letter does not represent the official 

position of the Section (or any other ABA Section), the Committee or the 

Subcommittee, and does not necessarily reflect the views of the Subcommittee 

members who have reviewed it. 

We respectfully request the Staffs guidance and positions with respect to the 

matters discussed herein prior to the first date as of which the DC Circuit's order 

may take effect.' We note that in testimony before the U.S. Senate Committee on 

Banking, Housing and Urban Affairs, on July 25, 2006, Chairman Cox stated that he 

has directed the Staff to take action to ensure that the transitional and exemptive 

rules adopted in Release No. IA-2333, Registration Under the Advisers Act of 

Certain Hed e Fund Advisers (the "Adopting ele ease")^, are restored to their full 

legal effect. !By responding to this request, the Staff can provide immediate 

assurance to the advisory community prior to any proposal and adoption of new 

rules or rule amendments by the Commission relating to these matters. Without 

clear guidance from the Staff, hedge fund advisers will face an uncertain regulatory 

environment. 

I. Implications of the Goldstein Opinion 

In pertinent part, Section 203(b)(3) of the Advisers Act exempts from 

registration any investment adviser who, during the preceding 12 months, has had 

fewer than 15 "clients" and who neither holds itself out generally to the public as an 

investment adviser nor acts as investment adviser to an investment company 

registered under the Investment Company Act of 1940 (the "Company Act") or a 

company that has elected to be regulated as a business development company 

pursuant to Section 54 of the Company Act and has not withdrawn its election (a 

"BDC").~ an^ hedge fund advisers have historically relied on this Section, and on 

-

Under the Circuit Rules of the DC Circuit, the DC Circuit "ordinarily will include as part of its 

disposition an instruction that the clerk withhold issuance of the mandate until the expiration of the 

time for filing a petition for rehearing or a petition for rehear~ng en banc and, if such petition is 

timely filed, until 7 calendar days after disposition thereof." Circuit Court Rule 41. The instruction 

to the clerk that fo1lowed the Goldstein Opinion addressed only the situation where a petition was 

filed and disposed of by the DC Circuit, but was silent as to when the mandate would issue in the 

event that the Commission did not seek to petition for rehearing. Assuming that Circuit Court Rule 

4 1 governs the issuance of the mandate in the absence of specific language in the order, then the 

mandate will issue on August 7, 2006, which is the date that the Commission's time to file a petition 

for rehearing or rehearing en banc expires. 

4 Supra, note 2. 

5 Regulation of Hedge Funds: Hearing Before the S. Comm. On Banking, Housing and Urban 

Afairs, 109th Cong. (2006) (statement of Christopher Cox, Chairman, Sec. & Exch. Comm'n). 

15 U.S.C. 5 80(b)-3(b)(3) (1997). 
Rule 203(b)(3)-1 under the Advisers Act (as in effect prior to its recent amendment 

by the Commission), so as to be exempt from the requirement of registration under 

the Advisers Act. The Commission's action (with a compliance date of February 1, 

2006) adopting Rule 203(b)(3)-2 and amending Rule 203(b)(3)-1 caused many 

hedge fund advisers to register as investment advisers by requiring advisers of 

"private funds," as defined by paragraph (d) of amended Rule 203(b)(3)-1, to count 

shareholders, limited partners and other owners of private funds as clients for 

purposes of the fewer than 15 client limitation set forth in Section 203(b)(3).~ 

In the Goldstein Opinion, the DC Circuit held that the Commission lacked 

the authority to adopt rules requiring hedge fund advisers to count investors in 

private funds as clients for purposes of Section 203(b)(3) of the Advisers Act and 

rejected the Commission's "equation of the term 'client' with 'inve~tor."'~ The 

Goldstein Opinion vacated the "Hedge Fund Rule," a term that the DC Circuit 

indirectly defined to mean the entire Adopting el ease.^ Thus, the Goldstein 

Opinion can be viewed not only as vacating the adoption of Rule 203(b)(3)-2 and 

the amendment of Rule 203(b)(3)-1, but also as vacating various other actions and 

interpretations taken by the Commission in the Adopting Release, which were 

intended, in large part, to facilitate the ability of newly registered hedge fund 

advisers to conduct their operations in accordance with the Advisers Act and the 

rules thereunder. 

The Goldstein Opinion raises issues for hedge fund advisers that registered 

with the Commission as a result of the Hedge Fund Rule and will remain registered 

as investment advisers, as well as for those hedge fund advisers that may wish to 

withdraw from registration as a result of the Goldstein Opinion. 

11. Issues Affecting Hedge Fund Advisers That Remain Registered 

Although many hedge fund advisers will no longer be required to be 

registered as investment advisers as a result of the Goldstein Opinion, it is likely 

that certain hedge fund advisers will nonetheless choose to remain registered. To 

address the needs of these advisers, and to avoid creating incentives for such 

advisers to withdraw their registrations, we believe the Staff should make available 

the relief from certain requirements of the Advisers Act and the rules thereunder 

that would have been available but for the Goldstein Opinion. 

" 17 C.F.R. 5 275.203(b)(3)- l(d) (2006). 

Goldstein, at 2. 

"This is a petition for review of the Securities and Exchange Commission's regulation of 'hedge 

funds' under the Investment Advisers Act of 1940, 15 U.S.C. $ 80b-I er seq. See Registration Under 

the Advisers Act of Certain Hedge Fund Advisers, 69 Fed Reg. 72,054 (Dec. 10, 2004) (codified at 

17 C.F.R. Pts. 275,279)("Hedge Fund Rule")." Coldstein, at 2. 
A. Offshore Advisers. 

In adopting Rule 203(b)(3)-2(c) under the Advisers Act, consistent with 

existing Staff positions relating to the exterritorial application of the Advisers ~ct," 

the Commission made clear that an adviser having a principal office and place of 

business outside the U.S. (an "offshore adviser") and advising a private fund 

organized or incorporated under the laws of a country other than the U.S. (an 

"offshore fund") would not be subject to the substantive provisions of the Advisers 

Act with respect to the offshore fund, but only to the client-counting and antifraud 

provisions of the Act." As adopted, the Rule reads "If you have your principal 

office and place of business outside of the United States, you may treat [an offshore 

fund] as your client for all purposes under the [Advisers] Act, other than Sections 

203,204,206(1) and 206(2)."12 

As contemplated by the Commission, although an offshore adviser would 

have been required to register as an investment adviser as a consequence of the 

amendment of Rule 203(b)(3)- 1 (the rule requiring that investors in private funds be 

counted in determining whether an adviser had fewer than 15 clients and in 

determining the number of U.S. resident clients of an offshore adviser), it would not 

have been required to comply with many of the rules adopted under the Advisers 

Act, assuming it had no U.S. clients other than for counting purposes under Rule 

203(b)(3)-1.l3 Moreover, in the Adopting Release the Commission stated that: 

"Because we do not apply most of the substantive provisions of the [Advisers] Act 

to non-U.S. clients of an offshore adviser, and because an offshore fund would be a 

non-U.S. client, the substantive provisions of the [Advisers] Act generally would 

not apply to the adviser's dealings with the offshore fund."'" 

Even though the Goldstein Opinion vacated the Hedge Fund Rule and, 

therefore, may be deemed to have vacated the interpretive positions of the 

Commission set forth in the Adopting Release relating to the application of the 

Advisers Act to offshore advisers of offshore funds, an offshore adviser required to 

register solely because of Rule 203(b)-1 and wishing to remain registered with the 

Commission may no longer be able to rely on those positions. As a result, because 

lo Uniao de Buncos de Brasilerios S.A., avalable July 28, 1992. 

I' Registration Under the Advisers Act of Certain Hedge Fund Advisers; Proposed Rule, 69 Fed. 

Reg. 45 172, at 45 184 (Jul. 28,2004) (to be codified at 17 C.F.R. pts. 275,279) ("[Wle propose to 

permit an offshore adviser to an offshore fund to treat the fund as its client (and not the investors) for 

all purposes under the Act, other than (i) determining the availability of the private adviser 

exemption (section 203(b)(3)), and (ii) those provisions prohibiting fraud (sections 206(1) and 

206(2)) [footnotes omitted].") 

l2 17 C.F.R. 8 275.203(b)(3)-2(c) (2006). 

13 For example, the following rules under the Advisers Act would not have applied to such advisers: 

(i) the compliance rule (I7 C.F.R. 8 275.206(4)-7 (2006)); (ii) the custody rule (1 7 C.F.R. 

8 275.206(4)-2 (2006)); and (iii) the proxy voting rule (17 C.F.R. $ 275.206(4)-6 (2006)). See 

generally, Adopting Release, at 72072-72073. 

'%dopting Release, text at notes 2 1 1 to 2 13 [footnotes omitted]. 
certain of such offshore fund advisers will in all likelihood remain registered with 

the Commission as investment advisers, we believe it appropriate for the Staff to 

reconfirm that, except as outlined in the Adopting Release, such offshore advisers 

will not be subject to the substantive provisions of the Advisers Act with respect to 

offshore funds or offshore clients.I5 We believe that this position would be 

consistent with the approach generally taken in prior Staff positions relating to the 

application of the Advisers Act to offshore advisers.16 

B. Records Su~porting Performance Information. 

Generally, paragraph (a)(16) of Rule 204-2 under the Advisers Act requires 

a registered investment adviser to maintain certain specified records that form the 

basis for or demonstrate the calculation of performance information used by the 

adviser in advertising and similar materials.I7 In the Adopting Release, the 

Commission amended Rule 204-2 to create a limited "transition" exception from 

this requirement for investment advisers to private funds. Under this exception, an 

adviser to a private fund was not required to maintain books and records pertaining 

to the investment performance of any private fund or other account for any period 

ended prior to February 10, 2005.'~ This rule amendment was intended to facilitate 

the ability of an adviser to a private fund to continue to use performance information 

for periods prior to its registration with the Commission despite lacking for the preregistration period all of the records needed to comply with Paragraph (a)(6) of Rule 

204-2. 

By vacating the Hedge Fund Rule, the Goldstein Opinion may be deemed to 

have vacated the amendment to Rule 204-2. Such a result will adversely affect 

hedge fund advisers that registered as investment advisers with the Commission in 

reliance upon the adoption of the amendment to Rule 203(b)(3)-1 because it may 

prohibit certain of these advisers from using performance information for periods 

ended prior to their registration under the Advisers Act. The exception to Rule 204- 

2 that the Commission sought to make available to advisers of private funds may 

well have factored into a hedge fund adviser's decision to register rather than to 

adopt another strategy to deal with the impending registration requirement. Not 

permitting hedge fund advisers this transitional relief is inconsistent with public 

policy because it creates an incentive for them to withdraw their registrations. For 

these reasons, we request that the Staff interpret paragraph (a)(16) of Rule 204-2 as 

inapplicable to an adviser of a private fund that makes use of investment 

l5 Nothing in the text is intended to affect the Staffs guidance regarding the recordkeeping 

obligations of registered advisers that are located offshore. See Adopting Release, notes 215, 216 

and surrounding text. 

l6 See supm, note 9. See also Royal Bank of Canada, available June 3, 1998. 

" 17 C.F.R. Q 275.204-2(a)(16) (2006). 

'*This relief was to be given provided that the adviser was not registered with the Commission as an 

investment adviser during that period and that the adviser continues to preserve any books and 

records in its possession pertaining to investment performance during the period. 
performance for any private fund or other account for any period ended prior to 

February 10, 2005, provided that the adviser was not registered with the 

Commission as an investment adviser during that period and continues to preserve 

any books and records in its possession that pertain to investment performance of 

such fund or other account during the period. 

C. Performance-Based Compensation Arrangements. 

With certain exceptions, Section 205(a)(l) of the Advisers Act prohibits 

advisory contracts that provide for compensation to a registered investment adviser 

on the basis of a share of capital gains upon or capital appreciation of the funds of a 

client ("performance-based c~mpensation").'~ Rule 205-3 under the Advisers Act 

provides an exemption from this prohibition under which a registered investment 

adviser may generally receive performance-based compensation from a person that 

is a "qualified client," as defined by the ~ule." 

In the Adopting Release, the Commission amended Rule 205-3 to 

"grandfather" existing advisory arrangements of hedge fund advisers that were 

required to register as a result of the amendment of Rule 203(b)(3)-1.~l The 

grandfather clause would allow such advisers to continue receiving performancebased cornpensation from persons that are not qualified clients. Without such an 

amendment, many hedge fund advisers registering with the Commission would have 

been required to revise or terminate advisory contracts and fee arrangements that 

provided for performance-based compensation. 

The Goldstein Opinion may be deemed to have vacated this amendment of 

Rule 205-3 to the extent that the DC Circuit vacated the Hedge Fund Rule. Such a 

result will adversely affect hedge fund advisers that were required to register as 

investment advisers with the Commission because of the adoption of the 

amendment to Rule 203(b)(3)-1 and would create an incentive for hedge fund 

advisers to withdraw their registrations so as not to be forced to revise or terminate 

contractual arrangements involving performance-based compensation. Accordingly, 

we request that the Staff interpret Rule 205-3 as inapplicable to an adviser of a 

private fund that receives performance-based compensation from a person that is not 

a "qualified client," as defined in Rule 205-3(d)(l), provided that: (i) the 

arrangements with such person were in effect prior to February 10, 2005; and (ii) 

the adviser was exempt from registration pursuant to Section 203(b)(3) of the 

Advisers Act prior to February 1,2006. 

l9 15 U.S.C. Ej 80(b)-5(a)(lj (1 997). 

20 The term "qualified client" is defined in paragraph (d)(l) of Rule 205-3. 

2' 17 C.F.R. Ej 275.205-3(c)(l),(c)(2) (2006). 
D. Custody Rule. 

In the Adopting Release, the Commission also amended Rule 206(4)-2 under 

the Advisers Act. That Rule specifies certain procedures that must be followed by 

registered investment advisers having custody of client funds or securities. 

Paragraph (a)(3) of the Rule generally requires that a client be provided with either: 

(i) quarterly account statements by a qualified custodian identifying the amount of 

funds and of each security in its account and setting forth all transactions in its 

account; or (ii) a similar quarterly account statement by the adviser and, in the latter 

case, that an independent public accountant verify all funds and securities by 

conducting an examination once each year at a time chosen by the accountant 

without prior notice to the adviser and provide notice to the Commission of material 

discrepancies.22 Tn the case of a client that is a limited partnership (or other type of 

pooled investment vehicle), the quarterly account statements must be sent to each 

limited partner (or member or other beneficial ~wner).'~ Paragraph (b)(3) of Rule 

206(4)-2 provides an exception from these requirements for limited partnerships and 

other pooled investment vehicles if there is an annual audit of their financial 

statements prepared in accordance with generally accepted accounting principles 

and such financial statements are distributed to all limited partners (or members or 

other beneficial owners) within a specified period following the end of the fund's 

fiscal year.24 

The amendment of Rule 206(4)-2 extended the deadline for delivery of 

audited financial statements to investors from 120 to 180 days following fiscal year 

end for a "fund of funds" as defined by the Rule. A "fund of funds" was defined by 

paragraph (b)(3) to mean a limited partnership, limited liability company or other 

type of pooled investment vehicle, that invests 10 percent or more of its total assets 

in other pooled investment vehicles that are not, and are not advised by, a "related 

person," as defined in Form ADV, of the limited partnership or other pooled vehicle, 

its general partners or its adviser." The Commission provided this extended period 

for distributing audited financial statements of funds of funds recognizing that 

advisers to funds of funds may not be able to comply with the 120 day deadline 

because their annual audits cannot be completed prior to completion of the audits of 

the financial statements of the underlying funds in which they invest. This extended 

period was made available to all registered investment advisers and not just to 

private fund advisers that registered because of the amendment of Rule 203(b)(3)-1. 

The Goldstein Opinion may be deemed to have vacated the amendment of 

Rule 206(4)-2 to the extent that it vacated the Hedge Fund Rule. However, given 

the practical difficulty that would be faced by advisers of funds of funds if they 

22 17 C.F.R. 5 275.206(4)-2(a)(3) (2006). 

23 g he requirements of Rule 206(4)-2 are not applicable to pooled investment vehicles that are 

registered under the Company Act. 17 C.F.R. 5 275.206(4)-2(b)(4) (2006). 

'"7 C.F.R. 5 275.206(4)-2(b)(3) (2006). 

25 Id. 
were required to distribute audited annual financial statements to investors within 

120 days, we believe that the Staff should interpret Rule 206(4)-2 so as to permit an 

adviser to a "fund of funds" to distribute such financial statements to investors 

within 180 days following the end of the fund of fund's fiscal year. 

111. 	 Issues Affecting Hedge Fund Advisers that Withdraw their 

Registrations 

The Goldstein decision also has implications for hedge fund advisers that 

registered as a consequence of the amendment of Rule 203(b)(3)-1 and may now 

have determined to withdraw their registrations if and when the order of the DC 

Circuit set forth in the Goldstein Opinion takes effect. We believe that, in fairness 

to these hedge fund advisers, the provisions of the Advisers Act and the rules 

thereunder should be interpreted by the Staff so as: (i) to ensure that withdrawing 

hedge fund advisers may rely on Section 203(b)(3) under the Advisers Act 

beginning as of the date their withdrawal from registration with the Commission is 

filed and (ii) to minimize the requirements applicable to these advisers in connection 

with their withdrawal from registration. 

A. Effect of Existing Regulations on Withdrawing; Hedge Fund 

Advisers. 

With respect to hedge fund advisers that were required to register solely as a 

result of the requirements of amended Rule 203(b)(3)-1 and Rule 203(b)(3)-2 and 

who seek to withdraw their registrations as investment advisers, we request that the 

Staff confirm that: (i) an adviser to a private fund that withdraws its registration 

will not be deemed to have violated any provision of the Advisers Act or the rules 

thereunder (other than those that are applicable to unregistered advisers) as a result 

of any act or omission of such adviser occurring subsequent to the date it files a 

Form ADV-W with the Commission, provided that the adviser files its Form ADVW on or before a specified date;" and (ii) an adviser to a private fund that 

withdraws by the specified date will not be precluded from again relying on the 

Section 203(b)(3) exemption from registration as an investment adviser if, during 

the period it was registered as an adviser, it held itself out generally to the public as 

an investment adviser or had more than 14 clients (excluding investors in funds that 

would not have been treated as clients but for the amendment of Rule 203(b)(3)-1). 

We believe that it is appropriate for the Staff to interpret the Advisers Act in this 

manner because hedge fund advisers that registered solely because of the 

26 We recommend that the Staff specify February 1, 2007 as the date by which advisers to private 

funds must file a Form ADV-W if they wish to rely on this requested Staff position. This will 

provide hedge fund advisers a reasonable period of time within which to make a reasoned decision 

about whether to remain registered and to assure that those hedge fund advisers that withdraw from 

registration have a reasonable period of time within which to take any steps necessary for them to 

rely on the Section 203(b)(3) exemption from registration. Hedge fund advisers that do not file their 

Form ADV-Ws by February 1, 2007 would be treated as fully subject to the Advisers Act and the 

rules thereunder from the date of their registration like any other registrant. 
amendment of Rule 203(b)(3)-1, which has now been vacated, and determine within 

a reasonable period to withdraw from registration in light of the Goldstein Opinion 

should not be prejudiced by having complied with the Commission's rules or by 

having engaged in conduct permissible for registered advisers during the period of 

their registration. 

With respect to these matters, we believe that the interpretations we request 

are necessary in order to clarify that hedge fund advisers that withdraw their 

registrations will not be deemed to have violated any provision of the Advisers Act 

or its rules applicable solely to registered advisers if they do not comply with any 

requirements of such provisions after they cease to be registered. One example 

illustrating the need for the Staff to address this matter relates to compliance with 

Rule 206(4)-2. In this regard, a hedge fund adviser may not have sent any quarterly 

statements to investors in private funds or other investment vehicles for which it 

serves as investment adviser in reliance on its expectation that within 120 days after 

the end of the current fiscal year (e.g., December 31, 2006) it would distribute 

audited financial statements to investors in those private funds or other vehicles. If 

the hedge fund adviser files a Form ADV-W to withdraw from registration after the 

order of the DC Circuit takes effect, and subsequently does not distribute audited 

financial statements within the period required by Rule 206(4)-2, it should not be 

deemed to have violated that Rule. 

Similarly, there is a need for the Staff to clarify that a hedge fund adviser 

that during the period of its registration as an adviser held itself out generally to the 

public as an investment adviser or took on additional clients should not be 

prejudiced by such actions, provided that it ceases holding itself out, reduces the 

number of clients that it advises to fewer than 15, or both, as applicable, on or prior 

to the date it files its Form ADV-W with the Commission. In this regard, the ability 

of a hedge fund adviser to withdraw its registration will depend on the availability 

of the exemption provided by Section 203(b)(3) of the Advisers Act. As previously 

noted, Section 203(b)(3) provides that the registration requirement of the Advisers 

Act does not apply to any investment adviser who during the course of the 

preceding 12 months has had fewer than 15 clients and who neither holds itself out 

generally to the public as an investment adviser nor acts as an investment adviser to 

any registered investment company or BDC. 

Under the circumstances, we believe it reasonable and appropriate for the 

Staff to interpret Section 203(b)(3) as applicable to a hedge fund adviser that 

withdraws its registration by a specified date2* so that such adviser will not be 

precluded from relying on the Section 203(b)(3) exemption from registration if 

during the period it was registered it held itself out generally to the public as an 

investment adviser or had 15 or more clients. 

See note 26, supra. 
B. Form ADV-W Balance Sheet Re~uirement. 

Item 7 of Form ADV-W requires an adviser withdrawing from registration 

under the Advisers Act to include on Schedule W2 an unaudited balance sheet of the 

adviser as of the end of the month prior to the filing of Form ADV-W, prepared in 

accordance with generally accepted accounting principles, if: (i) the adviser or a 

related person of the adviser has "custody" over client cash or securities; (ii) the 

adviser has received advisory fees for investment advisory services or publications 

that it has not rendered or delivered or has borrowed money from clients that it has 

not repaid; or (iii) there are any unsatisfied judgments or liens against the adviser. 

In many cases, hedge fund advisers are deemed to have custody of client 

cash or se~urities.~~ However, because hedge fund advisers registered with the 

Commission are not registered under the laws of any state,30 such advisers have not 

generally been required to include their balance sheets on Schedule G of Part I1 of 

their Form ADVS.~' Most hedge fund advisers are, therefore, not required to 

provide their balance sheets to clients (as part of the Form ADVs they deliver to 

clients). Moreover, except for the requirement of Form ADV-W, there is no 

requirement that an adviser file a balance sheet with the Commission. Thus, except 

for the requirement of Form ADV-W, hedge fund advisers registered with the 

Commission generally are not required to provide their balance sheets to clients or 

to file their balance sheets with the Commission. 

In view of the foregoing, we believe that as a matter of sound regulatory 

policy and fairness the Staff should interpret the requirements of Form ADV-W 

requiring the filing of a balance sheet as inapplicable to hedge fund advisers that 

withdraw from registration on or before a specified date." 

In summary, we believe that there are important implications of the 

Goldstein Opinion that affect hedge fund advisers and that it would be appropriate 

for the Staff to address these implications by issuing interpretive advice as requested 

29 The definition of "custody" in Rule 206(4)-2(c) means holding, directly or indirectly, client funds 

or securities, or having any authority to obtain possession of them. Custody includes: "[alny 

capacity (such as general partner of a limited partnership, managing member of a limited liability 

company or a comparable position for another type of pooled investment vehicle, or trustee of a 

trust) that gives you or your supervised person legal ownership of or access to client funds or 

securities." Because many hedge fund advisers form their domestic private funds as limited 

partnerships or limited liability companies and use an affiliated entity under common control and 

sharing the same offices as the investment adviser to act as general partner for a limited partnership 

or managing member for a limited liability company, the adviser may be deemed to have custody 

over the assets of a domestic private fund. 

30 Section 203A of the Advisers Act. 

31 Item 14 of Part I1 of Form ADV requires that an adviser having custody of client funds or 

securities include an audited balance sheet of the adviser on Schedule G of its Form ADV, but this 

requirement is not applicable to an adviser registering or registered only with the Commission. 

32 See note 26, supra. 
herein. We appreciate the Staffs attention to this matter and its consideration of the 

issues we have identified. We would be pleased to discuss with you and other 

members of the Staff any aspect of this letter. Questions may be directed to Paul N. 

Roth at (212)-756-2450 or to Jeffrey E. Tabak at (212) 310-8343. 

Respectfully submitted, /"1 

Subcommittee c$n Private 

Investment Entikes 

u" 


s$committ!ee on private 

Investment Entities 

cc: 	 The Hon. Christopher Cox, Chairman, Securities and Exchange Commission 

Andrew Donohue, Director, Division of Investment Management 

Douglas J. Scheidt, Associate Director and Chief Counsel 

Dixie L. Johnson, Chair, Committee on Federal Regulation of Securities 

Keith F. Higgins, Vice Chair, Committee on Federal Regulation Securities 

Members of the Subcommittee on Private Investment Entities