Introduction to Dodd-Frank Bill

The Dodd-Frank financial reform bill has been in practice for almost a year but at this time we have not noticed any large changes in how hedge funds conduct their business.  However, during the next several months, we will see an increase in regulatory activity.   By July 2011, the regulators will be required to provide Congress and the industry the final roadmap/rules and regulations. Further, as established under the Dodd-Frank Act, the Financial Stability Oversight Council (“FSOC”) will provide comprehensive monitoring, studies and rule suggestions to the SEC and others
to ensure the stability of our nation's financial system. The FSOC is charged with identifying threats to the financial stability of the United States; promoting market discipline and responding to emerging risks to the stability of the United States financial system.

As one example, on January 18, 2011 the FSOC issued a study which suggests restricting a banking entities’ direct investment in “hedge funds and private equity funds”.  And for those investments that are allowed, the “banking entity” must comply with new governance rules and transparency rules: 

Investment and risk oversight: the Study recommendations for the banking entity’s board of directors and other employees, including but not limited to the written procedures regarding the objectives, strategies and policies governing permissible investments, as well as active compliance monitoring of those internal policies and procedures.

Management and public attestation: the Study suggests that the banking entity’s CEO be required to attest publicly to the ongoing effectiveness of the internal compliance framework with respect to permitted investments in hedge funds and private equity funds.

Transparency: The study also requires banking entities to publicly disclose certain information regarding hedge funds and private equity funds which they are permitted to invest in, including the type and amount of investments, portfolio concentrations, returns, and their contributions to reported earnings and capital.

The above study is now under consideration by the SEC.  Though the proposed rules do not directly affect hedge funds or private equity firms, the banking entities’ CEO will be publicly attesting to the internal controls surrounding their own hedge fund investments.  Most likely the Banks’ CEO will want to ensure the banks relationship with the hedge fund is transparent and that the banks senior managers are comfortable with the hedge fund’s internal controls.