August 23, 2004
The proposed hedge fund registration rules need to be ammended to provide for registration when an offshore hedge fund manages US pension investments and when US investments in hedge funds are made through private placement variable annuity contracts.
Pension plans that invest with hedge funds due to a tax rule -UBIT- make investments with corporate structured offshore hedge funds. Offshore hedge funds under the proposed SEC rules need to register with the SEC only if they have more than 14 US investors.
For purposes of the 14 US investor test, an US pension plan is counted as one investor and there are no looks through rules that apply. So even though a pension plan might represent interests of many US investors, for the purposes of the investor test, a pension plan investment is counted as one.
In essence under the proposed SEC rule, offshore hedge funds that manage less than 14 US pension plans would not need to register with the SEC. To protect the small investors, US pension plans should also be subject to look-through rules.
The proposed hedge fund registration rules do not seem to address how the US investor rule applies to a US investors investment with a hedge fund that is made through a private placement variable annuity contract.
A variable annuity contract is an insurance contract that is wrapped around a mutual fund of fund, which is a fund separate account or parent fund that invests in several other mutual funds sub accounts that can be either the insurance companys proprietary funds or non-proprietary funds managed by different fund companies. A private placement variable annuity contract on the other hand -- used as an investment gate way into making investments with hedge funds-- is an insurance contract wrapped around a parent fund that invests with a hedge fund of fund. A hedge fund of fund is a fund that makes investments with several different hedge funds. In essence, the private placement variable annuity contract has three layers to its structure.
As I read the rule, the proposed SEC rule provides look-through for hedge fund of funds in determining the number of US investors, but does not seem to address how the rule will applly when the hedge fund of fund is held by a mutual fund 1940 Act fund that has an insurance overlay as in the case of a private placement variable annuity contract.