Investment Advisers Act of 1940
Section 206(4) and Rule 206(4)-2

August 28, 2006

By letter dated August 2, 2006, you, on behalf of certain accounting firms¹, request our assurances that we would not recommend enforcement action to the Commission under Section 206(4) of the Investment Advisers Act of 1940 (the "Advisers Act") and Rule 206(4)-2 thereunder against any "newly registered hedge fund adviser"² if the investment adviser, for purposes of complying with the adviser custody rule,³ relies on an audit of a limited partnership, limited liability corporation or other pooled investment vehicle (collectively, "hedge fund") by an accountant that has performed non-audit services for, or had certain relationships with, the hedge fund audit client or its affiliates, including the adviser, that would preclude the accountant from being independent under the Commission's independence rules,⁴ provided that (a) those services or relationships would not impair the accountant's independence under independence standards that were applicable to an audit of a hedge fund prior to registration by the adviser, and (b) those services or relationships prohibited by the Commission's independence rules cease no later than June 30, 2007.

The adviser custody rule requires the adviser to, among other things: (1) maintain client funds and securities with a qualified custodian; (2) provide certain information to clients concerning the arrangement with the qualified custodian; and (3) send (or have the qualified custodian send) account statements to clients on a quarterly basis.⁵ In lieu of distributing quarterly account statements, a hedge fund adviser may arrange for an annual audit of the hedge fund and distribute the audited financial statements to the hedge fund's investors within 120 days of the end of the hedge fund's fiscal year ("audit exception").⁶ The audit exception specifically requires the accountant to be independent in accordance with the Commission's independence rules.⁷

Based on the facts and representations in your letter, and without necessarily agreeing with your analysis, we would not recommend enforcement action to the Commission under Section 206(4) of the Advisers Act and Rule 206(4)-2 thereunder against any newly registered hedge fund adviser,⁸ if the adviser, for purposes of rule 206(4)-2(b)(3):

1. relies on an audit of a hedge fund by an accountant that has performed non-audit services for, or had certain relationships with, the hedge fund audit client or its affiliates, including the adviser, that would preclude the accountant from being independent under the Commission's independence rules, provided that (a) those services or relationships would not impair the accountant's independence under independence standards that were applicable to an audit of a hedge fund prior to registration by the adviser, and (b) those services or relationships prohibited by the Commission's independence rules cease no later than June 30, 2007; and
    
2. causes the hedge fund to disclose in the footnotes to its financial statements: (a) that the accountant was independent under independence standards that were applicable to an audit of a hedge fund prior to registration by the adviser, (b) that the accountant was not independent under the Commission's independence rules, (c) the general reasons why the accountant was not independent under the Commission's independence rules, and (d) a brief description of the relief and the duration of the relief granted by the staff.

Our conclusions and relief do not provide any assurance on an accountant's overall independence status with a hedge fund or its newly registered investment adviser. Any different facts or conditions might require a different conclusion. Should you have questions, please call James D. Campbell, Assistant Chief Accountant, or me at 202-551-6918.

Very truly yours,

Brian D. Bullard
Chief Accountant

Endnotes

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¹ The accounting firms that participated in preparing the request letter were BDO Seidman LLP, Deloitte & Touche LLP, Ernst & Young LLP, Goldstein Golub Kessler LLP, Grant Thornton LLP, KPMG LLP and PricewaterhouseCoopers LLP.

² For purposes of this letter, "newly registered hedge fund adviser" refers to those advisers that were not registered with the Securities and Exchange Commission prior to January 1, 2005, but were required to register with the Commission under Section 203(a) of the Advisers Act because the adoption of Rule 203(b)(3)-2 left them no longer able to rely upon the "private adviser" registration exemption contained in Section 203(b) of the Act. On June 23, 2006, the U.S. Court of Appeals District of Columbia Circuit issued a decision that vacated the hedge fund adviser rule. See Goldstein v. Securities and Exchange Commission, No. 04-1434 (D.C. Cir. June 23, 2006). To the extent that hedge fund advisers remain registered with the Commission, they are subject to all of the rules under the Advisers Act.

³ See Rule 206(4)-2 under the Investment Advisers Act of 1940.

⁴ See Rule 2-01 of Regulation S-X.

⁵ The rule specifically provides that the account statements must be sent to each limited partner (or member or other beneficial owner) of a limited partnership (or a limited liability company or other pooled investment vehicle). See Rule 206(4)-2(a)(3)(iii). An adviser that sends account statements directly to its clients must obtain an independent verification of client funds and securities by an independent public accountant without prior notice to the adviser. See Rule 206(4)-2(a)(ii)(B).

⁶ See Rule 206(4)-2(b)(3).

⁷ The adviser custody rule audit exception requires the adviser to subject its limited partnership to an "audit," as that term is defined in Section 2(d) of Article 1 of Regulation S-X. Section 2(d) of Article 1 of Regulation S-X requires the accountant conducting the audit to be independent in accordance with the Commission's rules.

⁸ The relief granted would apply as well to the accountant of the hedge fund if it was not independent under the Commission's independence rules.

Incoming Letter

The Incoming Letter is in Acrobat format.

http://www.sec.gov/divisions/investment/noaction/2006/deloitte082806.htm