The U.S. Securities and Exchange Commission recently adopted a series of new rules and amendments to existing rules1 under the Investment Advisers Act of 1940 so as to implement provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act2 relating to the registration of investment advisers, including private fund managers. These rules (i) extend the deadline for adviser registration with the SEC, (ii) include clarifications of certain exemptions from investment adviser registration that the Dodd-Frank Act created last year, (iii) implement new thresholds for adviser registration with the SEC, and (iv) create a reporting regime for certain advisers that are exempt from adviser registration under the new rules. This client alert provides a brief overview of some of the key provisions of the new SEC rules.
Postponement of Registration Deadline
Unless they qualify for an exemption from registration under the amended rules, advisers currently relying on the "private adviser exemption"3 (which exemption the Dodd-Frank Act repealed) must register with the SEC by March 30, 2012—not July 21, 2011, as the Dodd-Frank Act originally contemplated. Since the SEC may take up to 45 days to process an application for registration, advisers must file a complete application, including both Part 1 and Part 2A of Form ADV, by February 14, 2012 to meet the new deadline.
Certain New Adviser Registration Exemptions4
Exemption from Registration for Advisers Solely to Venture Capital Funds
The Dodd-Frank Act provides an exemption from registration under the Advisers Act for advisers that only advise "venture capital funds." The new rules define a "venture capital fund" as a private fund that: (i) represents itself as pursuing a venture capital strategy; (ii) immediately after the acquisition of any asset, holds no more than 20% of its aggregate capital commitments (other than short-term holdings) in non-qualifying investments;5 (iii) does not borrow, issue debt obligations, provide guarantees, or otherwise incur leverage, other than by engaging in limited short-term borrowings or providing limited guarantees of the obligations of qualifying portfolio companies; (iv) does not offer its investors redemption rights or other similar liquidity rights except in extraordinary circumstances; (v) is not registered as an investment company; and (vi) has not elected to be treated as a business development company. The rule also includes a grandfather clause that exempts certain existing funds from registration that would not meet all of the conditions set forth above, but that have historically held themselves out as pursuing a venture capital strategy.
Exemption from Registration for Advisers Solely to Qualifying Private Funds with Less than $150 Million of Assets Under Management in the United States
The Dodd-Frank Act provides an exemption from Advisers Act registration for advisers that advise only "qualifying private funds"6 and have less than $150 million in assets under management "in the United States." The SEC's new rules clarify that advisers with a principal office and place of business in the United States must count all private fund assets towards the $150 million limit, including assets for which day-to-day management takes place outside the United States. For purposes of this exemption, advisers with a principal office and place of business outside the United States need only count toward the $150 million limit such private fund assets as they manage from a place of business in the United States. Any such adviser whose principal office and place of business are outside the United States may also qualify for this exemption if it has non-U.S. clients that are not private funds.
Exemption from Registration for Non-US Advisers with No Place of Business in the United States
The Dodd-Frank Act provides an exemption from Advisers Act registration for an adviser that (i) has no place of business in the United States, (ii) has fewer than 15 U.S. clients and U.S. investors in the private funds that it manages, (iii) has less than $25 million in assets under management attributable to those U.S. clients and U.S. investors, and (iv) neither holds itself out to the public in the United States as an investment adviser nor acts as an investment adviser to (a) any registered investment company or (b) any business development company. Under the new Advisers Act Rule 202(a)(30)-1, a foreign private adviser generally does not need to "look through" the entities it advises (other than private funds) to count the owners of the entity in the United States as separate "clients." But in the case of any private funds that it advises, a foreign private adviser must "look through" and count all U.S. beneficial owners of the fund.
Eligibility for Registration with SEC
Mid-sized Advisers
The Dodd-Frank Act generally prohibits a U.S. investment adviser from registering with the SEC if the adviser: (i) is required to be registered in the state in which it maintains its principal office and place of business, (ii) is subject to examination by the securities regulator of that state because of its registration and (iii) has between $25 million and $100 million of assets under management. Advisers that have between $25 million and $100 million of assets under management are commonly referred to as "mid-sized advisers." Mid-sized advisers that are no longer eligible for registration with the SEC must withdraw their SEC registration no later than June 28, 2012, and no sooner than January 1, 2012. A mid-sized adviser that is either (i) not required to be registered as an adviser with the state securities authority in the state where it maintains its principal office and place of business or (ii) not subject to examination as an adviser by that state will be required to register with the SEC and to affirm annually that condition (i) or (ii) is true.
The SEC has indicated that all state securities authorities other than New York and Wyoming7 have advised its staff that advisers registered with them are subject to examination. Therefore, mid-size advisers in New York and Wyoming may remain registered with the SEC until they become subject to state examination.
Calculation of Assets Under Management
The SEC is adopting revisions to the instructions to Part 1A of Form ADV to implement a uniform method for advisers to calculate assets under management. Under the revised instructions, advisers must include in their regulatory assets under management all securities portfolios for which they provide continuous and regular supervisory or management services, regardless of whether the assets are family or proprietary assets, assets managed without receiving compensation, or assets of foreign clients. Regulatory assets are to be calculated on a gross basis and include the amount of any uncalled capital commitments made to a private fund managed by the adviser. Advisers must use either the market value of private fund assets or, if their market value is unavailable, the fair market value of private fund assets.
Buffer
Advisers may register with the SEC once they have $100 million of assets under management (unless they are otherwise eligible for registration with a lower amount under management); and they must register with the SEC once they have $110 million of assets under management (unless they are eligible to rely on an exemption from registration). Once registered with the SEC, an adviser need not withdraw its registration unless it has less than $90 million in assets under management at the end of its fiscal year, as reported in its annual updating amendment filed within 90 days after the end of its fiscal year. Any investment adviser registered with the SEC that reports in its annual updating amendment that it is no longer eligible for SEC registration must withdraw its SEC registration within 180 days of the end of its fiscal year (unless it is then eligible for SEC registration).
Exempt Reporting Advisers
Advisers relying on the exemptions from Advisers Act registration for: (i) advisers solely to venture capital funds or (ii) advisers solely to private funds with less than $150 million of assets under management in the United States will still be required to file with the SEC a limited subset of items in Part 1 of Form ADV, including general information about their funds' strategy and assets and investments and the identification of certain service providers to the funds. Those advisers must publicly file their Form ADVs with the SEC, and update the filed information annually or more frequently if certain information becomes inaccurate. The SEC indicates that this public reporting requirement provides a level of transparency that will help it to identify practices that may harm investors. While the SEC will have the authority to subject any such exempt advisers to routine examinations, it has indicated that it will not do so unless there are indications that those examinations are necessary. Like all investment advisers (whether or not they are registered with the SEC), exempt reporting advisers also will be subject to the general anti-fraud provisions of the Advisers Act.
Advisers that rely on the exemptions from registration for advisers solely to SBICs and for certain private fund advisers registered with the CFTC are not subject to these reporting requirements.
Additional Items of Interest
Amendments to Form ADV
The new rules amend Form ADV to require advisers to provide further information to the SEC about their advisory businesses (including data about the types of clients they have, their employees, and their advisory activities). Advisers will also be required to make Form ADV disclosures about aspects of their respective business practices that may raise significant conflicts of interest, including the identification of auditors, brokers, custodians, administrators, and marketers for private funds. Additionally, advisers will be required to provide information about their non-advisory activities and their financial industry affiliations.
Although advisers will not be required to disclose the names of their investors or the percentage of each fund that particular types of beneficial owners own, they will be required to disclose (i) the minimum amount that investors are required to invest in the fund, (ii) the approximate number of beneficial owners of the fund, (iii) the approximate percentage of the fund that the adviser and its related persons beneficially own, funds of funds, and non-U.S. persons, and (iv) the extent to which clients of the adviser are solicited to invest, and have invested, in the fund.
"Pay-to-Play" Rule
Advisers Act Rule 206(4)(5), known as the "pay-to-play" rule, is designed to prevent an adviser from seeking to influence government-awarded advisory contracts with political contributions. The SEC has amended this rule so that it applies to exempt foreign private advisers and exempt reporting advisers that qualify under the exemptions for advisers solely to venture capital funds and for advisers solely to qualifying private funds with less than $150 million under management in the United States.
In light of these new rules, all unregistered investment advisers should consider whether they will remain exempt under federal and state law, and SEC-registered advisers with less than $100 million of assets under management should evaluate whether they will be required to transfer from SEC to state registration and regulation before March 30, 2012.
Footnotes
1 Investment Advisers Act Rel. No. 3220 (June 22, 2011) available at www.sec.gov/rules/final/2011/ia-3220.pdf; Investment Advisers Act Rel. No. 3221 (June 22, 2011) available at www.sec.gov/rules/final/2011/ia-3221.pdf; and Investment Advisers Act Rel. No. 3222 (June 22, 2011) available at www.sec.gov/rules/final/2011/ia-3222.pdf.
2 The Dodd-Frank Wall Street Reform and Consumer Protection Act. Title IV, Section 409, Pub.L. No. 111-203, 124 Stat.1376 (2010).
3 The "private adviser exemption," which was set forth in Section 203(b)(3) of the Advisers Act, exempted from registration under the Advisers Act investment advisers with fewer than 15 clients that neither held themselves out to the public as investment advisers nor acted as advisers to registered investment companies.
4 The SEC also published a release clarifying the scope of the family office exclusion from the definition of investment adviser. We discuss that release in a separate client alert. The recent releases did not address the exemptions from SEC registration for (i) advisers solely to small business investment companies licensed under the Small Business Investment Act of 1958 (other than entities that are regulated as business development companies) and (ii) certain private fund advisers registered with the Commodity Futures Trading Commission whose business is not "predominately the provision of securities-related advice," both of which will continue to exist.
5 The Advisers Act now generally defines a "qualifying investment" as (i) an equity security issued by a qualifying portfolio company that is directly acquired by the fund from the company, or directly acquired equity; an equity security issued by a qualifying portfolio company in exchange for directly acquired equity issued by the same company, and (iii) an equity security that is issued by a company of which a qualifying portfolio company is a majority-owned subsidiary or a predecessor, and that is acquired by the fund in exchange for directly acquired equity. The Advisers Act now generally defines a "qualifying portfolio company" as any company that: (i) at the time of any investment, is not reporting or foreign-traded; (ii) does not borrow or issue debt in connection with the fund's investment, and does not distribute the proceeds of any borrowing or debt issuance to the fund in exchange for the fund's investment; and (iii) is not itself an investment company, fund, or commodity pool.
6 A "Qualifying Private Fund" is a fund that is not registered as an investment company under the Investment Company Act 1940 and that has not elected to be treated as a business development company. For purposes of this exemption, however, an investment adviser may also treat an entity as a qualifying private fund if that entity is excluded from the definition of "investment company," as defined in Section 3 of the Investment Company Act, because of any provision of that act, and if the adviser treats the entity as a "private fund" for purposes of the Advisers Act and the rules promulgated thereunder.
7 Although IA-3221 included Minnesota on this list, Minnesota indicated to the SEC after the release of IA-3221 that it now subjects advisers registered with its securities authority to examination.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
