October 10, 2012

Filing Deadline Approaches for Exemption from California Investment Adviser Registration

This Client Alert concerns new investment adviser regulations (the “New Regulations”) adopted by the California Department of Corporations on August 27, 2012 (the “Effective Date”).[1]

The New Regulations affect each individual or firm (a “California Adviser”) that: (i) provides investment advice for compensation; (ii) has an office, or six or more clients, in California; and (iii) is not registered as an investment adviser with the U.S Securities and Exchange Commission (the “SEC”). In particular, California Advisers that are exempt reporting advisers (“ERAs”) under the U.S. Investment Advisers Act of 1940 (the “Advisers Act”) are affected by the New Regulations.[2]


California law requires that each California Adviser register with the California Department of Corporations (the “DOC”) unless it is eligible for an exemption.[3]

Until recently, California provided an exemption (the “Prior Exemption”) for any California Adviser that advised fewer than 15 clients (and satisfied certain other requirements), with each fund managed by the California Adviser generally considered a single “client.”

The New Regulations eliminate the Prior Exemption and replace it with a substantially different exemption (the “New Exemption”).

Any California Adviser that intends to rely on the New Exemption must, at a minimum, file certain reports with the DOC by October 26, 2012 and pay a $125 fee for the 2012 calendar year.

Qualifying for the New Exemption

The New Exemption is available to a California Adviser that satisfies the following conditions.

  • The California Adviser provides advice only to Qualifying Private Funds. Most venture capital, private equity and hedge funds are “Qualifying Private Funds” under the New Exemption because such funds typically are exempt from registration as investment companies under one or more of the following sections of the U.S. Investment Company Act of 1940 (the “Company Act”): (i) Section 3(c)(1) (not more than 100 beneficial owners); (ii) 3(c)(5) (primarily investing in real estate, mortgages and certain other debt); or (iii) 3(c)(7) (beneficial owners consist exclusively of “qualified purchasers”).[4]
  • Neither the California Adviser nor any of its advisory affiliates[5] is disqualified under one of several “bad boy” provisions set forth in Rule 262 of Regulation A under the U.S. Securities Act of 1933 (the “Securities Act”) or California Corporations Code Section 25232(a) through 25232(h).[6]  These provisions are extensive and include, among other things, violations of securities laws, suspension from investment advisory activities by the SEC or a state securities regulator, and findings of liability in certain civil actions.
  • The California Adviser files with the DOC each report that an ERA is required to file with the SEC (regardless of whether the adviser is actually an ERA). Initial reports must be filed through the Investment Adviser Registration Depository (“IARD”) no later than October 26, 2012. Certain California Advisers have already satisfied this requirement by electing to share their federal ERA filings with California via Section 2.C. of their electronic Form ADV. A California Adviser that is unsure whether it has satisfied this requirement may consult the Investment Adviser Public Disclosure link on the IARD website.
  • The California Adviser pays an annual fee to the DOC (currently $125) through the IARD. Certain California Advisers paid this fee at the time they made their federal ERA filings.

Additional Requirements for Certain Non-Venture Capital Companies

In addition to satisfying the conditions listed above, a California Adviser seeking to rely on the New Exemption must satisfy certain requirements (the “Additional Requirements”) for each Retail Buyer Fund it advises. A “Retail Buyer Fund” is a Qualifying Private Fund that is neither a Venture Capital Company nor a 3(c)(7) Fund.[7]  For this purpose, there are two principal types of “Venture Capital Companies”: (i) “venture capital funds” under the Advisers Act[8]; and (ii) venture capital operating companies (VCOCs) under the Employee Retirement Income Security Act of 1974 (ERISA).

For each Retail Buyer Fund advised by a California Adviser, the Additional Requirements are as follows.

  • Audits. The California Adviser generally must provide annual audited financial statements to the Fund’s investors.
  • Disclosures. The California Adviser must provide to each investor, at or before the time it purchases an interest in the Fund, a plain English disclosure of all services to be provided, and all duties owed, by the California Adviser to the Fund and its investors.
  • Accredited Investors. Each investor that purchases an interest in the Fund must be (i) an “accredited investor” under the Securities Act or (ii) a manager, director, officer or employee of the California Adviser.
  • Qualified Clients. The California Adviser may accept performance-based compensation, such as carried interest, only in respect of Fund investors that are “qualified clients” under the Advisers Act.

Grandfather Rule for Existing Retail Buyer Funds

The New Exemption includes a “Grandfather Rule” applicable to Retail Buyer Funds organized prior to the Effective Date. Under the Grandfather Rule, the Additional Requirements generally are deemed satisfied with respect to such a Retail Buyer Fund if: (i) investors in the Fund receive annual audited financial statements for each fiscal year ending after the Effective Date; (ii) pre-existing Fund investors receive the disclosure described in the “Disclosures” bullet, above, by November 25, 2012 (and new investors receive such disclosure as described in the “Disclosures” bullet, above); (iii) from and after the Effective Date, the Fund sells interests solely to accredited investors; and (iv) the California Adviser accepts performance-based compensation solely in respect of pre-existing investors or qualified clients.

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For additional information regarding the New Exemption, please contact your Goodwin Procter Private Investment Funds attorney.

[1] The full text of the New Regulations is available here.

[2] Additional information regarding ERA status under the Advisers Act is available here.

[3] Cal. Corp. Code §§ 25230(a), 25230.1(a). Investment advisers that register with the DOC are subject to significant burdens, including the possibility of periodic examinations by the DOC and extensive recordkeeping requirements. Additionally, each member of the investment adviser’s investment staff must pass either a Series 65 Examination or both Series 7 and Series 66 Examinations administered by the Financial Industry Regulatory Authority (FINRA) unless an exemption is available.

[4] Private funds that qualify under Section 3(c)(7) of the Company Act (“3(c)(7) Funds”) are exempt from certain “Additional Requirements” described below. Section 3(c)(7) generally applies to funds that accept investments only from “qualified purchasers.”  Qualified purchasers generally include, without limitation, individuals with at least $5 million of investment assets and entities with at least $25 million of investment assets.

[5] The term “advisory affiliates” generally includes all managers, members, partners, directors and investment staff.

[6] A copy of Rule 262 is available here, and a copy of Cal. Corp. Code § 25232 is available here.

[7] See Footnote 4 for the definition of a 3(c)(7) Fund.

[8] A definition of “venture capital fund” under the Advisers Act is available here.