On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted final rules under the Investment Advisers Act of 1940 (the “Advisers Act”) relating to provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). These new rules implement and clarify the provisions of the Dodd-Frank Act that will require previously exempt advisers, including many advisers to private investment funds, to register as investment advisers or to become “exempt reporting advisers” (“ERAs”), and satisfy new compliance obligations. The new registration obligations result primarily from the Dodd-Frank Act’s deletion of the “fewer than 15 clients” adviser registration exemption (Advisers Act Section 203(b)(3)). The SEC adopted the new rules in two rule releases that focused on defining and clarifying the Advisers Act registration exemptions adopted under the Dodd-Frank Act (the “Exemptive Release”) and implementing those exemptions (the “Implementing Release”).
For the most part, the new rules are similar to the rules proposed November 19, 2010, with four principal modifications: (1) as a practical matter, compliance generally has been delayed from July 21, 2011 to March 30, 2012; (2) venture capital funds will have more flexibility under the new rules, including an ability to make non-conforming investments, subject to a 20% basket; (3) non-U.S. firms that deal with U.S. clients or U.S. fund investors may benefit from the continuing ability to avoid integrating a registered U.S. adviser and an affiliated, unregistered non-U.S. adviser under the Unibanco line of no-action letters (discussed here), although the future application and interpretation of prior guidance under the new rules remains undetermined; and (4) the new rules apply a more uniform test to measure “assets under management” both to make determinations regarding registration and to satisfy other regulatory requirements.
Key elements of the new rules are as follows:
- Foreign Private Adviser Exemption. For non-U.S. advisers, the new rules adopt key definitions and clarifications for the so-called “Foreign Private Adviser Exemption”; however, the exemption likely will be of limited benefit for most non-U.S. advisers dealing with U.S. clients or fund investors. The Foreign Private Adviser Exemption is only available to an adviser that has no place of business in the U.S. and that does not hold itself out to the public in the U.S. as an adviser. Moreover, the adviser must have both (1) fewer than 15 clients (or investors in “private funds”2) in the U.S. and (2) aggregate assets under management attributable to clients (or investors in private funds) in the U.S. of less than $25 million.
- “Exempt Reporting Advisers” or “ERAs”. The new rules establish exemptions and key definitions (1) for advisers whose clients are all “venture capital funds” and (2) for certain “private fund advisers” with less than $150 million in assets under management in the U.S. While exempt from registration, these advisers will be ERAs and required to file portions of Part 1 of Form ADV. The SEC will have examination authority over ERAs (although the SEC indicated it does not intend to conduct routine examinations of them).
- Registration Exemption for “Venture Capital Fund” Advisers. The “Venture Capital Exemption” applies to advisers whose only clients are “venture capital funds.” The new rules generally seek to distinguish a venture capital fund from a hedge, private equity or fund-of-funds by imposing limits on a venture capital fund’s structure (e.g., limits on redemption provisions and leverage), the type of investments it may make and the type of companies in which it may invest, subject to an overall “basket” for non-conforming investments capped at 20% of fund capital. The rules also require that a venture capital fund represent to current and prospective investors that it pursues a venture capital strategy. Broad “grandfather” relief is provided with respect to pre-existing funds that have made similar representations as to pursuit of a venture capital strategy. The new rules permit venture capital funds much greater flexibility than the proposed rules, with the result that many more advisers are expected to qualify for this exemption. Advisers relying on the Venture Capital Exemption will be ERAs.
- Registration Exemption for “Private Fund” Advisers. U.S.-based advisers with less than $150 million in total assets under management in “private funds” (and no other clients) will be able to use the “Private Fund Adviser Exemption.” Non-U.S.-based advisers with less than $150 million in assets under management in the U.S. in private funds (and no other U.S. clients) will also be able to use the Private Fund Adviser Exemption. Accordingly, the exemption’s primary beneficiaries will likely be non-U.S. advisers that do not manage any assets at a U.S. place of business and whose only U.S. clients are “private funds.” Advisers relying on the Private Fund Adviser Exemption will be ERAs.
- Calculating “Assets Under Management” and Its Implications. The SEC adopted a new methodology for calculating “assets under management” that applies to determine eligibility for the various exemptions and is the basis for certain disclosures under Form ADV. The methodology is based on the gross assets in “securities portfolios” for which the adviser provides “continuous and regular supervisory or management services,” and includes both proprietary and non-fee bearing assets.
- State vs. Federal Registration As advisers determine their obligations to file at the state vs. federal level, new transition rules, assets under management thresholds and other provisions apply. ERAs to venture capital and private funds with total assets under management under $100 million will likely not benefit from state law registration exemptions applicable to “federal covered advisers.” Such ERAs may be subject to state adviser registration unless the applicable state law provides an alternative exemption. However, NASAA, the organization for state securities administrators, has proposed a model rule creating an exemption from state registration for certain of these ERAs.
- Other Matters The SEC also: (1) updated Form ADV primarily to include “private fund” disclosures and “exempt reporting adviser” reporting obligations, which are marginally less detailed than originally proposed; (2) indicated that Form PF will be finalized later this year; and (3) revised the “pay to play” rule to cover ERAs and foreign private advisers, and to add certain municipal advisers as permitted solicitors.
2 Under Advisers Act Section 202(a)(29), the term “private fund” means “an issuer that would be an investment company, as defined in section 3 of the [Investment Company Act of 1940], but for section 3(c)(1) or 3(c)(7) of that Act.” As discussed elsewhere in this Alert, a fund organized outside the U.S. that does not use U.S. jurisdictional means to conduct an offering (and, in particular, does not offer interests to U.S. persons) generally would not be a “private fund” for this purpose, under the SEC’s prior interpretation of the Investment Company Act of 1940. (See Advisers Act Release No. IA-3222 FN 294.)