U.S. Advisers. Under the new rules, an adviser with its principal office and place of business in the U.S. is exempt from Advisers Act registration under the Private Fund Adviser Exemption if it: (1) acts solely as an adviser to one or more “Qualifying Private Funds”11; and (2) manages private fund assets of less than $150 million. For these purposes, a “principal office and place of business” means “the executive office of the investment adviser from which the officers, partners or managers of the investment adviser direct, control and coordinate the activities of the investment adviser.”
Non-U.S. Advisers. An adviser with its principal office and place of business outside the U.S. (a “non-U.S. adviser”) is exempt from Advisers Act registration under the Private Fund Adviser Exemption if: (1) all of its clients that are U.S. persons are Qualifying Private Funds; and (2) all assets it manages at any place of business in the U.S. are solely attributable to Qualifying Private Funds and have a total value of less than $150 million. For these purposes, a U.S. person is any person that is a “U.S. Person” as defined in Regulation S promulgated under the Securities Act of 1933 (“Regulation S”), except with respect to certain discretionary or similar accounts that are held for the benefit of U.S. persons by certain non-U.S. dealers or other non-U.S. professional fiduciaries. A “place of business” has the same definition as for a Foreign Private Adviser.
ERA Status. An adviser that relies upon the Private Fund Adviser Exemption is an ERA and, as such, is subject to the reporting and compliance requirements discussed above under “‘Exempt Reporting Advisers’ or ‘ERAs’.”
Interpretive Guidance. The new rules and the Releases provide guidance on the following concepts contained in the Private Fund Adviser Exemption:
Assets Managed in the U.S. If an adviser has its principal office and place of business in the U.S., it is deemed to manage12 within the U.S. all of its private fund assets, even if the adviser has offices outside of the U.S. Accordingly, for purposes of qualifying for the Private Fund Adviser Exemption, an adviser with its principal office and place of business in the U.S. is required to include all assets under management regardless of where they are managed (even if managed from outside of the U.S.). By contrast, an adviser with a principal office and place of business outside the U.S. is only required to consider assets that are managed at a place of business in the U.S. for purposes of the Private Fund Adviser Exemption and would not lose this exemption by virtue of: (1) managing from outside of the U.S. Qualifying Private Funds with an unlimited amount of investment from U.S. investors; (2) advising clients that are not U.S. persons and are not Qualifying Private Funds; or (3) relying on services that are not considered “management” and are provided by its own employees from within the U.S.
Whether an adviser is managing assets at a place of business in the U.S. is a facts and circumstances analysis. For example, while the SEC has indicated that providing research or conducting due diligence at a U.S. place of business may constitute “managing” assets at a place of business in the U.S. under certain circumstances, it would not if a person outside of the U.S. makes independent investment decisions and implements those decisions.
- “Qualifying Private Fund” Status; Special Rule. As noted above, a Qualifying Private Fund includes an issuer that would be an “investment company” under the 1940 Act but for the exclusions from that definition provided in Sections 3(c)(1) or 3(c)(7) of that Act. However, under a special rule, an adviser to a fund qualifying for another definitional exclusion, such as a real estate fund that qualifies for Section 3(c)(5)(C), may elect to treat such fund as a “private fund” for purposes of the Private Fund Adviser Exemption, so long as the adviser treats such fund as a “private fund” for all other Advisers Act purposes.13 Accordingly, an adviser to funds that can qualify for other definitional exclusions beyond 3(c)(1)/(7) is not precluded from relying on the Private Fund Adviser Exemption by virtue of this fact. In addition, similar to the flexibility provided under the Venture Capital Exemption (see above), an adviser could elect to treat a non-U.S. fund that has not made an offering to U.S. persons as a “private fund” for purposes of the Private Fund Adviser Exemption.
- Combining Exemptions. Given the structure of the Venture Capital and Private Fund Adviser Exemptions, a single adviser generally may not combine the Private Fund Adviser Exemption with other exemptions. For example, a single adviser could not advise VC funds with assets under management in excess of $150 million and also seek to rely on the Private Fund Adviser Exemption for other funds with assets under management of less than $150 million.
Calculating the Value of Assets. Advisers must annually (rather than quarterly, as initially proposed) calculate the amount of private fund assets that they manage to determine whether they continue to be eligible for the Private Fund Adviser Exemption and must report the amount in their annual updating amendments to Form ADV. Changes in the amount of private fund assets between annual updating amendments will not affect the availability of the exemption. If an adviser reports on its annual updating amendment that its assets under management in the U.S. equal or exceed $150 million such that it is no longer eligible for the Private Fund Adviser Exemption, then it will have up to 90 days after filing such amendment to apply for registration (i.e., up to 180 days in total after the end of the adviser’s fiscal year).
The value of private fund assets under management is required to be calculated in accordance with the instructions in Form ADV. As discussed in more detail below, the instructions to Form ADV require that the calculation of the value of private fund assets under management (1) be made on a gross basis; (2) be based on market value (or fair value where market value is unavailable); (3) include assets managed without compensation; (4) only include the portion of any “securities portfolio” for which the adviser provides “continuous and regular supervisory or management services;” and (5) include uncalled commitments.
Affiliated Advisers / Unibanco No-Action Letters. The SEC noted in the Implementing Release that an adviser cannot satisfy exemptions, such as the $150 million Private Fund Adviser Exemption, by simply reorganizing into two separate advisory entities to split the business so that each entity’s assets under management are below various thresholds, which would violate the general prohibition on doing indirectly what cannot be done directly. The SEC reiterated that whether two affiliated advisers would be integrated is based on a facts and circumstances analysis of certain factors discussed in prior no-action letters issued by the staff of the Division of Investment Management of the SEC (the “Staff”).14
Multi-national advisory structures with a registered investment adviser in the U.S. and an affiliated non-U.S. unregistered adviser have historically relied on the line of no-action letters issued by the Staff beginning with the Unibanco no-action letter.15 Under this line of no-action letters, the Staff adopted a less stringent approach to integrating a registered U.S. adviser and an affiliated, unregistered non-U.S. adviser than was the case under the position in the Richard Ellis no-action letter, by permitting such a non-U.S. adviser to remain separate and unregistered despite sharing resources and personnel with its affiliated, registered U.S. adviser (provided that certain other conditions were met). As noted above, a non-U.S. adviser with its principal office and place of business outside of the U.S. is only required to consider assets that are managed from a place of business in the U.S. for purposes of the $150 million threshold under the Private Fund Adviser Exemption; accordingly, many multi-national advisers sought affirmation from the SEC that it would continue to apply the Unibanco position in determining the assets that are managed by a non-U.S. adviser from a place of business in the U.S.
While the SEC stated in the Exemptive Release that it was not intending to withdraw any prior statement or views under the Unibanco line of no-action letters, it did not specifically affirm positions taken under the Unibanco line of letters, despite acknowledging the request to do so by a number of commentators. Moreover, the SEC noted that “the Unibanco letters were developed by the staff in the context of the private [adviser] exemption, which Congress repealed….. We expect that the staff will provide guidance, as appropriate, based on the facts that may be presented to the staff regarding the application of the Unibanco letters in the context of the new foreign private adviser exemption and the private fund adviser exemption.”
Given these statements made by the SEC and the nature of the new Foreign Private Adviser Exemption and Private Fund Adviser Exemption, which by their terms take a territorial approach that focuses on where assets are being managed, advisers should be cautious in relying on the Unibanco letters absent further guidance either generally or in respect of specific situations.
Certain multi-national advisers to private funds have a business model in which investment activities are conducted with relative independence and through separate legal entities, particularly in non-U.S. jurisdictions where local presence, relationships and knowledge are essential. In some cases, these advisers may manage exclusively VC funds in the U.S., but may have a broader mandate in another jurisdiction where the local professionals manage funds that are not VC funds. Viewed as a whole, these advisers may be unable to qualify for the Venture Capital Exemption (because of their non-U.S. business) or for the Private Fund Adviser Exemption (because of their U.S. business), even if each business, when viewed separately, would allow the adviser to be an ERA. Pending further guidance on the Unibanco analysis, these advisers may wish to consider whether their operations do or can satisfy the criteria set forth in the Richard Ellis no-action letter.16 Under appropriate facts and circumstances, it would not be necessary to integrate the business of affiliated entities for determining registration requirements and the availability of exemptions under the new rules.
11 Qualifying Private Funds means private funds that have not registered as investment companies under the 1940 Act or elected to be business development companies under that Act.
12 “Manage” means to provide continuous and regular supervisory or management services as contemplated in the instructions to Item 5 of Form ADV Part 1A.
13 Including the special rules for calculating private fund “assets under management”, as discussed below.
14 See, e.g., Richard Ellis, Inc., SEC Staff No-Action Letter (Sept. 17, 1981) (“Richard Ellis”).
15 Uniao de Bancos de Brasileiros S.A., SEC Staff No-Action Letter (July 28, 1992) (“Unibanco”). Under this no-action letter, the Staff indicated that it would not recommend enforcement action for failure to register against an unregistered non-U.S. adviser that is separately organized from an affiliated, registered U.S. investment adviser if: (1) each is separately organized and staffed with personnel (located in the U.S. or abroad) who are capable of providing investment advice; (2) all personnel of the unregistered adviser involved in the U.S. advisory activities are deemed “associated persons” of the registered adviser; and (3) the SEC has adequate access to trading and other records of each such unregistered affiliate and to its personnel to the extent necessary to enable the SEC to identify conduct that may harm U.S. clients or markets.
16 Richard Ellis involved an RIA and its non-U.S. affiliate that was seeking to avoid having its business integrated with the RIA, requiring the affiliate to be registered. The Richard Ellis letter conditioned relief for the affiliated entity of the RIA on the basis that the affiliate (1) is adequately capitalized; (2) has a buffer, such as a board of directors a majority of whose members are independent of the RIA; (3) has employees dedicated to the entity and not engaged in the advisory business of the RIA; (4) uses independent sources of investment information and itself makes the investment decisions; and (5) keeps its investment decisions and advice confidential until communicated to the client.