Alert February 21, 2012

Massachusetts Adopts Changes to Investment Adviser Registration Exemptions

The Massachusetts Securities Division (the “Division”) adopted final amendments (the “Amendments”) to its rules that (1) effectively phase out a commonly-used exemption from registration as an investment adviser and (2) create a new private fund adviser registration exemption.  The Amendments represent a re-working of the Division’s approach to regulating investment advisers in light of the changes to federal regulation of advisers effected by the Dodd-Frank Act and related SEC rulemaking, which are discussed in detail in the June 30, 2011 Goodwin Procter Alert.

Definition of Institutional Buyer.  The Amendments modify the definition of “institutional buyer” under Massachusetts regulations to limit the extent to which investment advisers are exempt from registration with the Commonwealth because their only clients are “institutional buyers.”  The Amendments carve back the existing category of institutional buyer that consists of any investing entity that accepts only “accredited investors,” each of whom has invested at least $50,000.  Under the Amendments, that category is subject to further conditions: (a) the funds must have existed prior to February 3, 2012; and (b) they must have ceased accepting new investors as of that date.  The Amendments include a grandfathering provision that allows an adviser to continue to treat a fund as an “institutional buyer” if the fund accepts additional investments from pre‑February 3, 2012 investors going forward.

Private Fund Adviser Exemption.  The Amendments create a new Massachusetts registration exemption for advisers whose only clients are funds excluded from the definition of “investment company” under either Section 3(c)(1) (a “3(c)(1) fund”) or Section 3(c)(7) of the Investment Company Act of 1940.  An adviser seeking to rely on this exemption is subject to additional conditions to the extent it advises a 3(c)(1) fund that is not a “venture capital fund” within the meaning of SEC Rule 203(l)-1 under the Advisers Act, which defines the term for purposes of the new venture capital fund adviser exemption created by the Dodd-Frank Act (as discussed in the June 30, 2011 Goodwin Procter Alert).  The adviser must (a) limit the investors in such a non-venture capital 3(c)(1) fund to persons who at the time of investment are “qualified clients” as defined in SEC Rule 205-3 under the Advisers Act (which definition the SEC has amended, as discussed here; and (b) provide the fund’s investors with (i) certain disclosures at the time of purchase and (ii) annual audited financial statements for the fund.  The condition relating to the qualified client status of fund investors requires that an investor deduct the fair market value of that person’s primary residence, less the amount of debt up to fair market value secured by the property, in determining whether the net worth standard has been met, and includes a grandfathering provision for pre-February 3, 2012 funds with non-qualified client investors.  All advisers relying on the new private fund adviser exemption must file with the Division the reports filed with the SEC by “exempt reporting advisers.”  (The reporting requirements for exempt reporting advisers are discussed in the June 30, 2011 Goodwin Procter Alert.)  Relying advisers must also meet a condition regarding the absence of any disqualification based on certain disciplinary matters, and pay a $300 reporting fee.

Enforcement.  The Division will begin enforcing the Amendments August 3, 2012.