On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted final rules to implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The final rules, which were adopted substantially as proposed, generally will require advisers to hedge funds and other private funds to register with either the SEC under the Investment Advisers Act of 1940 (the “Advisers Act”) or state securities authorities unless such advisers qualify for one of three new exemptions. Implemented in lieu of the now eliminated “private adviser” exemption of Section 203(b)(3) of the Advisers Act, the new exemptions apply to (i) advisers solely to “venture capital funds”; (ii) advisers solely to private funds with less than $150 million in assets under management (“AUM”) in the United States; and (iii) foreign private advisers. Although all three categories of advisers will be exempt from registration, the SEC will require advisers relying on the first two of these exemptions (“exempt reporting advisers”) to file certain reports with the SEC. Additionally, the final rules exclude “family offices” from the definition of investment adviser, thereby excluding these advisers from the registration requirements under the Advisers Act. The final rules also (i) reallocate regulatory responsibility for certain mid-size advisers from the SEC to the states and (ii) provide for certain new reporting requirements applicable to registered advisers and exempt reporting advisers.
In order to provide those advisers who relied on the “private adviser” exemption and may now be required to register with sufficient time to meet their obligations, the SEC has decided to delay the registration deadline until March 30, 2012.1
BackgroundSection 203 of the Advisers Act makes it unlawful to make use of any instrumentality of interstate commerce in connection with the provision of investment advice unless registered as an investment adviser under the Advisers Act or otherwise exempt from registration. Subject to certain specific exclusions, the Advisers Act defines an “investment adviser” broadly to include any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities. Advisers who fall within the scope of the definition of “investment adviser” are not required to register with the SEC if they satisfy an available exemption from registration
.Elimination of “Private Adviser” Exemption
As noted above, advisers to private funds historically have not been required to register with the SEC by virtue of the private adviser exemption, which exempted from registration any adviser that had fewer than 15 clients over the course of the preceding 12 months, did not hold itself out generally to the public as an adviser and did not act as an adviser to a registered investment company or business development company. For purposes of calculating whether an adviser had fewer than 15 clients, the adviser was allowed to count each private fund as a separate client. The Dodd Frank Act defines a “private fund” as any issuer that would be an investment company under the Investment Company Act of 1940 (the “Investment Company Act”) but for the exception provided by either Section 3(c)(1) or 3(c)(7) of the Investment Company Act. These exceptions require a fund to either limit itself to 100 total investors (Section 3(c)(1)) or permit only “qualified purchasers” to invest (Section 3(c)(7)). Most hedge funds, private equity funds, venture capital funds and other alternative investment funds rely on these exceptions to remain unregistered. Title IV of the Dodd Frank Act (“Title IV”) accomplishes the SEC’s goal of increasing oversight of private fund advisers by eliminating the private adviser exemption entirely. Accordingly, many investment advisers that currently rely on the exemption, including advisers that do not advise private funds, will be required to register with the SEC unless they can meet another available exemption.
New Exemptions and Exclusions
Although Title IV eliminates the private adviser exemption, it includes new exemptions for certain categories of investment advisers.
A. Exempt Reporting Advisers
Advisers relying on new exemptions under either Section 203(l) (the “venture capital exemption”) or Section 203(m) of the Advisers Act (the “private fund adviser exemption”) are referred to as “exempt reporting advisers.” While exempt reporting advisers are exempt from registering with the SEC as investment advisers, they still must file certain portions of Form ADV with the SEC.2 An exempt reporting adviser must submit its initial Form ADV electronically through the Investment Adviser Registration Depository (the “IARD”) within 60 days of relying on the exemption from registration under either Section 203(l) or Section 203(m) of the Advisers Act. The filing must be submitted by March 30, 2012. Additionally, such advisers may be required to register with the states in which they perform advisory services. Advisers qualifying for either the venture capital exemption or the private fund adviser exemption may decline to avail themselves of the exemption and instead choose to register with either the SEC or the appropriate state securities authorities depending on eligibility.
i. Advisers that Solely Advise “Venture Capital Funds”
Title IV exempts from SEC registration any investment adviser that advises solely “venture capital funds.” Because of the many similarities between venture capital funds and private equity funds, the SEC has issued a new rule defining venture capital funds narrowly in order to limit the number of advisers that can avail themselves of the venture capital exemption. Unlike advisers relying on the private fund adviser exemption, an adviser relying on the venture capital exemption may have an unlimited amount of AUM without having to register with the SEC.
Under the SEC’s new rules, a venture capital fund is a private fund that: (i) invests in equity securities of private companies in order to provide operating and business expansion capital, with at least 80% of each company’s securities owned by the fund having been acquired directly from the qualifying portfolio company;3 (ii) does not borrow or otherwise incur leverage (other than limited short-term borrowing); (iii) does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances; (iv) represents itself as a venture capital fund to investors; and (v) is not registered under the Investment Company Act and has not elected to be treated as a business development company.
ii. Private Fund Advisers with Less Than $150 Million of U.S. AUM
Any investment adviser that advises solely private funds and has AUM in the United States of less than $150 million is exempt from registration under the Advisers Act. For advisers with a principal office and place of business in the United States, all private fund assets of the adviser are considered to be “in the United States.” For non-U.S. advisers, only private fund assets that the adviser manages from a place of business in the United States4will count towards the $150 million threshold.
B. “Foreign Private Advisers”
Another new exemption created by Title IV is an exemption for “foreign private advisers.” Title IV defines a “foreign private adviser” as any investment adviser that (i) has no place of business in the United States; (ii) has, in total, fewer than 15 clients and investors in the United States in private funds advised by the investment adviser; (iii) has aggregate AUM attributable to U.S. clients and U.S. investors in private funds advised by the adviser of less than $25 million; (iv) does not hold itself out generally to the public as an investment adviser; and (v) does not act as a company that has elected to be a business development company or as an investment adviser to an investment company.
Note that in counting the number of “investors” the foreign private adviser has in the United States, Title IV requires the adviser to “look through” any private fund it advises and count the number of individual U.S. investors in any such private fund during the preceding 12 months. While Title IV requires advisers to “look through” for purposes of determining applicability of this exemption, it does not require a foreign private adviser to count investors in private funds managed by the advisor as “clients”5 under the Advisers Act.
Exclusion for “Family Offices”
Many family offices took advantage of the private adviser exemption, which is eliminated under the Dodd-Frank Act. Title IV amends the definition of investment adviser under the Advisers Act to exclude any “family office,” thus exempting many such advisers from regulation. Section 202(a)(11)(G)-(1) of the Advisers Act defines an exempt family office as one that (i) provides advice about securities only to family clients of a single family; (ii) is wholly owned and controlled by family members; and (iii) does not hold itself out to the public as an investment adviser. The rule also includes grandfathering provisions intended to cover certain advisers that were not previously required to be registered under the Advisers Act.
Increased State Oversight of “Mid-Sized Advisers”
Title IV generally broadens the number of advisers subject to state regulation to encompass “mid-sized advisers.” Prior to the Dodd-Frank Act, Section 203A of the Advisers Act prohibited an investment adviser regulated by the state in which it maintained its principal office and place of business from registering with the SEC unless the adviser had AUM of at least $25 million or advised a registered investment company. Further, an adviser having between $25 million and $30 million of AUM had the option to register with the SEC, while an adviser with over $30 million of AUM was required to register with the SEC unless it was eligible for an exemption
.Under the Dodd-Frank Act, “mid-sized advisers” with AUM of between $25 million and $100 million would generally be subject to supervision at the state level, rather than with the SEC.6 If an investment adviser with AUM of $25 million to $100 million (i) is required to register with a state and (ii) would be subject to examination by the state authorities as a result of such registration,7 then the adviser must register in the state(s) in which it operates, although the adviser may register with the SEC if it would otherwise be required to register with 15 or more states. If the adviser is not required to register or is not subject to examination at the state level, the threshold for SEC registration remains $25 million. Thus, many investment advisers that were previously exempt from registration under Section 203(b)(3) now will find themselves categorized as “mid-sized advisers.”
The SEC amended Item 2 of Part 1A on Form ADV to reflect the new $100 million statutory threshold. Item 2.A requires each adviser registered with the SEC (and each applicant for registration) to identify whether it is eligible to register with the SEC because it (i) is a large adviser that has $100 million or more of regulatory AUM (or $90 million or more if an adviser is filing its most recent annual updating amendment and is already registered with the SEC); (ii) is a mid-sized adviser that does not meet the criteria for state registration or is not subject to examination; (iii) has its principal office and place of business in Wyoming (which does not regulate advisors) or outside the United States; (iv) meets the requirements for one or more of the revised exemptive rules under Section 203A of the Advisers Act; (v) is an adviser (or subadviser) to a registered investment company; (vi) is an adviser to a business development company and has at least $25 million of regulatory AUM; or (vii) received an order permitting it to register with the SEC.
Each registered investment adviser will have to file an amended Form ADV using a new uniform method for calculating AUM in order to determine eligibility for federal registration and any potential exemptions. In brief, an adviser’s regulatory AUM is calculated, on a gross basis, as the market value of the “securities portfolios” for which the adviser provides “continuous and regular supervisory or management services.” An adviser that provides these services to a private fund must count all of the private fund’s assets as a securities portfolio, regardless of whether those assets actually qualify as “securities.” This determination must be made within 90 days of filing the amended Form ADV. Each adviser registered with the SEC on January 1, 2012 must file an amendment to its Form ADV no later than March 30, 2011. In addition to being required to file an amended Form ADV no later than March 30, 2012, advisers that are no longer eligible for federal registration will be required to withdraw by filing Form ADV-W and register with the appropriate state(s) within 90 days of filing the amended Form ADV but no later than June 28, 2012.
Exemptions from the Prohibition on Registration with the Commission
Section 203A(c) of the Advisers Act authorizes the SEC to permit advisers to register with the SEC even if they would otherwise be prohibited from doing so. Pursuant to this authority, the SEC issued has permitted six types of investment advisers to register with the SEC under Rule 203A-2: (i) nationally recognized statistical rating organizations (“NRSROs”); (ii) certain pension consultants; (iii) certain investment advisers affiliated with an adviser registered with the Commission; (iv) investment advisers expecting to be eligible for Commission registration within 120 days of filing Form ADV; (v) certain multi-state investment advisers; and (vi) certain internet advisers. The final rules amend these exemptions by removing the exemption for NRSROs (now excluded from the definition of “investment adviser” under the Advisers Act), raising the minimum value of plan assets required to be managed by pension consultants from $50 million to $200 million, and lowering from 30 to 15 the number of states in which a multi-state investment adviser would be required to register before it is eligible to register with the SEC.
While new Rule 203A-5 becomes effective on July 21, 2011, an investment adviser may, at its own discretion, register with the SEC under the Investment Advisers Act prior to that date. Mid-sized advisers applying for registration with the SEC may register either with the SEC or the appropriate state authorities. Mid-sized advisers registered with the SEC as of July 21, 2011 must remain registered with the SEC (unless an exemption is available) until January 1, 2012. Thereafter, the adviser may transition to state registration. After July 21, 2011, newly registering mid-sized advisers must register with the appropriate state authorities. The SEC is only exempting those mid-sized advisers that are already registered with the SEC by July 21, 2011 if they have at least $25 million AUM. Each adviser registered with the SEC on January 1, 2012 must file an amendment to its Form ADV by March 30, 2012. Those mid-sized advisers who are no longer eligible for SEC registration must withdraw their registrations no later than June 28, 2012.
- The proposed rule would have allowed for a 90-day transitional period with two “grace periods.” Advisers would have had to first determine by August 20, 2011 whether they were eligible for SEC registration and file an amended Form ADV. Then, advisers would have had to register with state authorities and withdraw registration from the SEC by October 19, 2011. However, under the final rules all investment advisers, including exempt reporting advisers, must submit Form ADV to the SEC by March 30, 2012. ?
- Exempt reporting advisers must complete and file the following items of Part 1A of Form ADV: Items 1 (Identifying Information), 2.B. (SEC Reporting by Exempt Reporting Advisers), 3 (Form of Organization), 6 (Other Business Activities), 7 (Financial Industry Affiliations and Private Fund Reporting), 10 (Control Persons), and 11 (Disclosure Information). Exempt reporting advisers also must complete the corresponding sections of Schedules A, B, C and D.?
- A “qualifying portfolio company” is a company that is not publicly traded, does not incur leverage in connection with the fund’s investment, uses the fund’s capital for operating or business expansion purposes rather than to buy out other investors, and is not itself a fund.?
- A “place of business in the United States” is defined as any office where the investment adviser regularly provides advisory services, solicits, meets with, or otherwise communicates with clients, and any location held out to the public as a place where the adviser conducts any such activities that is located in the United States. To determine if a place of business is “in the United States” or if an investor is a U.S. Person, SEC Rule 202(a)(30)-1 defines the terms generally by incorporating the definitions of a “U.S. person” and “United States” from Regulation S under the Securities Act of 1933.?
- A “client” generally means (i) a natural person, their minor children, family members of the same household and related accounts and (ii) a legal organization, but not its owners.?
- The SEC further increased this threshold to $110 million under Rule 203A-1. The amended rules provide a buffer for mid-sized advisers with AUM close to $100 million to determine whether and when to switch between state and SEC registration. An adviser must register with the SEC once AUM reach the $110 million threshold, but does not need to withdraw registration until it has less than $90 million of AUM. The buffer is intended to prevent constant registering and withdrawing of registration because of fluctuations of AUM above and below the $100 million threshold due to market fluctuation or the departure or addition of clients.?
- New York, Minnesota and Wyoming advised the SEC that they will not subject investment advisers to examination at the state level. Advisers registered with all other states are subject to state examination.?