On June 22, 2011, the US Securities and Exchange Commission (SEC) adopted final rules exempting or excluding from SEC registration certain venture capital, private fund, foreign private and family office advisers that, as of July 21, 2011, may no longer rely on the newly-repealed "private adviser" or "less than 15 clients" registration exemption.1 Some of these advisers will need to begin making filings and taking other actions as "exempt reporting advisers." The SEC also confirmed the anticipated extension of the deadline by which advisers who do not qualify for an exemption or exclusion need to register to March 30, 2012. As a result, advisers that need to register with the SEC must take the following actions by February 14, 2012:2

  • Applications for registration must be submitted electronically
  • A chief compliance officer must be designated
  • A compliance manual must be finalized
  • A compliance infrastructure must be operational

This Client Alert discusses the final rules regarding the exemptions and exclusions and other related amendments. Please ask about our US Investment Adviser Registration Introductory Materials for information about registration and developing a compliance program.

The Exemptions and Exclusions

Venture Capital Fund Advisers

Investment advisers acting solely for venture capital funds are exempt from registration with the SEC (but may be "exempt reporting advisers" as discussed below).

Definition of Venture Capital Fund

Funds that meet all of the following criteria are venture capital funds:4

  1. Exempt from registration under Section 3(c)(7) (funds whose only investors are "qualified purchasers" as defined in the Investment Company Act of 1940 (Investment Company Act)) or Section 3(c)(1) (funds with fewer than 100 beneficial owners) of the Investment Company Act.
  2. Make "Qualifying Investments," i.e., directly-acquired equity securities3 of Qualifying Portfolio Companies (described below), provided that the fund can hold non-Qualifying Investments (described below) in an aggregate amount not to exceed 20 percent of its aggregate capital contributions and uncalled committed capital.
  3. Do not incur fund-level leverage other than: (1) short-term borrowings (i.e., not to exceed 120 calendar days) in an amount up to 15 percent aggregate capital contribution and uncalled committed capital and (2) certain guarantees of Qualifying Portfolio Company obligations.
  4. Do not offer investors redemption or similar liquidity rights (except under extraordinary circumstances such as tax and regulatory changes).
  5. Hold themselves out as pursuing a venture capital strategy.
  6. Are not registered investment companies or business development companies.

Qualifying Portfolio Companies

Qualifying Portfolio Companies must meet all of the following criteria:

  1. Are not and do not have a control relationship with reporting or foreign traded companies at the time of acquisition by the fund.
  2. Do not incur leverage in connection with the fund’s investment for the purpose of distributing the proceeds to the fund.
  3. Are operating companies (i.e., are not themselves investment funds).

Non-Qualifying Investments

The criteria for permissible investments by venture capital funds in non-Qualifying Investments (other than short-term holdings5) are the following:

  1. Limited, in the aggregate, to no more than 20 percent of capital commitments, measured at the time of acquisition of each non-Qualifying Investment using historical cost or fair value, consistently applied based on how the fund has determined value since inception.
  2. Includes investments in non-Qualifying Portfolio Companies and/or any investments that do not otherwise satisfy the criteria for Qualifying Investments, such as debt securities and securities acquired in a secondary market.

Grandfathering Provision

Each pre-existing fund that meets all of the following criteria is grandfathered and may therefore be treated as a venture capital fund without satisfying any of the other criteria set forth above:

  1. The fund accepted all capital commitments by July 21, 2011 (whether or not such commitments have been called by that date).
  2. Fund interests were sold to one or more unrelated investors before December 31, 2010.
  3. The fund held itself out to investors and potential investors through statements and representations as pursuing a venture capital strategy.

Applicability to Non-US Advisers

Non-US advisers may rely on the venture capital fund adviser exemption only if all of their clients, whether US or non-US, are venture capital funds.

Co-Investment Vehicles

  1. Co-investment vehicles consisting of one single investor may be considered private funds only to the extent they do not receive individualized investment advice apart from the fund with which they co-invest. Otherwise, a co-investment vehicle may be deemed a separate account — precluding both US and non-US advisers from relying on the venture capital adviser exemption (the exemption requires the adviser to advise only venture capital funds). Alternatively, if a co-investment vehicle is in fact a fund, it must meet all of the criteria described above to meet the definition of a venture capital fund.
  2. With respect to existing co-investment vehicles, an adviser should view the co-investment vehicle in the same manner it did for purposes of counting clients in connection with the previous exemption known as the "private adviser" or "less than 15 clients" exemption.

Private Fund Advisers

Investment advisers acting solely for qualifying private funds with assets of less than $150 million in private fund assets under management in the US are exempt from registration with the SEC (but may be exempt reporting advisers as discussed below).

Definition of Qualifying Private Fund

Funds that are exempt from registration under Section 3(c)(7) (funds whose only investors are "qualified purchasers" as defined in the Investment Company Act) or Section 3(c)(1) (funds with fewer than 100 beneficial owners) of the Investment Company Act, are not registered as investment companies and are not business development companies are qualifying private funds.6

Calculating Assets Under Management

  1. Assets are measured by market value or fair value (where market value is not available) on a gross basis with leverage, if any, including proprietary assets, uncalled capital commitments and assets managed without compensation.7
  2. Except as otherwise provided for non-US advisers (as discussed below), all private fund assets, including those outside the United States, must be counted. Advisers with a principal office and place of business, i.e., where the adviser controls management of the private fund assets (although day-to-day management may also take place at another location) in the United States are considered US advisers.
  3. After the initial calculation for registration by March 30, 2012, the calculation must be conducted annually based on the adviser’s fiscal year end for purposes of determining whether an adviser may rely on the exemption.

Applicability to Non-US Advisers

  1. Advisers with a principal office and place of business outside of the United States are non-US advisers. A place of business is not necessarily a principal office, but, rather, is any office where the adviser regularly provides, or holds out to the general public that it provides, advisory services, solicits, meets with or otherwise communicates with clients. Research and due diligence alone would not cause an office to be a place from which assets were under management in the United States, if a person outside the United States made and implemented independent investment decisions for the adviser.
  2. Non-US advisers may only rely on the exemption if their only clients that are US Persons are private funds. "US Persons" are defined in the manner in which it is defined in Regulation S under the Securities Act of 1933, which looks to the residence of an individual, and treats legal partnerships and corporations as US Persons if they are formed in the United States.
  3. A new rule requires an adviser relying on the exemption to treat a discretionary or other fiduciary account as a US Person if the account is held for the benefit of a US Person by a non-US fiduciary who is a related person (such as an affiliate of the adviser).
  4. Non-US advisers need only count private fund assets managed at a place of business in the United States for purposes of the $150 million threshold.

Co-Investment Vehicles

  1. Co-investment vehicles consisting of one single investor may be considered private funds only to the extent they do not receive individualized investment advice apart from the fund with which they co-invest. Otherwise, it may be deemed a separate account — precluding a US adviser from relying on the private fund adviser exemption (the exemption requires the adviser to advise only private funds). Alternatively, if a co-investment vehicle is in fact a fund, the US adviser must include the co-investment vehicle’s assets in the adviser’s calculation of assets under management for purposes of the $150 million threshold.
  2. With respect to existing co-investment vehicles, an adviser should view the co-investment vehicle in the same manner it did for purposes of counting clients in connection with the previous exemption known as the "private adviser" or "less than 15 clients" exemption.
  3. In the case of non-US advisers, a co-investment vehicle which is a separate account would preclude the adviser from relying on the private fund adviser exemption unless the co-investment vehicle is managed outside of the United States. The non-US adviser, however, may still be able to rely on the foreign private adviser exemption described below. If the co-investment vehicle managed by a non-US adviser is a fund, then, if it is managed from a place of business in the United States, its assets must be included in the $150 million threshold for purposes of the private fund adviser exemption.

Foreign Private Advisers

Definition of Foreign Private Adviser

Investment advisers meeting all of the following criteria are exempt from registration with the SEC (also, such advisers will not be exempt reporting advisers):

  1. No place of business in the United States. This place of business requirement is determined in the same manner as for purposes of the private fund adviser exemption discussed above.
  2. Fewer than 15 clients in the United States and investors in the United States. For this purpose, the beneficial owners of fund securities are included for purposes of counting the number of investors in a Section 3(c)(1) fund or determining whether all investors are qualified purchasers in a Section 3(c)(7) fund, excluding Knowledgeable Employees.8 A fund to which an adviser provides investment advice based on its investment objective rather than the individual investment objectives of its investors is one client. An adviser must also count toward the fewer than 15 clients threshold those clients for whom it provides advisory services without compensation such as principals of the firm. A client who is also an investor in a private fund is only counted once. Similarly, an adviser does not have to count a private fund as a client if it already includes in the count an investor in the fund. The owners of debt, including short-term paper, issued by the private fund, are counted as investors. Whether clients and investors are in the US is determined in the manner described above for the private fund adviser exemption.
  3. Aggregate assets under management attributable to clients in the US and investors in the US in private funds of less than $25 million.
  4. Do not hold themselves out generally to the US public as investment advisers.

Calculation of Assets Under Management

  1. Assets under management are measured by market value or fair value (where market value is not available) on a gross basis with leverage, if any, including proprietary assets, uncalled capital in the case of funds, and assets managed without compensation.
  2. For purposes of the Foreign Private Adviser exemption, only assets under management attributable to clients in the US and investors in the US in private funds are included.

Foreign Affiliated Advisers of US Registered Advisers

The SEC stated in the release adopting the exemptions that nothing in the new rules is intended to withdraw any prior statement of the SEC as expressed in a line of no-action letters know as the Unibanco letters. In the Unibanco letters, the SEC provided assurances that it would not recommend enforcement action in situations in which: (i) an unregistered non-US adviser and its registered affiliate are separately organized; (ii) the registered affiliate is staffed with personnel (located in or out of the United States) who are capable of providing investment advice; (iii) all personnel of the non-US adviser involved in US advisory activities are deemed "associated persons" of the registered affiliate and (iv) the SEC has adequate access to trading and other records of the non-US adviser and to its personnel to the extent necessary to enable it to identify conduct that may harm US clients or markets. Although the SEC confirmed that its position in Unibanco may continue to be relied upon, it also said that it would provide guidance, as appropriate, based on facts that may be presented regarding the application of Unibanco in the context of the new exemptions.

Co-Investment Vehicles

As previously discussed with respect to the private funds adviser exemption, a co-investment vehicle investing alongside a private fund which consists of one single investor may be considered a private fund only to the extent the vehicle does not receive individualized investment advice apart from the fund with which it co-invests. A non-US adviser may be able to rely on the foreign private adviser exemption if it meets the less than $25 million and 15 client criteria described above. For purposes of the foreign adviser exemption, if the co-investment vehicle is a fund, the assets in the vehicle attributable to US investors as well as the number of US investors in the fund, would be included in the less than $25 million and 15 client calculations, respectively. If the co-investment vehicle is a separate account, it would be included in the adviser’s calculation of assets and clients if the investor is a US Person.

Family Office Advisers

Advisers meeting all of the following conditions may be excluded from the Advisers Act registration requirement under the family office adviser exclusion (these advisers will not be exempt reporting advisers):

Conditions to Exclusion:9

  1. Limited to family offices that provide advice about securities only to certain "family clients" (as discussed below).
  2. Requires that family clients wholly own the family office and family members and/or family entities control the family office.
  3. Precludes a family office from holding itself out to the public as an investment adviser.
  4. Cannot provide advice to multiple families.

Definition of Family Clients:

  1. Current and former family members ("family member" includes all lineal descendants of a common ancestor10 (who may be living or deceased) as well as current and former spouses or spousal equivalents of those descendants, provided that the common ancestor is no more than 10 generations removed from the youngest generation of family members; a "family member" includes current and former stepchildren, foster children and persons who were minors when another family member became their legal guardian.
  2. Certain employees of the family office (and, under certain circumstances, former employees).
  3. Charities funded exclusively by family clients, estates of current and former family members or key employees.
  4. Trusts existing for the sole current benefit of family clients or, if both family clients and charitable and non-profit organizations are the sole current beneficiaries, trusts funded solely by family clients, revocable trusts funded solely by family clients, certain key employee trusts, and generally, companies wholly owned exclusively by, and operated for the sole benefit of, family clients.

Grandfathering Provision:

Pre-existing family office advisers that meet all of the following criteria are grandfathered and may therefore be excluded from registration.

  1. Were not registered or required to be registered on January 1, 2010.
  2. Meet all of the required conditions under the family office exclusion but for their provision of investment advice to certain clients (including, for example, natural persons who, at the time of their applicable investment, are officers, directors, or employees of the family office who have invested with the family office before January 1, 2010 and are accredited investors or any company owned exclusively and controlled by one or more family members).

Advisers qualifying for the family office adviser exclusion are not exempt reporting advisers.

Exempt Reporting Advisers

Advisers qualifying for the venture capital fund adviser or private fund adviser exemptions will be subject to certain SEC reporting requirements. Specifically, exempt reporting advisers must file their first public reports on Form ADV electronically through the IARD system between January 1 and March 30, 2012. Exempt reporting advisers will be required to identify the exemption they are relying upon and complete certain items on Form ADV. These items call for identification details such as form of organization and control persons; other business activities of the adviser and its affiliates; disciplinary history (including each disciplinary event) and information on each private fund advised (including service providers and gross assets). Reports must be amended at least annually within 90 days of an adviser’s fiscal year end, and more frequently for certain changes that make the previously reported information inaccurate. Also, record keeping requirements for exempt reporting advisers will be addressed in a future SEC release. According to Form ADV instructions, exempt reporting advisers may continue to be subject to state registration, reporting or other obligations. Exempt reporting advisers, although not subject to routine examinations, may be subject to inspection if the SEC determines necessary.

Amended Form ADV

The SEC adopted amendments to Form ADV to reflect the new threshold for registration with the SEC from $25 million to $100 million11 in assets under management.12 The regulation of advisers with less than $100 million in assets under management will generally be left to the States.

The amendments also require more information from registered advisers and exempt reporting advisers. The amendments require additional information about three areas of an adviser’s operations: (i) additional information about private funds advised by the adviser; (ii) more detailed information about the types of clients, employees, and advisory activities, conflicts of interests and (iii) non-advisory activity and other financial industry affiliations. As to private fund reporting, the amendments require an adviser to complete a separate schedule for each private fund that it advises. This schedule requires an adviser to provide basic information regarding the organization, operation, and characteristics of each fund. It also requires information about five types of service providers that are commonly referred to as "gatekeepers" (administrators, prime brokers, custodians, auditors and marketers). Specifically, an adviser must identify each such provider, report its location, and indicate which, if any of them, are related to the adviser. The amended form also requires each adviser to a private fund to identify persons involved in the management of the fund, whether it is part of a master-feeder arrangement, whether it is a fund of funds, and what category, within seven broadly defined categories, best describes the fund’s investment strategy.

Advisers already registered with the SEC must file the new Form ADV by March 30, 2012. If an adviser must switch to State registration because it has less than $100 million in assets under management, it has until June 28, 2012 to withdraw from SEC registration and register with the State(s). Advisers in New York, Minnesota and Wyoming who do not otherwise qualify for an exemption or exclusion with assets between $25 and $100 million, must register with the SEC as opposed to those states. Advisers registering for the first time will be required to use the new Form ADV starting January 1, 2012 and, as previously stated, must be registered by March 30, 2012.

Form PF

The SEC only briefly discussed proposed Form PF in the releases adopting the above-discussed final rules, generally stating that, if adopted, registered advisers would use Form PF to report information about the private funds they manage for use by the Financial Stability Oversight Council in its assessment of systemic risk in the US financial system. Chairman Mary Schapiro, however, reported in the SEC’s Open Meeting on June 21, 2011 adopting the final rules that the SEC would supplement those rules with consideration of Form PF.

Form PF would require all private fund advisers to disclose assets under management and provide specific data in periodic non-public filings with the SEC including:

  • Gross and net asset value of each private fund
  • Monthly and quarterly fund performance data
  • Each private fund’s total borrowings, along with a breakdown of the fund’s borrowings among domestic and international financial institutions and non-financial institutions
  • Identities of creditors to which any of the adviser’s funds owes an amount equal to at least 5 percent of such fund’s net asset value
  • Total number of beneficial owners
  • Percentage ownership of five beneficial owners having the largest equity interests in the fund

Advisers with $1 billion or more in assets under management would be required to provide additional reporting, the focus of which would depend on the type of fund advised. These advisers would be required to report additional detailed information about each private equity fund under management, including:

  • Information about fund borrowings
  • Information about debt of controlled portfolio companies (including debt-to-equity ratios and debt maturity profiles)
  • Identity of persons providing bridge financing to portfolio companies and the amount of such financing
  • Additional information regarding financial industry portfolio companies
  • Information on events of default on any fund debt or portfolio company debt during the reporting period
  • A breakdown of the fund’s investments by industry and geography

Pay to Play

Rule 206(4)-5 was adopted on July 1, 2010 to prevent "pay to play" practices, which are the making of political contributions to elected officials in order to induce the award of investment advisory contracts to government investment plans. Rule 206(4)-5 prohibits:

  1. An investment adviser from receiving compensation for providing investment advisory services to a government entity for a period of two years after the investment adviser or certain of its personnel makes a political contribution to an elected official who is able to influence the selection of the investment adviser to such government entity (the 2-Year Ban).
  2. An investment adviser from paying any third parties (other than certain registered advisers or brokers) such as a solicitor or placement agent to solicit a government entity to which the investment adviser provides or seeks to provide investment advisory services.
  3. An investment adviser or certain of its personnel from coordinating or soliciting any person or political action committee to make a political contribution to a government entity to which the investment adviser provides or seeks to provide investment advisory services or make a payment to a political party of a state or locality in which the adviser provides or seeks to provide advisory services to a government entity. The 2-Year Ban took effect on March 14, 2011.

The recently adopted final rules amend Rule 206(4)-5 to clarify that it applies to foreign private advisers, venture capital fund advisers and private fund advisers.