Effective as of July 21, 2011, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) repeals a key exemption from investment adviser registration currently relied upon by many private fund managers and replaces it with several much more limited exemptions from registration.
On November 19, 2010, the Securities and Exchange Commission (the “SEC”) proposed new rules, summarized below, that would implement and provide guidance regarding certain exemptions applicable to:
- an adviser that (i) provides advice solely to one or more private funds1 and (ii) has assets under management in the United States of less than $150 million (the “Private Fund Adviser Exemption”);
- an adviser solely to one or more venture capital funds (the “Venture Capital Exemption”); or
- a foreign private adviser that (i) has no place of business in the United States; (ii) has, in total, fewer than 15 U.S. clients and investors in private funds advised by that adviser; (iii) has less than an aggregate of $25 million in assets that are attributable to U.S. clients and investors in private funds advised by that adviser; (iv) does not hold itself out to the public as an investment adviser in the United States; and (v) does not advise any registered investment companies or business development companies (the “Foreign Adviser Exemption”).
Private Fund Adviser Exemption
The SEC’s proposed rules would exempt from the registration requirements of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), (but not certain recordkeeping and reporting requirements):
- any adviser with its principal office and place of business in the United States (a “U.S. adviser”) if that adviser satisfies the criteria set forth above;2 and
- any adviser with its principal office and place of business outside the United States (a “non-U.S. adviser”) if (i) all of the non-U.S. adviser’s clients that are U.S. persons3 are qualifying private funds and (ii) all assets managed by that adviser from a place of business in the United States are solely attributable to private fund assets, the aggregate value of which is less than $150 million.
To ensure compliance with the $150 million threshold, advisers would be required to calculate the value of all private fund assets they manage in the United States based upon the fair value thereof at the end of each calendar quarter. For purposes of calculating the value of “private fund assets,” advisers would include any assets managed without compensation and the amount of any uncalled capital commitments made by fund investors. Advisers would not be permitted to deduct any liabilities (such as accrued fees and expenses or the amount of any borrowing) for purposes of this calculation. U.S. advisers would be required to include the value of all private fund assets that they manage, including private fund assets of any non-U.S. clients, while non-U.S. advisers would be required to consider only the private fund assets they manage from a place of business in the United States.
An adviser generally would be required to register with the SEC by the end of the calendar quarter following the quarter-end date at which its private fund assets equaled or exceeded $150 million.
Venture Capital Exemption
As set forth above, an adviser solely to one or more “venture capital funds” is exempt from registration with the SEC as an investment adviser. The SEC’s proposed rules would define the term “venture capital fund” as a private fund that:
- owns solely (i) the equity securities of “qualifying portfolio companies” (as defined below), with at least 80 percent of the equity securities of each qualified portfolio company being acquired directly from that company (rather than from its security holders), (ii) cash and cash equivalents and (iii) U.S. Treasuries with a remaining maturity of 60 days or less;4
- directly, or through its fund manager(s), offers or provides significant managerial assistance to,5 or controls,6 each qualifying portfolio company;
- does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage in excess of 15 percent of the fund’s aggregate capital contributions and uncalled committed capital and any such borrowing, indebtedness, guarantee or leverage is for a non-renewable term of no longer than 120 days;
- does not offer its limited partners the ability to withdraw contributed capital or redeem their interests (except in “extraordinary” circumstances);
- represents itself as a venture capital fund to its investors; and
- is not registered as an investment company under the Investment Company Act of 1940, as amended (the “Company Act”), and has not elected to be treated as a “business development company,” as defined under the Company Act.
For purposes of the Venture Capital Exemption, a “qualifying portfolio company” would be defined as any company that:
- at the time of the venture capital fund’s investment or follow-on investment is not publicly traded or controlled by or under common control with a publicly traded company;7
- does not borrow, issue debt obligations or otherwise incur leverage in connection with the venture capital fund’s investments;
- uses the capital provided by the fund for operating or business expansion purposes rather than for the purpose of buying out other investors; and
- is not itself a private investment fund.8
The SEC’s proposed rules also include a grandfathering provision that would broaden the definition of venture capital fund with respect to certain existing funds. To qualify as a venture capital fund under the grandfathering provision, a private fund must: (i) have represented to investors and potential investors at the time it offered its securities that it was a venture capital fund; (ii) have sold its securities to one or more outside investors prior to December 31, 2010; and (iii) not sell any securities to (including the acceptance of any additional capital commitments) any person after July 21, 2011.
A non-U.S.-based adviser may rely on the Venture Capital Exemption only if all of its clients, whether U.S. or non-U.S., are venture capital funds.
As with the Private Fund Adviser Exemption, advisers qualifying for the Venture Capital Exemption will nevertheless be subject to certain recordkeeping and reporting requirements promulgated under the Advisers Act in accordance with the Dodd-Frank Act.
Foreign Adviser Exemption
The SEC’s proposed rules would provide the following guidance with respect to certain of the terms included in the statutory definition of foreign private adviser:
- For purposes of calculating the number of “clients,” the proposed rules would utilize the same general safe harbor for counting clients that is currently in place with respect to the private adviser exemption, with certain modifications;
- For purposes of calculating the number of “investors,” the proposed rules would define “investor” as any person who would be included in determining the number of beneficial owners under Section 3(c)(1) of the Company Act, or whether the outstanding securities of a private fund are owned exclusively by qualified purchasers under Section 3(c)(7) of the Company Act (including knowledgeable employees and any beneficial owners of short-term paper issued by a private fund);
- To avoid “double counting” of investors, a foreign private adviser would be permitted to treat as a single investor any person who is an investor in two or more private funds managed by that adviser.
In contrast with the Venture Capital Exemption and the Private Fund Adviser Exemption, advisers qualifying for the Foreign Adviser Exemption will not be required to register with the SEC or comply with any of the recordkeeping and reporting requirements applicable to registered advisers and exempt reporting advisers.
The SEC is currently seeking public comment on the proposed rules for a period of 45 days following their publication in the Federal Register. Promptly following the completion of this public comment period, the SEC is expected to consider any comments and adopt final rules.