Recent changes to the Investment Advisers Act of 1940 codified in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) have resulted in significant changes in the mix of investment advisers registered with the SEC. Dodd-Frank eliminated the “15 client” exemption while adding in other narrower exemptions. Because of Dodd-Frank, the SEC also has added new reporting requirements for private advisers who are still exempt from registration.
As a result of Dodd-Frank, new SEC registrations of private fund investment advisers has risen sharply with 1,504 such new registrations since the enactment of Dodd-Frank. Of the 11,002 investment advisers now registered with the SEC, there are a total of 4,061 advisers who characterize themselves as advisers to private funds.
Private Fund Adviser Exemption. Before Dodd-Frank, private advisers were not subject to SEC registration so long as the adviser did not represent itself to the public as an investment adviser and had no more than 15 clients (each private fund counted as one client within the preceding 12-month period). The Private Fund Adviser Exemption is available if the adviser provides advice exclusively to so-called “private funds” and has less than $150 million in assets under management (AUM). An adviser managing between $25 million and $150 million in AUM is now required to register with the applicable state agency. Additionally, the SEC considers these advisers “exempt reporting advisers” that must file an annual report with the SEC on Form ADV. They also are subject to SEC examination but generally are not subject to provisions applicable to registered investment advisers.
In addition to the Private Fund Adviser Exemption, Dodd-Frank also created several other narrower exemptions. Two of the more prominent of these are the Foreign Private Adviser Exemption and the Venture Capital Adviser Exemption.
Foreign Private Adviser Exemption. A foreign adviser is exempt from state or SEC registration if the adviser: 1) has no place of business in the United States; 2) has, in total, fewer than 15 clients which number includes investors in the United States in private funds advised by the adviser; 3) has assets under management attributable to these clients and investors of less than $25 million; and 4) is not holding itself as an investment adviser to the public in the United States.
Venture Capital Adviser Exemption. This exemption is available to advisers that solely manage one or more venture capital funds. A venture capital fund is a private fund that: a) pursues a venture capital strategy; b) does not afford investors with redemption rights; c) holds at least 80 percent of its investment in cash, short-term holdings, and equity securities in private companies, and does not borrow against the investment to make fund distributions; and d) does not incur leverage in connection with more than 15 percent of the fund’s assets. Like the Private Fund Adviser Exemption, an adviser relying upon the Venture Capital Adviser Exemption must file an annual report on Form ADV with the SEC and is subject to SEC examination.
In addition to the jump in newly registered private advisers, the total assets under management of SEC-registered advisers has risen about 13 percent to $5.7 trillion. However, this increase in the AUM of registered advisers has likely occurred because of changes in the way AUM is measured under rules promulgated to implement Dodd-Frank in addition to the new registration requirements.
Before Dodd-Frank, investment advisers calculated their assets on a net basis. New SEC rules issued in conjunction with Dodd-Frank require that investment advisers calculate their AUM on a “gross” basis, rather than a net basis. As a result, advisers must calculate the fair value of their assets under Generally Accepted Accounting Principles without taking into account liabilities. Thus, it is likely that the increase in assets under management of SEC registered advisers partially resulted from this new valuation method for reporting purposes.
The foregoing changes are some of the more prominent changes instituted because of Dodd-Frank and its implementing regulations. Because of these changes private advisers must use the utmost diligence to ensure that they comply with SEC requirements, whether registered or properly exempted from the registration requirements.