In December 2010, the North American Securities Administrators Association, Inc. (NASAA), which represents the securities administrators of all 50 states, the District of Columbia, the Commonwealth of Puerto Rico, Mexico, and the various provinces of Canada, published for comment a proposed model rule (Model Rule) that would exempt investment advisers to certain types of private funds from state investment adviser registration. In response to public comments from the December proposal, NASAA recently published a revised version of the Model Rule for additional public comment.

An adviser to a private fund or to a venture capital fund who relies on an exemption from SEC registration must also rely on an exemption from the state(s) securities law in which it has a place of business. NASAA proposes that the Model Rule, if and when adopted by NASAA and then the states, will serve as the state investment adviser registration exemption for investment advisers to private funds or venture capital funds as exempt under the Investment Advisers Act of 1940, by way of Section 203(l) and (m).

The Model Rule would be available to advisers to private funds, excluded from the definition of an investment company under Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940. However, 3(c)(1) funds would only be included within the Model Rule coverage to the extent that all of the investors in such a fund met the definition of a “qualified client” under SEC Rule 205-3(d)(1). This SEC rule is in the process of being revised (see article herein, Performance-Based Compensation Rule to be Revised) to require a person to have at least $1 million of assets under management with the adviser or a net worth in excess of $2 million not including the value of the individual investor's personal residence and indebtedness on such residence.

In addition, an adviser to a Section 3(c)(1) fund who would rely on the Model Rule as an exemption from state registration must provide, on an annual basis, audited financial statements to each of the investors along with certain other disclosure information. The Model Rule as currently proposed would also provide a grand fathering provision to cover advisers who manage funds with existing investors who do not qualify as qualified clients.

Further, the exemption would not be available if the adviser or any of its affiliates are subject to a disqualification under Rule 262 of SEC Regulation A. Finally, the adviser would also be required to file a notice and pay a fee with the state securities administrator in order to qualify for the exemption.

NASAA's revised Model Rule proposal is currently out for comment until July 13, 2011. A copy of the proposal is available on the NASAA Web site at