On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") into law. Set forth in Title IV of the Dodd-Frank Act is the Private Fund Investment Advisers Registration Act of 2010 (the "Registration Act"). The purpose of the Registration Act is to close a "regulatory gap" and create a more cohesive and robust regulatory regime that will address the perceived lack of effective monitoring and examination of investment advisers to hedge funds and certain other private funds. Broadly speaking, the Registration Act: (i) eliminates the "private adviser exemption" from the Investment Advisers Act of 1940 (the "Advisers Act"), thereby requiring many investment advisers that were previously exempt from registration to register with the Securities and Exchange Commission (the "SEC"); (ii) requires certain smaller investment advisers that were previously eligible to register with the SEC to transition to state registration; and (iii) imposes additional recordkeeping and reporting obligations on registered, as well as certain non-registered, investment advisers that advise "private funds" (as defined below). While investment advisers that are no longer exempt from SEC registration will be required to make significant changes in order to comply with the new regime, the Registration Act will also have an impact on many investment advisers that are exempt from SEC registration. The Registration Act becomes effective on July 21, 2011. During this one-year period, the SEC is expected to adopt rules and regulations providing procedures for registration and reporting and clarifications with respect to certain ambiguous provisions of the Registration Act.
Do I Need to Register with the SEC?
The Registration Act eliminates both (i) the "private adviser exemption" from SEC registration previously contained in Section 203(b)(3) of the Advisers Act for investment advisers that do not hold themselves out to the public as investment advisers and have fewer than 15 clients; and (ii) the "intrastate exemption" from SEC registration (applicable to investment advisers with clients that are all residents of the state in which the adviser maintains its principal place of business) where the investment adviser advises any private fund. As a result of the foregoing, many investment advisers to private funds will be required to register with the SEC, unless they fall within one of the specified exemptions.
Certain Private Fund Advisers. The Registration Act provides that an investment adviser that solely advises private funds and has aggregate assets under management ("AUM") in the United States of less than $150 million is exempt from registration with the SEC. A "private fund" is defined as any issuer that would be an investment company under Section 3 of the Investment Company Act of 1940 (the "Investment Company Act"), but for the exception provided by either Section 3(c)(1) or Section 3(c)(7) thereunder. Most private investment funds1 commonly rely on these provisions of the Investment Company Act to avoid regulation as an investment company and will therefore qualify as a "private fund." Note, however, that based upon a plain reading of this exemption, if an investment adviser advises private funds, but the adviser also advises separately managed accounts or other types of investment vehicles that do not fall within the definition of a private fund, such an adviser would not be eligible to rely on this exemption. In order for certain advisers to avail themselves of this exemption, there may be a trend in the future whereby separately managed accounts are structured as "private funds" rather than as managed accounts. In addition, no guidance is provided with respect to how "aggregate assets under management in the United States" for purposes of the $150 million threshold test will be determined. Will the SEC look to the principal place of business of the investment adviser, the jurisdiction in which the private fund is organized, the domicile of individual investors or the location of the portfolio investments of the private funds?2 Importantly, investment advisers that avail themselves of this exemption will remain subject to such recordkeeping and reporting requirements as the SEC "determines necessary or appropriate in public interest or for the protection of investors."
Venture Capital Fund Advisers. An investment adviser will also qualify for an exemption from SEC registration if it acts as an investment adviser solely to one or more venture capital funds. Within the next year, the SEC must define the term "venture capital fund." A Senate report on the Registration Act released earlier this year described venture capital funds as a subset of private investment funds specializing in long-term equity investments in small or start-up businesses. This has been the only attempt thus far to define venture capital funds and implies that the definition will focus on the types of investments that these funds make. In any event, one would expect that the definition will be narrowly construed so as not to capture private equity funds. Also note that similar to the reporting requirements described above, such advisers will be required to maintain records and provide to the SEC reports that the SEC "determines necessary or appropriate in public interest or for the protection of investors."
Foreign Private Advisers. The Registration Act provides a limited exemption for a "foreign private adviser," which is defined as an 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 clients and investors in the United States in private funds advised by such adviser of less than $25 million (or such higher amount as the SEC may, by rule, determine); and (iv) neither holds itself out generally to the public in the United States as an investment adviser nor acts as an investment adviser to any investment company registered under the Investment Company Act or any business development company.
Family Offices. The Registration Act excludes from the definition of "investment adviser" contained in Section 202(a)(11) of the Advisers Act investment advisers that advise only "family offices," consequently exempting such advisers from SEC registration. The Registration Act requires the SEC to define the term "family office" for purposes of this exclusion, and the SEC must do so in a manner that: (i) is consistent with its existing exemptive orders on family offices and the grandfathering provisions set forth in clause (iii) below; (ii) recognizes the range of organizational, management and employment structures employed by family offices; and (iii) does not exclude certain "grandfathered" investment advisers (i.e., persons that were not registered or required to be registered under the Advisers Act on January 1, 2010, solely because such persons provide investment advice to, and were engaged, prior to January 1, 2010, in providing investment advice to, certain natural persons and entities associated with a family office). Notwithstanding the foregoing, family offices excluded from the definition of the term "investment adviser" by virtue of this grandfathering provision will nevertheless be deemed investment advisers for purposes of certain antifraud provisions of the Advisers Act, specifically, Sections 206(1), (2) and (4) thereunder.
CFTC Registered Advisers that Advise Private Funds. The Registration Act provides a conditional exemption from registration for investment advisers registered with the Commodity Futures Trading Commission as commodity trading advisers that advise private funds. If the "business of the advisor should become predominately the provision of securities- related advice," however, then such adviser must register with the SEC. There is currently no guidance as to how this standard will be measured.
Small Business Investment Company Advisers. An investment adviser that solely advises small business investment companies, which are regulated by the Small Business Administration, is also exempt from SEC registration. Mid-Sized Private Fund Advisers. With respect to "mid-sized private funds," the Registration Act requires the SEC to provide registration and examination procedures that reflect the level of systemic risk posed by such funds taking into account the size, governance and investment strategy of such funds. For these purposes, the Registration Act does not define "mid-sized funds;" however, in the provisions of the Registration Act delineating the AUM thresholds for state and federal regulation of investment advisers (discussed below), mid-sized investment advisers are characterized as those with AUM between $25 million and $100 million. It is unclear whether the same standard will be applied here.
Do I Need to Register with State Securities Regulators?
The Registration Act prohibits an investment adviser from registering with the SEC if the adviser: (i) has AUM between $25 million and $100 million (or such higher amount as the SEC may, by rule, determine); and (ii) is required to be registered as an investment adviser with the securities regulator of the state in which it maintains its principal office and place of business and, if registered, would be subject to examination as an investment adviser by such state regulator (unless the investment adviser is an adviser to a registered investment company or business development company). If any investment adviser would be required to register with 15 or more states, it may instead register with the SEC. As a result, some investment advisers that are currently registered with the SEC must de-register with the SEC and, instead, register with their home state(s). This change will allow the SEC to focus its time and resources on larger investment advisers. Importantly, advisers located in states that do not have registration and examination requirements are still subject to the SEC's current registration threshold, specifically, advisers with AUM of more than $30 million must generally register with the SEC, and advisers with AUM between $25 million and $30 million may elect to register with the SEC.
What are my Recordkeeping and Reporting Obligations?
The Registration Act will subject certain registered investment advisers to enhanced recordkeeping, examination, reporting and disclosure requirements. In addition, the records of any private fund advised by an SEC-registered investment adviser are "deemed to be the records and reports of the investment adviser." SEC-registered investment advisers to private funds are required to maintain records regarding each private fund they advise, including a description of the following: amount of AUM; use of leverage; counterparty credit risk exposures; trading and investment positions; valuation policies and practices of the fund; types of assets held; side arrangements or side letters; trading practices; and other information relevant to determining potential systemic risk. There is currently no guidance as to what types of other information the SEC will deem relevant to determining potential systemic risk. SEC-registered investment advisers will also be subject to ongoing periodic reporting requirements which could be expanded beyond the current requirements under Form ADV.
Certain investment advisers not subject to registration with the SEC will also be subject to recordkeeping and reporting requirements. Specifically, investment advisers that solely advise (i) private funds and have AUM in the United States of less than $150 million; and (ii) venture capital funds are, in each case, required to maintain records and provide to the SEC reports that the SEC "determines necessary or appropriate in public interest or for the protection of investors." Although this broad standard creates uncertainty as to the extent of the recordkeeping and reporting requirements that will be promulgated by the SEC, practitioners expect that the SEC may adopt a "registrationlite" form applicable to this category of investment advisers.
The SEC will report annually to Congress on how the SEC uses the data collected to monitor the markets for the protection of investors and the integrity of the markets. The SEC will share with the Financial Stability Oversight Council (the "Council") such reports and other documents provided to it by investment advisers as the Council considers necessary for the purposes of assessing the systemic risk of private funds. Confidentiality protection is provided for any proprietary information submitted to the government, including sensitive, non-public information regarding the investment adviser's investment or trading strategies, analytical or research methodologies, trading data, computer hardware or software containing intellectual property. Also note that Section 210(c) of the Advisers Act has been amended to permit the SEC to require an investment adviser to disclose the identity, investments or affairs of any client "for purposes of assessment of potential systemic risk."
As per the Registration Act, reports filed with the SEC3 by investment advisers are not subject to disclosure pursuant to Freedom of Information Act ("FOIA") requests. In addition, pursuant to Section 9291 of the Dodd- Frank Act, the SEC "shall not be compelled to disclose records or information" if that information was obtained for "surveillance, risk assessments or other regulatory and oversight activities." Since the passage of the Dodd- Frank Act, a number of bills have been proposed to amend Section 9291 over concerns that the exemption is too broad, does not serve the public interest and is inconsistent with the goal of greater transparency for consumers and investors. House Financial Services Committee Chairman Barney Frank has scheduled a hearing for September 23, 2010, to examine whether the scope of the SEC's exemption from FOIA requests should be narrowed. In letters submitted to Chairman Frank and Senate Banking Committee Chairman Christopher Dodd, SEC Chairman Mary Schapiro stated, "The Dodd-Frank Act mandates a number of new responsibilities for the SEC to protect investors, including new authority over hedge funds, private equity funds and venture capital funds. . . . Fulfilling these responsibilities will require the SEC to expand and improve our examination and surveillance capabilities in order to provide the type of risk-focused regulatory oversight investors deserve. In order for our efforts to be successful, it is important that registered entities be able to provide us with access to confidential information without concern that the information will later be made public."
What will SEC Registration entail?
Once registered with the SEC, investment advisers are subject to routine and surprise examinations by the SEC staff. SEC-registered investment advisers must also comply with various substantive requirements of the Advisers Act. Some of the key areas of responsibility include:
- Compliance Policies and Procedures - adopting and implementing a compliance program reasonably designed to prevent and detect any violation of the Advisers Act, including appointing a chief compliance officer and reviewing compliance policies on an annual basis;
- Investment and Trading Practices - complying with the anti-fraud rules under the Advisers Act and complying with substantive requirements of the Advisers Act, including rules relating to performance fees, custody arrangements, pay to play prohibitions, agency-cross transactions, principal transactions, etc.;
- Record Retention - maintaining and retaining corporate, accounting and performance records, client related correspondence and trade confirmations for at least five years;
- Code of Ethics - adopting standards of conduct covering the adviser's employees, including personal securities trading by such employees;
- Rules on Advertising - complying with the advertising restrictions and prohibitions contained in the Advisers Act;
- Additional Disclosure Obligations - disclosing financial or disciplinary actions; and
- Filings - filing, updating and amending Form ADV as required by the Advisers Act.