Registration Compliance for Private Fund Advisers Postponed Until March 30, 2012
On June 22, 2011, the Securities and Exchange Commission ("SEC") adopted final rules and rule amendments ("Final Rules") under the Investment Advisers Act of 1940 ("Advisers Act") to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). The Final Rules, which replace the proposed rules the SEC published in November 2010, amend and expand the registration and reporting requirements applicable to investment advisers, affecting both advisers that are currently registered with the SEC and advisers that have been previously exempt from registration.
Many private equity and venture capital fund managers have historically not registered with the SEC as investment advisers pursuant to an exemption for advisers to fewer than 15 clients or funds. The Dodd-Frank Act eliminated that broad exemption and replaced it with more narrow exemptions for five classes of fund advisers:
- Fund advisers that solely advise venture capital funds
- Fund advisers that solely advise private funds that have, in aggregate, less than $150 million in assets under management
- Fund advisers that qualify as "foreign private advisers"
- Fund advisers that solely advise SBICs
- Fund advisers to family offices
Venture Capital Fund Exemption
The Final Rules generally adopt the definition of "venture capital fund" from SEC’s proposed rules, but with one major addition: 20% of a fund’s committed capital may be invested in investments that would otherwise disqualify the fund from using the exemption. The Final Rules define "venture capital fund" as a private fund that: (a) invests in qualifying investments (generally equity securities in privately held companies), subject to a basket of 20% of the fund's capital commitments to invest in non-qualifying investments; (b) does not borrow or provide leverage of more than 15% of its fund size and for not more than 120 days; (c) does not offer its investors redemption or liquidity rights; (d) presents itself as a venture capital fund; and (e) is not registered under the Investment Company Act of 1940 and is not treated as a business development company.
Private Fund Adviser Exemption
The Final Rules also implement exemption (2) above, referred to by the SEC as the "private fund adviser exemption." Significantly, while many fund managers think of assets under management ("AUM") in terms of committed capital, the Final Rules take a much broader view of AUM. Under the Final Rules, AUM is calculated using the market value of a private fund's assets, or the fair value where market value is unavailable. The calculation is made on a gross basis, without deducting any outstanding indebtedness or other accrued but unpaid liabilities. In addition, AUM must include family or proprietary assets, assets managed without receiving compensation, assets of foreign clients, and uncalled capital commitments.
Foreign Private Adviser Exemption
The Dodd-Frank Act defined a "foreign private adviser" as an investment adviser with (a) no place of business in the United States, (b) fewer than 15 clients in the United States in the private fund it advises and (c) less than $25 million in aggregate AUM. The Rules implement and clarify the exemption for foreign private advisers.
Advisers to Multiple Funds
The commentary accompanying the Final Rules contains interpretive guidance of interest to advisers with multiple funds. First, the SEC indicates that it will not permit advisers to combine multiple exemptions where no single exemption would apply. For example, if an adviser manages an SBIC and a non-SBIC fund, each of which has $100 million of AUM, the adviser would not qualify for the SBIC adviser exemption (because it does not solely advise SBICs) or the private fund adviser exemption (because it has $200 million of AUM). The commentary also indicates that advisers that are separately organized but operationally integrated may be treated as a single adviser in determining whether exemptions apply. Fund advisers thus cannot avoid registration by reorganizing their operations into multiple entities with less than $150 million each of AUM.
Reporting and Compliance Requirements
Private fund managers that are no longer exempt must register with the SEC by filing Form ADV and have their registrations accepted by March 30, 2012. Because the initial applications for registration can take up to 45 days to be approved, the SEC strongly encourages advisers registering with the SEC for the first time to file a complete application no later than February 14, 2012. Form ADV is filed electronically through the SEC’s Investment Adviser Registration Depository (IARD) and is made available to the public.
In addition, each investment adviser registered with the SEC must develop and implement a compliance program that includes a code of ethics and written policies and procedures and must review such policies and procedures annually for their adequacy and effectiveness. The adviser must also designate a compliance officer to oversee the adviser’s investment activities and ensure compliance with the Advisers Act. This program must be in place when an investment adviser’s registration becomes effective.
Fund managers that are exempt under the venture capital fund exemption or the private fund adviser exemption will also be subject to new record keeping and reporting requirements, in addition to any applicable state requirements regarding registration, examination and reporting. These fund managers, referred to as "exempt reporting advisers," must disclose limited information to the SEC on Form ADV, including information regarding organization, ownership, business activities that pose conflicts of interest, disciplinary actions and an overview of private funds advised. These disclosures must be made electronically through IARD, and information disclosed will be publicly available. Exempt reporting advisers must file Form ADV between January 1, 2012 and March 30, 2012. Exempt reporting advisers also must file updating amendments to their Form ADV at least annually and must file promptly for changes in certain information such as disciplinary information and control persons. Advisers that solely advise SBICs are not subject to these reporting requirements.
Mid-Sized Investment Advisers
Investment advisers with between $25 million and $100 million of AUM are prohibited from registration with the SEC and instead must register with the states, so-called "mid-sized advisers," subject to exceptions for (a) advisers in states not requiring registration or states that do not impose an examination requirement (currently Minnesota, New York and Wyoming), (b) nationally recognized statistical rating organizations, (c) pension consultants and (d) advisers registered with 15 or more states.
Each mid-sized adviser currently registered with the SEC must file an amended Form ADV by March 30, 2012 and, no later than June 28, 2012, must withdraw its registration with the SEC by filing Form ADV-W and register with the states. As is the requirement for all advisers registered with the SEC, each mid-sized adviser registered with a state or states must continue to file annual updating amendments to its Form ADV and must file an amendment promptly for changes in certain information such as disciplinary information and control persons.
Eligibility for registration with the SEC is to be determined annually, as part of an adviser's annual updating amendment. The Rules implement a buffer for advisers managing close to $100 million of AUM. To be required to switch from state regulation to SEC regulation, an adviser's AUM must be $110 million, and once registered with the SEC, an adviser is not required to withdraw its registration until it has less than $90 million of AUM.
Private fund managers should consult with counsel as soon as possible to determine their obligations under the new regulatory framework. Fund managers that must register should begin compliance efforts well in advance of the March 30, 2012 compliance date.