The SEC recently proposed rules implementing certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that, among other things: (i) facilitate registration of advisers to hedge funds and other private funds; (ii) define “venture capital fund” and clarify certain exemptions to investment adviser registration; (iii) implement the mandate to require reporting by certain advisers that are exempt from SEC reporting; and (iv) increase the asset threshold that triggers adviser registration with the SEC.
Private Fund Advisers and Commission Registration
Previously, advisers to hedge funds and other private equity funds could take advantage of an exemption from registration for investment advisers with fewer than 15 clients, which counted each fund as a client rather than each investor in a fund. The Dodd-Frank Act eliminated this private adviser exemption. As a result, many advisers to hedge funds and other private equity funds will have to register with the SEC and be subject to the same oversight and other requirements as other SEC-registered investment advisers.
Advisers to these private funds will be subject to disclosure of certain additional information that is intended to assist and inform the SEC in performing its new role in overseeing investment advisers to private funds. Under the SEC’s proposed rules, such advisers would have to provide:
- Basic organizational and operational information about the funds they manage, such as information about the amount of assets held by the fund, the types of investors in the fund, and the adviser's services to the fund; and
- Identification of the auditors, prime brokers, custodians, administrators and marketers that perform critical roles for advisers and the private funds they manage.
In addition, all investment advisers registering with the SEC will now have to disclose:
- The types of clients they advise, their employees and their advisory activities;
- Any business practices that may present significant conflicts of interest (such as the use of affiliated brokers, soft-dollar arrangements and compensation for client referrals); and
- Additional information about any non-advisory activities and financial industry affiliations.
New Exemptions and Reporting Requirements for Such Exempted Advisers
Certain private fund advisers may rely on three new exemptions from registration created under the Dodd-Frank Act: (i) advisers solely to “venture capital funds”; (ii) advisers solely to private funds with less than $150 million in assets under management in the United States; and (iii) certain foreign advisers without a U.S. place of business. The SEC has proposed rules implementing the foregoing exemptions, including defining “venture capital fund” as a private fund that:
- Represents itself as being a venture capital fund;
- Only invests in equity securities of private operating companies to provide primarily operation or business expansion capital (not to buy out other investors), U.S. Treasury securities with a remaining maturity of 60 days or less, or cash;
- Is not leveraged and its portfolio companies may not borrow in connection with the fund's investment;
- Offers to provide a significant degree of managerial assistance, or controls its portfolio companies; and
- Does not offer redemption rights to its investors.
The SEC also proposes to grandfather existing funds that make venture capital investments in light of the difficulty or impossibility to conform existing funds.
However, under broad authority granted to the SEC by the Dodd-Frank Act, the SEC has proposed rules that would nonetheless require such exempted advisers to report certain information to the SEC on the same form that other investment advisers use to register with the SEC. Rather than completing all items on the form, these exempt reporting advisers would complete a limited subset of items, including identifying information, information about the funds private funds managed by the adviser and any conflict-of-interest information.
$100 Million Threshold for SEC Registration
Since 1996, regulatory responsibility for investment advisers has been divided between the SEC and the states with the threshold being $25 million under management that would require registration with the SEC. The Dodd-Frank Act raised this threshold for registration of investment advisers to $100 million by creating a new class of “mid-sized advisers” that would be subject to state registration rather than SEC registration. A “mid-sized adviser” is one that manages between $25 million and $100 million, is required to register in the state where it maintains its principal office and place of business and would be subject to examination by such state, if required to register. The SEC’s proposed rules relate to this definition and provide for the transition between federal and state registration for affected investment advisers.
The SEC also proposed to amend its pay-to-play rules prohibiting advisers from engaging in payto- play practices. Under the proposed amendment, an adviser would be permitted to pay a registered municipal advisor to solicit government entities on its behalf if the municipal advisor is subject to a pay-toplay rule adopted by the Municipal Securities Rulemaking Board that is at least as stringent as the investment adviser pay-to-play rule. The Dodd-Frank Act conferred new authority to the Municipal Securities Rulemaking Board over municipal advisors.