On June 22, 2011 the Securities and Exchange Commission ("SEC") adopted final rules (the "Final Rules") under the Investment Advisers Act of 1940 ("Advisers Act") to implement provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") that eliminated the long-standing registration exemption for advisers with less than 15 clients and instead created new exemptions for advisers to venture capital funds, private fund advisers with less than $150 million in assets under management, and foreign private advisors. The SEC proposed the exemption and implementation rules in November 2010. Each of these rules, except for the exemption for advisers to venture capital funds, has been adopted in substantially the same form as previously proposed by the SEC and become effective on July 21, 2011. In addition, the SEC adopted the "family office" rule, which defines those "family offices" that are excluded from the definition of investment adviser under the Advisers Act and, thus, are not subject to regulation under the Advisers Act.1
Extension of Compliance Deadline
As expected, the Final Rules contain an extension of the registration deadline for advisers currently relying on the "less than fifteen client" exemption2 until March 30, 2012. In order to obtain clearance by March 30, 2012, advisers required to register should file their complete registration application on Form ADV no later than February 14, 2012.
Transition of SEC Registered Advisers to State Regulation
SEC registered investment advisers that must withdraw their federal registration and transition to state registration as a result of the Final Rules (discussed below) must do so by June 28, 2012.
Private Fund Advisers and SEC Registration
Many venture capital and private equity fund managers have avoided registration under the Advisers Act by relying on the "private investment adviser" exemption in Section 203(b)(3) of the Act, which exempts firms that (i) have fewer than 15 clients over the course of the preceding 12 months and (ii) neither have held themselves out generally to the public as an investment adviser nor acted as an investment adviser to any investment company registered under the Investment Company Act of 1940 (the "40 Act").
Title IV of the Dodd-Frank Act eliminates the private adviser exemption effective July 21, 2011 and creates three, more narrow exemptions for:
- Advisers solely to venture capital funds.
- Advisers solely to private funds with less than $150 million in assets under management in the United States.
- Certain foreign advisers without a place of business in the United States.
Exemptions for Managers of Venture Capital Funds
The Dodd-Frank Act amended the Advisers Act to exempt from registration advisers that only manage venture capital funds, and directed the SEC to define the term "venture capital fund." Rule 203(l)-1 of the Final Rules provides that investment managers that advise only "venture capital funds" that meet specific criteria are exempt from registration.
Under the Final Rules, a venture capital fund is a private fund that:
- Invests primarily in "qualifying investments" (generally, equity of privately-held operating companies that do not distribute proceeds from debt financings in exchange for the fund's investment in the company).
- Is not leveraged except for a limited amount of short-term debt.
- Does not offer redemption rights to its investors.
- Represents itself to investors as pursuing a venture capital strategy.
In a departure from the proposed rule, the Final Rules permit a venture capital fund's portfolio investments to include a "basket" of "non-qualifying investments" (i.e., investments by the fund that do not constitute qualifying investments in portfolio companies) of up to 20 percent of its committed capital. Additionally, the Final Rules eliminate the requirement that the venture capital fund or its adviser be involved in the management of its qualifying portfolio companies.
Under a grandfathering provision, funds that began raising capital by the end of 2010 and represented themselves as pursuing a venture capital strategy will generally be considered venture capital funds if they do not sell securities to, or accept any capital commitments from, any person after July 21, 2011.
Exemption for Private Fund Advisers with Less Than $150 Million in Assets under Management in U.S.
The Final Rules also implement the Dodd-Frank Act exemption for private fund advisers with less than $150 million in assets under management in the United States. Under new rule 203(m)-1, an adviser may advise an unlimited number of private funds, provided that the aggregate value of the assets of the private funds is less than the $150 million limit. Under the Final Rules, advisers must determine assets under management on an annual basis (rather than quarterly as proposed). If the fair value of assets under management exceeds the $150 million threshold in a given year, the adviser then has 90 days after filing its annual updating amendment (due by March 30 of each year) to register under the Advisers Act (effectively a transition period of up to 180 days after the end of a fund's fiscal year rather than the 90-day transition period in the proposed rules). Finally, the definition of a "private fund" was expanded to include any company excluded from the definition of "investment company" under Section 3 of the 1940 Act (for example certain real estate funds under 3(c)(5)(C)), rather than only those excluded pursuant to Sections 3(c)(1) and 3(c)(7).
Exemption for Foreign Private Advisers
The Dodd-Frank Act also amended the Advisers Act to provide an exemption from registration for foreign advisers that do not have a place of business in the United States, and have:
- Less than $25 million in aggregate assets under management from U.S. clients and private fund investors; and
- Fewer than 15 U.S. clients and private fund investors.
Reporting Requirements for Private Fund Advisers
While providing the exemptions from registration for private fund advisers and venture capital advisers discussed above, Sections 407 and 408 of the Dodd-Frank Act gave the SEC authority to require exempt advisers to maintain such records and submit such reports as the SEC "determines necessary or appropriate in the public interest." The Final Rules require these so-called "exempt reporting advisers" to submit an annual report with the SEC by filing an abbreviated Form ADV Part 1 that includes only a limited subset of items3, including:
- Basic identifying information for the adviser and the identity of its owners and affiliates.
- Information about the private funds the adviser manages and about other business activities in which the adviser and its affiliates are engaged that present conflicts of interest that may suggest significant risk to clients.
- The disciplinary history (if any) of the adviser and its employees that may reflect on the integrity of the firm.
In addition, exempt reporting advisers will be required to comply with the enhanced private fund reporting requirements adopted under the Final Rules, including completing Item 7.B. and Schedule D of Form ADV for "private funds" advised by exempt reporting advisers.
Exempt reporting advisers will file reports on the SEC's investment adviser electronic filing system (IARD), and these reports will be publicly available on the SEC's website. These advisers will be required to file their first reports in the first quarter of 2012. The SEC also noted that "exempt reporting advisers" will be subject to recordkeeping rules to be adopted in the future and will be subject only to limited SEC examination oversight.
Reallocation of Regulatory Responsibility
Section 410 of the Dodd-Frank Act raised the threshold for SEC registration of advisers to $100 million from $25 million and created a new category of advisers called "mid-sized advisers." A mid-sized adviser, which generally may not register with the SEC, but rather must register with state securities regulators, is defined as an adviser that:
- Manages between $25 million and $100 million for its clients.
- Is required to be registered in the state where it maintains its principal office and place of business.
- Would be subject to examination by that state, if required to register.
If the mid-sized adviser's principal office and place of business is located in a state that requires it to register as an investment adviser, the adviser must register with the state. A mid-sized adviser must register with the SEC if it is not required to register in the state where it maintains its principal office and place of business, or if registered with that state, the adviser would not be subject to examination by that state's securities commissioner.4
Transition to State Registration; Registration Deadline
Advisers registered with the SEC as of January 1, 2012 will have to declare that they are permitted to remain registered by amending their Form ADV no later than March 30, 2012 pursuant to new rule 203A-5.
Mid-sized advisers that are no longer eligible for SEC registration must amend their Form ADV no later than March 30, 2012 to transition to state registration and withdraw their SEC registration by filing Form ADV-W no later than June 28, 2012. Mid-sized advisers registered with the SEC as of July 21, 2011 must remain registered with the SEC (unless otherwise exempted) until January 1, 2012.
Until July 21, 2011 (the effective date of the Final Rules), advisers applying for registration that qualify as mid-sized advisers may register with either the SEC or the appropriate state securities authority. Thereafter, mid-sized advisers must register with the appropriate state securities authority of their home states (and potentially other states in which they have clients or offices).
According to the SEC, approximately 3,200 of the current 11,500 registered advisers will switch from registration with the SEC to registration with the states. These advisers will continue to be subject to the Advisers Act's general anti-fraud provisions.
Family Office Rule
The SEC also adopted Final Rules exempting so-called "family offices." Traditionally, many family offices have relied on the new Section 203(b)(3) exemption and thus Congress instructed the SEC to adopt a rule to exclude family offices from adviser registration. The Final Rule contains an expanded exemption that includes additional categories of family members and key employees as family clients that can receive investment advice without violating the exemption.
The SEC also amended the pay-to-play rule5 to permit an adviser to pay a registered municipal advisor, or an SEC registered investment adviser or broker-dealer, to act as placement agent to solicit government entities on its behalf, so long as the municipal advisor is subject to the MSRB-adopted pay-to-play rule, or the SEC registered adviser or broker-dealer is subject to a FINRA-adopted pay-to-play rule, that is at least as stringent as the investment adviser pay-to-play rule.