1. INTRODUCTION

On 22 June 2011, the Securities and Exchange Commission ("SEC") adopted final rules and rule amendments under the Investment Advisers Act of 1940, as amended, (the "Advisers Act") implementing certain provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd Frank Act"). The new rules and amendments, which are largely in line with those proposed in November 2010, repeal the exemption from registration previously provided under Section 203(b)(3) of the Advisers Act for certain private investment advisers (the "Private Adviser Exemption"), 1 establish certain new exemptions from registration under the Advisers Act, and establish additional reporting requirements under the Advisers Act for certain exempt advisers.

1.1 Repeal of the Private Adviser Exemption

Effective as of 21 July 2011, the Dodd Frank Act repealed the Private Adviser Exemption under former Section 203(b)(3) of the Advisers Act. The Private Adviser Exemption was relied upon by investment advisers (i) which had fewer than 15 clients in the preceding 12 months; (ii) who did not hold themselves out to the public in the United States as an investment adviser; and (iii) who did not act as an investment adviser to an investment company registered under the US Investment Company Act of 1940 (the “Investment Company Act”) or a company that has elected to be a business development company under the Investment Company Act. Because advisers to US-based funds could typically count each fund as a single client for the purposes of the Private Adviser Exemption, irrespective of the total number of investors in that fund, under the previous rules an investment adviser could avoid registration under the Advisers Act as long as it only advised up to a maximum of 14 funds.2 Investment advisers who availed themselves of the Private Adviser Exemption were not required to provide reports or maintain or submit records for examination by the SEC.

By 30 March 2012, advisers who are or have been relying on the Private Adviser Exemption must either qualify for another exemption or register with the SEC and come into compliance with the obligations of a registered adviser under the Advisers Act.3 This memorandum will focus on two of the three new exemptions from registration.

1.2 New Exemptions Under the Advisers Act

The SEC has long held the view that activities conducted abroad by non-US advisers are less likely to implicate US regulatory interests. As a result, in place of the Private Adviser Exemption, the Dodd Frank Act establishes certain new exemptions from the registration requirements of the Advisers Act which could be utilized by foreign advisers, including, among others:4

  • · an exemption for certain foreign private advisers (the "Foreign Private Adviser Exemption") as codified in amended Section 203(b)(3) of the Advisers Act; and
  • an exemption for investment advisers solely to private funds with less than $150 million in assets under management in the United States (the "Private Fund Adviser Exemption") as codified in new Section 203(m) of the Advisers Act.  

2. FOREIGN PRIVATE ADVISER EXEMPTION

Effective as of 21 July 2011, the Foreign Private Adviser Exemption exempts from registration under the Advisers Act any investment adviser who meets the definition of "foreign private adviser" under new Section 202(a)(30) of the Advisers Act. 5 Section 202(a)(30) defines a "foreign private adviser" as any investment adviser who:

  • has no place of business in the United States;
  • has, in total, fewer than 15 clients in the United States and investors in the United State in the equity or debt securities of clients that are private funds;
  • has aggregate assets under management attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser of less than $25 million; and
  • 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 business development company regulated by the Investment Company Act.

The Exemptions Release provides guidance on new Rule 202(a)(30)-1, which defines certain of the terms used in the, Foreign Private Adviser Exemption as discussed below.  

2.1 Place of Business in the United States

The now-superseded Private Adviser Exemption permitted exempt foreign advisers to have a place of business in the United States, provided it was not the adviser's "principal" place of business. The new Foreign Private Adviser Exemption significantly narrows the availability of this exemption, by prohibiting any adviser seeking to avail itself of the exemption from having any "place of business" in the United States.

The "place of business" of an adviser refers to (i) any office at which it regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients; and (ii) any other location that is held out to the general public as a location at which the adviser conducts these activities. A "place of business" is considered to be "in the United States" if its physical location is in the United States.6  

The Exemptions Release clarifies that the term "place of business" is not intended to capture an office used solely for administrative or back-office activities, if such activities are not "intrinsic to providing investment advisory services" and do not involve communicating with clients. Unfortunately, the Exemptions Release offers little guidance on what activities would be considered "intrinsic to providing investment advisory services," aside from conducting research, which the Exemptions Release states is inherent to an advisory relationship. If research was conducted in a US office, that office would be considered a "place of business" in the United States and would therefore disqualify an adviser from using the Foreign Private Adviser Exemption. A client service office in the United States which is involved in communicating with clients, or an office in the United States that conducts marketing activities, are both likely to be considered a "place of business" in the United States even if no investment advice is provided. Only a US office with a purely administrative or back-office function would permit reliance on the Foreign Private Adviser Exemption, and even in this case advisers will need to make a subjective and fact intensive analysis of the activities conducted at this office, which the SEC may challenge.  

The Exemptions Release further clarifies that there is no presumption that a non-US adviser has a place of business in the United States merely because it has a US-based affiliate. However, if the non-US adviser regularly conducts activities which are "intrinsic to providing investment advisory services," as described above, from its affiliate's office in the United States, then the non-US adviser will be considered to have a place of business in the United States and be unable to avail itself of the Foreign Private Adviser exemption.

2.2 US Clients and Investors

As with the "place of business" element of the Foreign Private Adviser Exemption, the new rules significantly tighten the manner in which US clients and investors are counted for purposes of the "fewer than 15 clients and investors in the United States" limit. The new rules create a requirement to "look through" the private fund clients of a foreign adviser by counting the US-based investors of those clients, making it more difficult for foreign advisers to qualify for the exemption if the private fund clients they advise have a significant number of investors in the United States.  

A "client" or "investor" is considered to be "in the United States" for purposes of this exemption if such person meets the definition of "US person" under Regulation S of the Securities Act7 (herein after referred to as a "US client" or "US investor", as the case may be) at the time it becomes a client of the adviser or at the time it acquired securities issued by the private fund.8 New Section 202(a)(29) of the Advisers Act defines the term "private fund" in this context as an issuer that would meet the definition of an "investment company" under Section 3 of the Investment Company Act, but is not required to register under the Investment Company Act based on its reliance on an exemption provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.9 The Section 3(c)(1) and 3(c)(7) exemptions from Investment Company Act registration are the most commonly used exemptions by which foreign funds may sell securities to investors who are US persons without triggering the requirement to register under the Investment Company Act.  

For purposes of determining the number of investors in the United States in the adviser's private fund clients, an adviser seeking to rely on the Foreign Private Adviser Exemption must count any person that would be included in determining of the number of beneficial owners of a private fund's outstanding securities under Section 3(c)(1) of the Investment Company Act, or whether such private fund's outstanding securities are owned exclusively by qualified purchasers under Section 3(c)(7) of the Investment Company Act.10 This effectively requires a "look-through" to the number of underlying US investors whose interests in the adviser's private fund clients may be held through nominee and similar arrangements.11 As an example of this look-through mechanism in practice, an adviser to a master fund in a masterfeeder arrangement would have to count towards the fewer than 15 holder limit any US investors in any feeder fund formed or operated as a conduit for the purposes of investing in the master fund. An adviser would also need to count towards the fewer than 15 holder limit any US investor in an instrument, such as a total return swap, that effectively transfers the risk of investing in the private fund client from the record owner to the swap counterparty. However, to avoid double counting, the new rules provide that an investment adviser (i) can treat as a single US investor any person who is a US investor in two or more private funds advised by that investment adviser; (ii) need not count a private fund client towards the total if the adviser also counts any US investor in that private fund; and (iii) is not required to count a person as an investor if the adviser counts such person as a client.12  

Section 3(c)(7) of the Investment Company Act permits an issuer to treat as a "qualified purchaser" any person whom it reasonably believes is a qualified purchaser.13 Similarly, for the purposes of the Foreign Private Adviser Exemption, an investment adviser is able to apply a reasonable belief standard in determining the status of the US investors in its private fund clients. Therefore, if an investment adviser reasonably believes that any of the investors in its private fund clients are not in the United States, it need not count such investors toward the fewer than 15 US holder limit.  

Although the new "look-through" element of counting US investors is somewhat complex, counting the number of US-based clients of the adviser is relatively straight-forward. The most significant change compared to the previous rules is that under the Foreign Private Adviser Exemption an adviser must count US clients for whom the investment adviser provides advisory services without compensation.  

2.3 Assets Under Management

Although advisers who are eligible for the Foreign Private Adviser Exemption will not be required to report their assets under management to the SEC, the new rules require advisers to use the method of calculation in Form ADV for purposes of determining whether they are under the $25 million threshold. Specifically, in determining whether assets under management attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser has totalled less than $25 million, an adviser will be required to use the same method as is required for calculating "regulatory assets under management" under Item 5.F of amended Form ADV ("RAUM"). Item 5.F bases RAUM on the market value (or fair value, where market value is unavailable) 14 of the securities portfolio15 for which the adviser provides continuous and regular supervisory or management services. For purposes of the RAUM calculation, this portfolio must include the adviser's proprietary assets, assets managed without compensation and, in the case of private fund clients of the adviser, uncalled capital commitments available to the private funds from their investors.

Furthermore, for the purposes of the Foreign Private Advise Exemption, an investment adviser must calculate its RAUM on a gross basis without deduction of any outstanding indebtedness or accrued fees and expenses. For marketing and client communications, the SEC has acknowledged that an investment adviser may inform its clients of assets on a net basis.  

For purposes of calculating RAUM, an adviser provides "continuous and regular supervisory or management services" if (i) it has discretionary authority over a given account on an ongoing basis; or (ii) the adviser has a responsibility to recommend specific investments that would be executed by the adviser upon acceptance of such recommendations by the client.16

2.4 Reporting Requirements

Investment advisers who qualify for the Foreign Private Adviser Exemption are not subject to any reporting and recording keeping requirements by the SEC, unlike investment advisers who qualify for the Private Fund Adviser Exemption (discussed further below). However, investment advisors relying on the Foreign Private Adviser Exemption are still subject to the Adviser Act's antifraud provisions.17

2.5 Availability of Foreign Private Adviser Exemption

Many non-US advisers providing management or sub-management services to non-US and US private funds who access US markets through the exemptions provided by Section 3(c)(7) and Section 3(c)(1) of the Investment Company Act will not be able to rely on the Foreign Private Adviser Exemption because of the lower ceiling on US clients and US investors, which will be more difficult to meet than under the old rules, due to the introduction of the look-through requirements. In addition, the $25 million limit on RAUM in the United States does not distinguish between the initial capital invested or committed by US clients and US investors and any subsequent increases in value of their assets under management. As a result, a non-US adviser who is initially eligible for the Foreign Private Adviser Exemption may become a victim of its own success, and lose the exemption if its RAUM were to grow above the $25 million limit. Furthermore, an investment adviser may only rely on the Foreign Private Adviser Exemption if it does not have any offices in the United States at which the investment adviser regularly provides investment advisory services or communicates with clients, which is more restrictive than the previous rules, which were limited to foreign advisers with a "primary" place of business in the United States.

As a result, despite the clear advantages of the Foreign Private Adviser Exemption given its lack of SEC reporting requirements, reliance on the Foreign Private Adviser Exemption may be limited, and non-US advisers may need to rely on the Private Fund Adviser Exemption.

3. THE PRIVATE FUND ADVISER EXEMPTION

Section 203(m) and accompanying new Rule 203(m)-1(b) of the Advisers Act, effective as of 21 July 2011, generally exempts from registration non-US investment adviser which has:18

  • its principal office and place of business outside the United States;
  • US person clients who solely consist of private funds;19 and
  • assets under management managed at a place of business in the United States of less than $150 million.

The Exemptions Release provides guidance on new Rule 203(m)-1, which sets out the terms of the Private Fund Adviser Exemption.  

3.1 Application to non-US advisers

A non-US adviser – defined as an adviser whose principal office and place of business is outside the United Sates – can rely on the Private Fund Adviser Exemption regardless of the type or number of its non-US clients, the amount of assets it manages outside the United States or the size or nature of its advisory or other businesses outside the United States.

3.2 Principal Place of Business

A place of business for purposes of this exemption, like the Foreign Private Adviser Exemption, is (i) any office at which the adviser regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients; and (ii) any other location that is held out to the general public as a location at which the adviser conducts these activities. A "place of business" is considered to be "in the United States" if its physical location is in the United States.20

An adviser's principal office and place of business is the location where the adviser controls or has ultimate responsibility for, its advisory services, although day-to-day management of certain assets may take place elsewhere.

3.3 Clients

A non-US adviser may rely on the Private Fund Adviser Exemption if all of its clients who are US persons at the time of becoming its client are "private funds", as defined. As with the Foreign Private Adviser Exemption, a "private fund" in this context is defined in new Section 202(a)(29) of the Advisers Act as a fund which relies on an exemption from Investment Company Act registration provided by either Section 3(c)(1) or 3(c)(7) of the Investment Company Act.21 Unlike the Foreign Private Adviser Exemption, there is no requirement that an adviser "look through" its US private fund clients to count or assess the clients' US security holders.

If a non-US adviser has a US person client who is not a private fund, on the face of the rule it would not be able to rely on the Private Fund Adviser Exemption and would be subject to full SEC registration as an investment adviser. Notwithstanding the strict definition of a "private fund", if the adviser's private fund client is relying on another exemption from the Investment Company Act - for example, the Section 3(c)(5) real estate exemption - the SEC has clarified that the adviser would not lose its Private Fund Adviser status. The adviser would, however, have to count all that client's assets under management towards the $150 million US limit, and reflect them on the Form ADV submitted to the SEC (as described below).

Like the Foreign Private Adviser Exemption, new Rule 203(m)-1 of the Advisers Act, which sets out the new Private Fund Adviser Exemption, defines a US person by generally incorporating the definition of "US person" under Regulation S of the Securities Act.22 For the purposes of the Private Fund Adviser Exemption, determination of whether or not a client is a US person takes place at the time such person becomes a client of the adviser. If a non- US client subsequently relocates to the United States or otherwise becomes a US person without the knowledge of, or facilitation by, the adviser, the adviser can still rely on the Private Fund Adviser Exemption even if such client is not a private fund.

The treatment of managed accounts for purposes of the Private Fund Adviser Exemption is somewhat ambiguous. Although SEC guidance has set out certain limited circumstances in which US single-investor funds (which are in effect, managed accounts when placed under the discretion of the adviser) could be considered "private funds" for purposes of the Private Fund Adviser Exemption, 23 these circumstances appear to be quite limited. Because a traditional managed account in the United States would not be a private fund at all (in that it would have issued no securities and therefore would not be reliant on a Section 3(c)(1) or 3(c)(7) exemption from registration under the Investment Company Act), establishing a single investor fund for the sole purpose of allowing the adviser to avail itself of the exemption would risk running afoul of the Advisers Act prohibition on doing indirectly anything which would be unlawful to do directly.  

3.4 Assets Under Management in the United States

A US adviser, which by definition is one which has a principal office and place of business in the United States, must count all the assets it manages, worldwide, towards the $150 million asset limit for purposes of the Private Fund Adviser Exemption.24 A non-US adviser, on the other hand, need only count the assets it manages for US private fund clients at a place of business in the United States.25 As with the Foreign Private Adviser Exemption, for purposes of the RAUM calculation, the assets must include the adviser's proprietary assets, assets managed without compensation and, in the case of private fund clients of the adviser, uncalled capital commitments available to the private funds from their investors. Like the Foreign Private Adviser Exemption, assets under management are based on the adviser's RAUM as calculated according to Item 5.F of Form ADV and on a gross basis (though for marketing purposes, an investment adviser may advertise the amount of assets it manages on a net basis).

The analysis of the amount of RAUM in the United States frequently will turn not on whether the non-US adviser has a place of business in the United States, but rather on the amount of private fund assets it manages from such a US place of business. The SEC clarifies in the Exemptions Release that an office in the United States which is limited to providing research or conducting due diligence would not be considered an office where the adviser "manages assets" for the purposes of the $150 million limit. Marketing and conducting back office activities may also not be considered asset management activities for purposes of the Private Fund Adviser Exemption.26  

Finally, since an adviser relying on the Private Fund Adviser Exemption is subject to certain annual reporting requirements to the SEC (as discussed below), it is only required to calculate its RAUM annually rather than quarterly as originally proposed.

Due to the fixed $150 million ceiling, which does not take into account, for example, growth which results from investment returns, non-US Advisers relying on the Private Fund Adviser Exemption may want to limit the role of their US office to activities which would not cause that office to be deemed "managing assets" according to the exemption. With this in mind, the adviser's US office would be limited to conducting due diligence, providing research and performing back-office services; investment decisions would only be carried out from a non- US office.

3.5 Reporting Requirements

Advisers who qualify for the Private Fund Adviser Exemption will remain subject to the Adviser Act's antifraud provisions. In addition, one of the most significant changes brought into effect by the new rules is that advisers who avail themselves of the Private Fund Adviser Exemption, despite being exempt from the full SEC reporting requirements of the Advisers Act, certain advisers will be considered “Exempt Reporting Advisers” which are subject to reporting and recording keeping requirements.27 This information will be publicly available on the SEC's website and enable investors to compare the information on the Form ADV with information they receive in offering documents and pursuant to due diligence.28

In reporting to the SEC, an adviser relying on the Private Fund Adviser Exemption will be required to complete limited portions of the revised Form ADV, specifically:  

  • Item 1 (Identifying Information) which requests basic identifying information such as the adviser's name, address, contact information and principal office and place of business;
  • Item 2.B. (SEC Reporting by Exempt Reporting Advisers) which identifies the exemption adviser is relying on;
  • Item 3 (Form of Organization) which requests basic information regarding the adviser's form of organisation, fiscal year end and country of organisation;
  • Item 6 (Other Business Activities) which requests information regarding the adviser's other business activities;
  • Item 7 (Financial Industry Affiliations and Private Fund Reporting) – Item 7A. requests information regarding business activities of an adviser's affiliates and new Item 7B and revised accompanying Schedule D requires an adviser to provide basic organisational, operational and investment characteristics of each private fund it manages, identifying information regarding such funds' service providers, the gross asset value of such funds and limited information regarding such funds' investors (including any minimum investment required and approximate number of beneficial owners). However, it should be noted that a non-US adviser is not required to provide the information required by Schedule D for any private fund that during the last fiscal year (i) was not a US person, (ii) did not offer its securities in the United States and (iii) not beneficially owned by any US person;
  • Item 10 (Control Persons) which requests the identities of control persons;
  • Item 11 (Disclosure Information) which requests information regarding the disciplinary history of the adviser and its employees; and
  • corresponding sections of Schedules A, B, C and D.

As the new exemptions are first being implemented, advisers relying on the Private Fund Adviser Exemption must file their first reports on Form ADV between 1 January and 30 March 2012. Going forward, advisers relying on the Private Fund Adviser Exemption will be required to submit an initial Form ADV within 60 days of relying on the relevant exemption from registration and pay a nominal filing fee based on the amount of assets the adviser has under management.29

An adviser relying on the Private Fund Adviser Exemption must update its Form ADV at least annually, within 90 days of the end of the adviser's fiscal year, or more frequently as required by the instructions to Form ADV such as changes to identifying information (Item 1 of Form ADV), organisation (Item 3 of Form ADV) or disciplinary information (Item 11 of Form ADV).

Since an adviser relying on the Private Fund Adviser Exemption must update its Form ADV annually, it is only required to calculate the amount of assets under management in the United States annually in line with its updates to its Form ADV. If, as a result of its annual update, an adviser has $150 million or more of private fund assets RAUM in the United States, then it is no longer eligible under the Private Fund Adviser Exemption and must register under the Advisers Act unless it qualifies for another exemption. Such an adviser, if it is unable to find another exemption, may apply for registration under the Advisers Act up to 90 days after the annual updating amendment to Form ADV and continue advising private fund clients during this transition period.30

The SEC has indicated that it does not currently anticipate conducting compliance examinations of advisers relying on the Private Fund Adviser Exemption on a regular basis unless there are indications of wrong doing (which may be prompted by tips, complaints or referrals.

Advisers relying on the Private Fund Adviser Exemption will also be subject to certain record keeping requirements going forward, which the SEC will address in a future release.

4. TIMING

Advisers who are or have been relying on the now-discontinued Private Adviser Exemption can continue to rely on it until 30 March 2012, when they must either qualify for another exemption or register with the SEC and come into compliance with the obligations of a registered adviser under the Advisers Act. Since initial applications for registration under the Advisers Act can take up to 45 days to become effective, new registrants should file their complete form ADV by 14 February 2012.