At today’s open meeting, the Securities and Exchange Commission (SEC) approved the proposal of several new rules and rule amendments (the “Proposed Rules”) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), that implement various provisions of Title IV of the Dodd- Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Chairman Shapiro noted that prior to the passage of the Dodd-Frank Act, there existed a substantial gap in legislation that allowed many investment advisers to private funds to escape registration. The Dodd-Frank Act has closed this gap and, together with the Proposed Rules, tailors the investment adviser registration process and reforms the information the SEC receives from investment advisers. Specifically, the Proposed Rules would:  

  • increase the statutory threshold for registration by investment advisers with the SEC;  
  • amend Form ADV to reflect new registration requirements, and require reporting by certain investment advisers that are exempt from registration;  
  • provide or clarify exemptions to registration; and  
  • revise the adviser pay-to-play rules.  

New Registration Requirements for Investment Advisers

The Proposed Rules would shift oversight of “mid-sized” investment advisers to state regulators by requiring investment advisers that manage between $25 million and $100 million in assets under management to register with, and be subject to examination by, regulators in the state in which they are located. If the state in which the investment adviser is located does not require the investment adviser to register, or does not subject the investment adviser to examination, the investment adviser would then be required to register with the SEC. The SEC intends to rely on representations from state securities regulators regarding whether investment advisers would be subject to examination in a state.

In order to facilitate this shift in registration, the Proposed Rules would implement a two-step process to identify investment advisers that must switch to state registration. First, all investment advisers would have 30 days to file with the SEC a revised Form ADV to determine if they need to switch to state registration. Second, those investment advisers that are determined to be required to switch to state registration would then have 60 days to withdraw their registration with the SEC.

Amendments to Form ADV

In light of the revisions to the investment adviser registration regime, the Proposed Rules would amend Form ADV to both allow it to be used as a means of collecting new information regarding investment advisers to hedge funds and other private funds, which were previously not required to register with the SEC, and to restructure Form ADV to allow it to also serve as a reporting form for new classes of investment advisers that are not required to register with the SEC, but are still required to report certain information to the SEC, or “exempt reporting advisers.” As amended by the Proposed Rules, Form ADV would:

  • elicit from investment advisers important census-like data regarding the funds they advise and the service providers they use, particularly auditors, prime brokers, custodians, administrators and marketers;
  • require all investment advisers to provide information regarding certain business practices and potential conflicts of interest; and
  • require exempt reporting advisers to complete a subset of items on Form ADV, including items relating to (1) basic identifying information regarding the investment adviser, its owners and affiliates; (2) information regarding the funds managed by the investment adviser and any activities conducted by the investment adviser that may give rise to conflicts of interest; and (3) the investment adviser’s disciplinary history.

Exemptions to Registration

The Proposed Rules would clarify three exemptions to registration for certain investment advisers provided by the Dodd-Frank Act. While these three types of investment advisers would be exempt from registration with the SEC, the first two categories would be exempt reporting advisers and would nonetheless be subject to a reporting regime designed to allow the SEC to monitor for systemic risk and investor protection.

1. Venture Capital Fund Advisers

The Proposed Rules would define “venture capital fund” for purposes of the exemption from registration provided by the Dodd-Frank Act to advisers that solely advise venture capital funds. The Proposed Rules would define venture capital fund as a fund that:

  • only invests in equity securities of private operating companies. The fund must acquire 80 percent of the equity securities of such portfolio companies directly from the private operating company, rather than in the secondary market. Furthermore, the private operating company receiving money from the venture capital fund must use such funds for expansion purposes;
  • provides significant management assistance to the portfolio companies in which it invests;
  • does not borrow more than 50 percent of the capital it invests. Any borrowing by the fund must be short-term;
  • only offers redemption rights to its investors in extraordinary circumstances; and
  • represents itself to its investors as a venture capital fund.

The Proposed Rules recommend a grandfathering provision for investment advisers to existing venture capital funds in an effort to ensure minimal disruption to the operating of these existing funds.

2. Private Fund Advisers with Less than $150 Million in Assets Under Management

The Proposed Rules would also clarify the exemption from registration for investment advisers that (1) advise only private funds and (2) have less than $150 million of assets under management attributable to U.S. clients.

3. Foreign Private Advisers

Finally, the Proposed Rules would clarify the exemption from registration for investment advisers that (i) have no place of business in the United States, (ii) have fewer than 15 U.S. clients and investors in private funds advised by the adviser, (iii) have less than $25 million (or such higher amount as the SEC may determine by rulemaking) of aggregate assets under management attributable to U.S. clients and investors in private funds advised by the adviser, (iv) do not hold themselves out as investment advisers in the United States and (v) do not advise any registered investment company or business development company. The Proposed Rules would draw on existing definitions under the securities laws and rules to define terms in this exemption and, in calculating assets under management, would require an investment adviser to include uncalled capital commitments.

Amendments to Pay-to-Play Rules

The Proposed Rules would amend the existing pay-to-play rules to allow municipal advisers to be governed by the Municipal Securities Rulemaking Board (MSRB) if the MSRB enacts pay-to-play rules that are at least as stringent as those in existence under the Advisers Act.

Effective Date of Proposed Rules

While the Dodd-Frank Act does not require the Proposed Rules to be effective until July 2011, Chairman Shapiro noted that the SEC is seeking to release final rules well in advance of that date in an effort to provide clarity for investment advisers that will be affected by the Proposed Rules.

The full text of the Proposed Rules is not yet available, so the descriptions provided in this special alert are based on the statements made by the Commissioners and the staff at the open meeting. Once the proposing release is made available, a more detailed advisory will follow.