On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted final rules and amendments under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), designed to implement various provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The new rules and amendments, among other things, extend the deadline for registration for advisers relying on the private adviser exemption, clarify the eligibility of advisers to register (or remain registered) with the SEC, modify the method advisers use to calculate their assets under management, establish reporting requirements applicable to “exempt reporting advisers” and adopt significant amendments to Form ADV.
Extension of Registration Deadline
Many private fund advisers historically have avoided registration with the SEC by relying upon the “private adviser exemption” set forth in Section 203(b)(3) of the Advisers Act (the “Private Adviser Exemption”). Effective as of July 21, 2011, the Dodd-Frank Act eliminates the Private Adviser Exemption and replaces it with several much more limited exemptions from registration. As a result, many private fund managers (including many hedge fund and private equity fund managers) will be required to register with the SEC and comply with various recordkeeping, reporting and other requirements. Pursuant to new Rule 203-1(e) under the Advisers Act, a private fund manager that was relying on, and was entitled to rely on, the Private Adviser Exemption on July 20, 2011, may delay registration with the SEC until March 30, 2012. To ensure that its registration is declared effective by the SEC before the March 30 deadline, a private fund adviser should file its registration documents with the SEC by February 14, 2012.
Registration of Mid-Sized Advisers
Under the Dodd-Frank Act, advisers with assets under management of between $25 and $100 million (“mid-sized advisers”) generally are prohibited from registration with the SEC. As a result, many mid-sized advisers that are currently registered with the SEC will be required to withdraw their SEC registrations and register with applicable state regulatory authorities. To provide for an orderly transition by mid-sized advisers from SEC registration to state registration, new Rule 203A-5 under the Advisers Act requires:
- each mid-sized adviser registered with the SEC as of July 21, 2011 to remain registered with the SEC until January 1, 2012 (unless an exemption from registration is otherwise available);
- each adviser registered with the SEC on January 1, 2012 to (i) file an amendment to its Form ADV by no later than March 30, 2012, and (ii) report the current market value of its assets under management determined within 90 days of the filing; and
- each mid-sized adviser that is no longer eligible for SEC registration to withdraw its SEC registration by filing Form ADV-W no later than June 28, 2012.
Advisers no longer eligible for SEC registration should ensure that they are properly registered with applicable state regulatory authorities before withdrawing their SEC registrations. Due to the length of time that may be required to register with state regulatory authorities, mid-sized advisers should begin the transition process well before the June 28, 2012 deadline.
If a mid-sized adviser desires to register after July 21, 2011, it will be prohibited from registration with the SEC and must register with applicable state regulatory authorities.
Adoption of “Buffer” for Mid-Sized Advisers
To prevent advisers from having to switch frequently between state and SEC registration as a result of fluctuations in the value of their assets under management, the SEC adopted amended Rule 203A-1 that provides for a “buffer” for advisers with close to $100 million in assets under management to determine whether and when to switch between state and SEC registration. The amended rule raises the threshold above which a mid-sized investment adviser must register with the SEC to $110 million. Once registered with the SEC, an adviser need not withdraw its registration until it has less than $90 million of assets under management (as reported on its annual updating amendment to Form ADV). Advisers are only required to determine their eligibility for SEC registration on an annual basis, in connection with their annual updating amendments.
Exempt Reporting Advisers
As proposed, the SEC adopted a new rule that requires “exempt reporting advisers” to electronically file with the SEC, and periodically update, public reports on Form ADV, using the same process as registered advisers. An “exempt reporting adviser” is an adviser exempt from registration with the SEC under Section 203(l) (provides an exemption for an adviser that advises solely one or more “venture capital funds”) or Section 203(m) (provides an exemption for any adviser that acts solely as an adviser to private funds and has assets under management in the U.S. of less than $150 million) of the Advisers Act.1 The reports consist of a limited subset of the items in Part 1A of Form ADV, including the following information:
- the name, address, contact information, form of organization and the owner(s) of the adviser;
- other business activities of the adviser;
- disciplinary history of the adviser and its employees; and
- detailed information about each private fund managed by the adviser.
An “exempt reporting adviser” generally is required to file updating amendments to its report filed on Form ADV: (i) at least annually, within 90 days of the end of its fiscal year; (ii) more frequently, if required by the instructions to Form ADV; and (iii) if it ceases to be an “exempt reporting adviser.” An “exempt reporting adviser” must file its initial report on Form ADV no later than March 30, 2012.
Calculation of “Regulatory Assets Under Management”
To provide for a more uniform method of calculating assets under management, the SEC adopted amendments to Form ADV to define “regulatory assets under management” for purposes of (i) determining whether an adviser is eligible to register with the SEC, (ii) reporting assets under management on Part 1 of Form ADV, and (iii) determining whether an adviser qualifies for one or more exemptions from registration.
In general, an adviser must include in its “regulatory assets under management” any securities portfolios for which it provides continuous and regular supervisory or management services, regardless of whether such assets are family or proprietary assets, assets managed without compensation or assets of foreign clients (each of which may have been excluded under the prior Form ADV). In addition, an adviser is not allowed to subtract any outstanding indebtedness and other accrued but unpaid liabilities for purposes of this calculation.
The amendments also provide guidance regarding how a private fund manager should determine the amount of its regulatory assets under management. In particular, a private fund manager must:
- include in its regulatory assets under management the value of any private fund assets over which it exercises continuous and regular supervisory or management services, regardless of the nature of those assets;
- include in its regulatory assets under management the amount of any uncalled capital commitments made by investors to a fund; and
- value private fund assets based upon (i) their market value or (ii) their fair value determined in accordance with U.S. generally accepted accounting principles or applicable international accounting standards if market value is unavailable.
Consistent with current law, an adviser generally is required to update its regulatory assets under management on at least an annual basis.
Amendments to Form ADV
To implement various provisions of the Dodd-Frank Act and enhance the SEC’s ability to oversee investment advisers, the SEC adopted amendments to Part 1A of Form ADV that require advisers to provide additional disclosure regarding the following:
- each private fund that it advises;
- its advisory business (including data about its clients, employees and advisory activities) and business practices that may present conflicts of interest; and
- its non-advisory activities and financial industry affiliations.
Disclosure about Private Funds. The Form ADV amendments specifically require detailed disclosure of the following information about each private fund that an adviser advises:
- (i) the name of the fund, (ii) the jurisdiction of its organization, (iii) the name of the fund’s general partner, directors, trustees or persons occupying similar positions, (iv) whether the fund is a master fund or feeder fund, (v) the exclusion relied upon by the fund from the definition of an investment company under the Investment Company Act of 1940, as amended, (vi) whether the investment adviser is subject to regulation by a foreign regulatory authority and (vii) whether the fund relies on an exemption from registration under the Securities Act of 1933, as amended;
- the type of investment strategy employed by the adviser (including whether the private fund is a hedge fund, liquidity fund, private equity fund, real estate fund, securitized asset fund, venture capital fund or other private fund);
- whether the fund invests in securities of registered investment companies;
- the gross asset value of the fund; and
- the number and types of investors in the fund, the minimum investment amounts required from investors, whether clients of the adviser are solicited to invest in the fund and what percentage of the adviser’s clients have invested in the fund.
A fund manager also is required to report detailed information regarding the service providers of its private funds, including auditors, prime brokers, custodians, administrators and marketers.
Advisory Business Disclosures. The Form ADV amendments also require each investment adviser to disclose the following additional information about its business:
- the number of employees that are registered investment adviser representatives or insurance agents and numerical responses to questions about employees;
- the number of clients and whether the adviser advises certain types of clients, including business development companies, insurance companies and other investment advisers;
- a approximate number of clients (if more than 100), the percentage of the adviser’s clients that are not U.S. persons and the percentage of its regulatory assets under management attributable to each different client type; and
- whether certain types of advisory activities are provided, including portfolio management for pooled investment vehicles.
Disclosure about Non-Advisory Activities and Financial Industry Affiliations. The Form ADV amendments also require each adviser to disclose the following additional information regarding its non-advisory activities and financial industry affiliations:
- whether the adviser or any related person is engaged in business as a trust company, registered municipal adviser, registered security-based swap dealer, major security-based swap participant, accounting firm or law firm;
- whether a related person of the adviser is a sponsor, general partner or managing member of a pooled investment vehicle;
- whether the adviser is engaged in another business and certain information related to such other business;
- information regarding certain related persons of the adviser;
- whether any brokers or dealers chosen by the adviser or recommended to clients are related persons of the adviser;
- whether the adviser receives “soft dollar benefits” and, if so, whether such benefits qualify for the safe harbor provided under Section 28(e) of the Securities Exchange Act of 1934, as amended;
- whether the adviser or a related person receives direct or indirect compensation for client referrals;
- the total number of persons that act as qualified custodians for the adviser’s clients; and
- whether the adviser had $1 billion or more in “assets”2 as of the last day of the adviser’s most recent fiscal year.
Revisions to the Pay to Play Rule
Finally, the SEC adopted amendments to Rule 206(4)-5 under the Advisers Act (the “Pay to Play Rule”), which generally prohibits registered and certain unregistered advisers from directly or indirectly providing advisory services for compensation to government clients for two years after making political contributions.
The amendments broaden the Pay to Play Rule’s scope by making it applicable to both “exempt reporting advisers” and advisers relying upon the foreign private adviser exemption. The amended Pay to Play Rule also allows an adviser to pay any regulated municipal adviser to solicit government entities on its behalf.