On June 22, 2011, the Securities and Exchange Commission adopted new rules and amendments (the "Final Rules") under the Investment Advisers Act of 1940, as amended (the Advisers Act), that implement various provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). Although the Final Rules1 were adopted largely as first proposed in November 2010, certain changes from the proposed rules have been included in response to comments received, including changes to the definition of "venture capital fund."
The Final Rules require an investment adviser2 to a private fund3 to register with the SEC under the Advisers Act by March 30, 2012, unless it qualifies for one of three exemptions. They also implement reporting requirements for advisers exempt from reporting under two of these three exemptions (so-called "exempt reporting advisers"). The Final Rules also require exempt reporting advisers to file initial reports by March 30, 2012.
As a practical matter, advisers becoming subject to registration for the first time (and therefore not eligible to rely on one of the exemptions below) should prepare to comply with the Advisers Act and file the full Form ADV no later than February 14, 2012 to permit the SEC the 45 days required under the Advisers Act to declare the registration effective. Exempt reporting advisers need not have their filings declared effective by the SEC, and therefore may take advantage of the additional time until the March 30th deadline.
The Final Rules will require attention from all types of advisers, U.S. and non-U.S., regardless of whether or not they are currently registered with the SEC. In this bulletin, we focus on the exemptions available, and what they may mean for non-U.S. advisers, below.
Exemptions Before Effecting Final Rules
By way of background, many non-U.S. advisers currently rely on the "private adviser" exemption under Section 203(b)(3) of the Advisers Act to avoid registration. This private adviser exemption with respect to non-U.S. advisers is available to an adviser with 14 or fewer "clients" in the United States that does not hold itself out publicly in the United States as an investment adviser. The "private adviser" exemption counted clients as each fund such adviser advises.
Exemptions After Effecting Final Rules
Title IV of the Dodd-Frank Act eliminated the private adviser exemption. As a result, many previously unregistered advisers to hedge funds and private equity funds will have to register with the SEC and be subject to regulatory oversight rules and examination. In place of the previous private adviser exemption, there are three exemptions under the Final Rules: (i) a complete exemption for foreign private advisers; (ii) a partial exemption for venture capital fund advisers; and (iii) a partial exemption for private fund advisers that have less than $150 million in assets under management in the United States. Each exemption is discussed in more detail below.
Pursuant to each of the three exemptions, investment advisers will be exempt from registration with the SEC. However, advisers exempt under the two "partial" exemptions are subject to a public reporting regime designed to allow the SEC to monitor for systemic risk and investor protection, including by requiring disclosure of each U.S. private fund they manage. In addition, exempt reporting advisers are subject to examination by the SEC; however, the SEC has clarified in the Final Rules that it does not anticipate that it will conduct such examinations on a regular basis.
Complete Exemption: Foreign Private Advisers
The foreign private adviser exemption is available for a non-U.S. investment adviser that (i) has no place of business in the United States; (ii) has fewer than 15 individual U.S. clients or U.S. investors in the private funds it advises (each U.S. investor is counted as a client, as opposed to only counting each fund); (iii) has aggregate assets under management attributable to individual U.S. clients or U.S. investors in the private funds it advises of less than $25 million; and (iv) does not hold itself out generally to the U.S. public as an investment adviser or advise a U.S.-registered investment company or business development company. Even if a fund manager has only one U.S. fund, it may not qualify for this exemption based on the number of U.S. investors in that fund. Particular care should be taken in analyzing an adviser's number of clients. In the Final Rules, the counting rules for clauses (ii) and (iii) have been clarified so that "knowledgeable employees" are not counted, the same investors invested in more than one of the adviser's private funds are counted only once and investors are classified as being in the United States on the basis of the reasonable belief of the General Partner. In light of the tight requirements for the complete exemption, particularly the low threshold amount of $25 million and the 15 U.S. investors limitation, we do not anticipate that many non-U.S. advisers will be able to avail themselves of the complete exemption.
Partial Exemption: Venture Capital Fund Advisers
A venture capital fund is defined as a private fund that (i) holds no more than 20% of the fund's capital commitments in non-qualifying investments;4 (ii) does not borrow or otherwise incur leverage (other than on a short-term basis); (iii) does not offer redemption or liquidity rights to its investors other than in extraordinary circumstances; (iv) is not a registered investment company and has not elected to be treated as a business development company; and (v) represents itself to its investors as pursuing a venture capital strategy.
This definition of "venture capital fund" in the Final Rules makes a number of changes to the earlier definition proposed by the SEC and, in particular, provides flexibility with respect to the restrictions on portfolio investments. For example, the Final Rules allow a venture capital fund to invest in a public company or purchase stock on the secondary market, to the extent the fund has room for such investment in its 20% "non-conforming basket." The Final Rules also expand "qualifying investments" from the SEC's previously proposed rules to include other typical venture capital investments, such as recapitalizations, other exchanges, and mergers and acquisitions. In addition, the definition of "venture capital fund" has been expanded in the Final Rules to include funds that are formed and marketed outside the United States, making the exemption apply equally to U.S. and foreign venture capital funds.
Partial Exemption: Private Fund Advisers with Less than $150 Million in Assets Under Management
The new private fund adviser exemption is available for an investment adviser (i) whose clients are solely private funds (so long as none of the investors in the private funds use the services of such adviser outside of the fund – e.g., to manage a separate account on such investor's behalf) and (ii) who, in the aggregate, has less than $150 million in assets under management in the United States (calculated on an annual basis, based upon market value, or fair value when market value is unavailable). Assets under management must include proprietary assets and assets managed without compensation as well as uncalled capital commitments and must be calculated on a gross basis (i.e., without deduction for liabilities or borrowing). The Final Rules provide that "[a] non-U.S. adviser,5 however, need only count private fund assets it manages at a place of business in the United States toward the $150 million asset limit under the exemption." Therefore, a non-U.S. adviser with no office in the United States from which it advises investors would calculate its assets under management in the United States as $0, and therefore would be able to avail itself of the partial exemption. In contrast, a non-U.S. adviser that advises investors from a U.S. office must count the private fund assets that it manages from its U.S. office toward the $150 million asset limit. Accordingly, a non-U.S. adviser with one or more U.S. offices should consult with counsel to determine the appropriate allocation of its U.S. private fund assets for purposes of determining the applicability of this exemption. The Final Rules clarify that a non-U.S. adviser can rely on this exemption as long as all of its U.S. clients are qualifying private funds.
While we have focused our discussion here on non-U.S. advisers, we note that there are differing counting rules for U.S. and non-U.S. advisers. Because this exemption defines clients as private funds of the investment adviser, it is irrelevant how many U.S. investors there are in the fund or how much in commitments U.S. investors have made to the fund.
Exempt reporting advisers are required to file a Form ADV, completing only the following items in Part 1A of the form: Items 1 (Identifying Information), 2.B. (SEC Reporting by Exempt Reporting Advisers, a new section being added to the form whereby the adviser discloses the basis of its exemption from registration), 3 (Form of Organization), 6 (Other Business Activities), 7 (Financial Industry Affiliations and Private Fund Reporting), 10 (Control Persons) and 11 (Disclosure Information, including with respect to any disciplinary history). In addition, an exempt reporting adviser will have to complete corresponding sections of Schedules A, B, C, and D. This information will be made publicly available by the SEC.
Note that non-U.S. advisers are not required to report with respect to private funds organized outside the United States that are not offered to, or owned by U.S. persons.
In response to public comment, in the Final Rules, the SEC changed several of the previously proposed disclosure requirements. The changes include (but are not limited to) the SEC no longer requiring disclosure as a part of Item 7 of net assets of each private fund, reporting of private fund assets and liabilities by class and categorization under GAAP nor specification of the percentage of fund interests owned by types of beneficial owners.
Exempt reporting advisers are to file the initial Form ADV in the first quarter of 2012, but no later than March 30, 2012. Thereafter, a Form ADV is to be filed annually, no later than 90 days after the end of the fiscal year of the adviser, and promptly during the year to reflect (i) material inaccuracies with respect to disclosure in Item 10 (Control Persons) and (ii) any inaccuracy with respect to disclosure in any of Items 1 (Identifying Information), 3 (Form of Organization) or 11 (Disciplinary Information).
The filing fee (a component of which is annual) is anticipated by the SEC to be the same as those for registered investment advisers, which currently range from $40 to $200, based on the amount of assets an adviser has under management.
Non-U.S. advisers will be required to make a one-time filing of Form ADV-NR to irrevocably appoint the Secretary of the SEC as an agent for service of process.
The U.S. Congress is considering legislation, the Small Business Capital Access and Job Preservation Act, that would provide for a specific exemption from registration for certain private equity fund advisers and require the SEC to issue final rules to define the term "private equity fund." The legislation was considered and approved with bipartisan support by the House Financial Services Committee on June 22, 2011. It is now being reported to the full House of Representatives.
For the time being, it would appear prudent for advisers to private equity funds to prepare for compliance with the Final Rules as adopted by the SEC. We will continue to monitor the proposed legislation.