Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), an investment adviser which acts solely as an adviser to private funds1 will be required to register with the Securities and Exchange Commission (the “SEC”) as a registered investment adviser (an “RIA”) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) upon reaching $150 million of assets under management2 in the United States.3 U.S. advisers (i.e., those with their principal office and place of business in the United States) are required to count all of their assets under management for purposes of the $150 million threshold and all of their clients for purposes of determining whether they advise solely private funds. Non-U.S. advisers (i.e., those with their principal office and place of business outside of the United States), however, would not be required to consider non-U.S. clients or assets that are managed from a place of business outside of the United States. Thus, a non-U.S. adviser should be able to rely on the $150 million threshold to avoid registration so long as: (i) the only U.S. persons advised by the non-U.S. manager are private funds and (ii) the non-U.S. manager advises no more than $150 million in assets from a U.S. place of business.
The Act provides exemptions from registration for certain types of investment advisers. In particular:
- Foreign Private Advisers. “Foreign private advisers” are exempt from registration as RIAs. Foreign private advisers are defined as investment advisers that (i) have no place of business in the U.S.; (ii) have, in total, fewer than 15 U.S. persons as clients or investors in the U.S. in private funds advised by the investment adviser; (iii) have aggregate assets under management attributable to U.S. persons of less than $25 million; and (iv) neither (A) hold themselves out generally to the public in the U.S. as an investment adviser nor (B) advise any registered investment company (mutual fund) or registered business development company.
- Family Offices. Advisers that are “family offices” will not be included in the definition of “investment adviser” under the Advisers Act, and thus will not be required to register as investment advisers.4 The SEC recently proposed a rule that provides a definition of “family office” for purposes of being excluded under the Advisers Act that encompasses the characteristics of the family offices to which the SEC has previously issued exemptive orders.
- Exempt Reporting Advisers. Advisers to venture capital funds and mid-sized private fund advisers described below will not be required to register as an RIA. However, such advisers, which the SEC refers to as “Exempt Reporting Advisers”, will be required to file basic disclosure information with the SEC on a newly amended Form ADV reporting form. Such advisers will also be subject to recordkeeping requirements (to be determined by the SEC at a later date) and certain provisions of the Advisers Act, including the anti-fraud provisions.
- Venture Capital Fund Advisers. The SEC recently proposed a rule defining venture capital funds as any fund that: (i) is a private fund; (ii) invests in equity securities of qualifying portfolio companies, which are generally companies that are not publicly traded at the time of investment, in order to provide operating and business expansion capital; (iii) has acquired at least 80% of its equity investment in each qualifying portfolio company directly from the qualifying portfolio company; (iv) offers significant managerial assistance to the qualifying portfolio company; (v) does not incur leverage in excess of 15% of the fund’s assets; (vi) does not offer liquidity rights to invests except in extraordinary circumstances; and (vii) represents itself as a venture capital fund to investors.
- Mid-Sized Private Fund Advisers. Under the SEC’s recently proposed rules, a Mid-Sized Private Fund Adviser will be any investment adviser solely to private funds with “Regulatory AUM” in the United States of less than $150 million in the United States. As noted above, the SEC proposes to treat U.S. advisers in a manner substantially different than non-U.S. advisers in determining qualification for this exemption.
If you believe that your business falls within one of these exemptions, please contact us to discuss the parameters of the relevant exemption in more detail.
Steps to Registering as an RIA
The process of registering as an RIA is fairly simple; most of the burdensome aspects of registration relate to compliance with the requirements imposed by the Advisers Act upon RIAs, not the actual registration process. Compliance under the Advisers Act is addressed below. The steps to achieving registration are:
- The first step in the SEC registration process is to create an Investment Advisers Registration Depository (IARD) User Account through a process called “Entitlement” that is managed by the Financial Industry Regulatory Authority (“FINRA”). This process involves completing several forms and sending them to FINRA. Approximately two weeks after receiving the forms, FINRA will send the firm a username and password to access IARD.
- Once the applicant has set up an IARD account, the next step is to complete Form ADV, the investment adviser registration form. Part 1A of Form ADV, which is intended to solicit basic information from the investment adviser (mostly through check-the-box and fill-in the blank style questions), must be filed electronically through IARD together with a nominal filing fee. Beginning January 1, 2011, new registrants must also prepare and file Part 2A of Form ADV (the “brochure”), a narrative brochure describing the adviser’s business, management styles and practices, fees and conflicts.
Both Part 1A and Part 2A will be available to the public through the SEC’s website and Part 2A must be provided to clients at or before engaging the adviser.5
- The SEC will review Part 1A of Form ADV to confirm that it is complete and in compliance with the Advisers Act. Registration must be accepted or denied within 45 days (and generally advisers are notified within a few weeks).
As noted above, Exempt Reporting Advisers will also be required to file informational reports on a modified Form ADV and will need to create an IARD account.
Complying with the Advisers Act
Conducting business as an RIA subjects the investment adviser to certain substantive requirements, including the requirement to establish a compliance program reasonably designed to prevent violations of the Advisers Act. There are many aspects of compliance with the Advisers Act that are beyond the scope of this memorandum; we have briefly listed those that we think will be of the most concern to an unregistered investment adviser. An RIA is expected to be in compliance with the Advisers Act and the rules thereunder upon registration, so the investment adviser should plan on being in compliance with the following requirements before submitting Part 1A of its Form ADV to the SEC. Exempt Reporting Advisers are exempt from registering as an RIA but are still required to comply with certain provisions of the Advisers Act, as well as become subject to examination by the SEC.
Development of a Compliance Program
Rule 206(4)-7 under the Advisers Act (the “Compliance Rule”) requires each RIA to establish an internal compliance program that addresses the adviser’s substantive and fiduciary obligations under the Advisers Act. Although the Compliance Rule requires all RIAs to implement internal compliance programs, it gives each RIA the flexibility to decide how to structure its own policies and procedures (although a number of suggested areas on which an RIA should focus are listed in the adopting release to the Compliance Rule).
Chief Compliance Officer
The Compliance Rule requires an RIA to designate a chief compliance officer with knowledge of the Advisers Act and who has the authority to create and administer appropriate compliance policies and procedures for the RIA. The chief compliance officer’s (and, if applicable, his or her subordinates’) duties could include, among others:
- Reviewing the policies and procedures of the RIA at least annually for adequacy and effectiveness;
- Reviewing brokerage arrangements and execution, portfolio management and trade allocation, and valuation procedures;
- Reviewing all advertising to ensure compliance with the specific requirements of the Advisers Act (especially those related to performance reporting);
- Managing personal trading procedures as required by the RIA’s Code of Ethics (see below);
- Managing the recordkeeping required by the Advisers Act (see below);
- Filing “blue sky” offering notices with the SEC and state regulatory authorities (actually required whether the adviser is registered or not);
- Filing SEC Forms 3, 4, 5, 13D, 13F and/or 13G, to the extent required (generally where the investment adviser takes significant positions in publicly-traded equity securities); and
- Serving as the point of contact for the SEC during inspections, examinations or other inquiries.
Development of a Code of Ethics
Rule 204A-1 under the Advisers Act (the “Code of Ethics Rule”) requires RIAs to develop and follow a Code of Ethics. An RIA’s Code of Ethics is largely comprised of procedures to promote ethical, fiduciary conduct and to monitor (and sometimes prevent) the personal activities of personnel that may conflict with the interests of advisory clients. The Code of Ethics must include standards of conduct, rules governing personal securities transactions, pre-approval of certain securities transactions and guidelines regarding the reporting of violations.
Under Rule 204-2 under the Advisers Act (the “Books and Records Rule”) an RIA must maintain (and retain) true, complete and current books and records relating to its investment advisory business. These books and records generally fall within three categories: (i) business records of the adviser; (ii) records of the adviser that relate to the adviser’s clients and the advisory activities of the adviser; and (iii) records relating to the adviser’s compliance program. Rule 204-2 lists many specific categories of materials which must be maintained; the RIA’s compliance staff will need training and guidance to develop an appropriate and robust recordkeeping system.
Exempt Reporting Advisers will be subject to recordkeeping requirements, the extent to which the SEC has yet to determine.
Custody of Client Assets
Rule 206(4)-2 under the Advisers Act (the “Custody Rule”) requires that an RIA which has custody of client assets (which private funds and managed accounts are generally deemed to have if they have authority to withdraw funds from the client’s accounts to pay fees) must maintain them with a “qualified custodian.” The Custody Rule is complex and requires attention to several considerations in order to ensure compliance.
Certain assets in which the RIA may invest (i.e., those which are (i) acquired from the issuer in a private placement; (ii) uncertificated; and (iii) transferable only with the consent of the issuer or the other holders of such securities) do not require custody with a qualified custodian to the extent that they are held in a private fund which is audited on an annual basis (such securities, “Restricted Securities”). However, if funds managed by the RIA hold securities which are not Restricted Securities, the RIA will be required to custody them with a qualified custodian (which could be the private fund’s prime broker).
With respect to a managed account, the RIA will generally need to avoid having custody of the assets of the account (other than custody derived from the ability to withdraw fees from the account) in order to avoid the account being subject to “surprise” audits under the Custody Rule.
Managed account clients must also receive quarterly statements directly from the qualified custodian.
New Reporting Requirements for Private Fund RIAs
The Act will significantly increase the burden of complying with the Advisers Act. In particular, RIAs and Exempt Reporting Advisers will be required to report to the SEC, on a regular basis, specific information with respect to each of their private funds, including among other things: (i) basic organizational, operational and investment characteristics; (ii) gross and net asset levels to determine a fund’s use of leverage; and (iii) identity and other information regarding certain “gatekeeper” service providers of the fund (i.e., auditors, prime brokers, custodians, administrators, and marketers).
Please do not hesitate to contact us if you have questions regarding any of the above. We look forward to assisting you in determining whether you are required to become an RIA or an Exempt Reporting Adviser and, if applicable, with the registration or reporting process.