On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which, among other things, significantly amended the regulatory requirements applicable to investment advisers under the Investment Advisers Act of 1940 (the Advisers Act). On June 22, 2011, the Securities and Exchange Commission (the SEC) adopted final rules under the Advisers Act implementing various aspects of the Dodd-Frank Act (the Final Rules). Below is a summary of some of the key provisions of the Final Rules and the impact that they will have on investment advisers, particularly advisers to private equity and hedge funds. Generally, the deadline for advisers who have previously been exempt from SEC registration and who must now register with the SEC under the Final Rules is March 30, 2011.
Elimination of the Private Adviser Exemption
The most significant change under the Dodd-Frank Act is the elimination of the so-called “private adviser exemption” from registration with the SEC upon which most advisers of private equity and hedge funds have historically relied. Under the private adviser exemption, investment advisers were not required to register with the SEC if they had fewer than 15 clients and did not hold themselves out to the public as investment advisers. The legislative history of the Dodd-Frank Act indicates that the primary purpose of the elimination of the private adviser exemption was to require most, if not all, private equity and hedge fund advisers to register as investment advisers under the Advisers Act. Although the Final Rules contain certain narrow exemptions from SEC registration (discussed below), the elimination of the private adviser exemption will require the vast majority of large private equity and hedge fund advisers to register with the SEC and mid-sized advisers to register with state regulatory authorities.
Exemptions from SEC Registration
The following narrow exemptions from SEC registration are the most likely exemptions available under the Final Rules to advisers that previously relied upon the private adviser exemption:
- Venture capital fund advisers. The Dodd-Frank Act exempts advisers from registration that only advise “venture capital funds.” The term “venture capital fund”, as defined in the Final Rules, is generally limited to private funds that invest at least 80% of their assets in equity securities purchased directly from private operating companies (as opposed to shareholders or company executives). In addition, venture capital funds may only engage in short-term borrowing (less than 120 days), cannot incur leverage in excess of 15% of their capital commitments, and generally cannot offer investors redemption rights.
- Private fund advisers. The Dodd-Frank Act and Final Rules exempt advisers from SEC registration that manage only private funds and have less than $150 million in assets under management.
- Family offices. The Dodd-Frank Act and Final Rules exempt advisers from SEC registration whose only clients are (1) lineal descendants (including by adoption, stepchildren, foster children, and, in some cases, by legal guardianship) of a common ancestor (who is no more than 10 generations removed from the youngest generation of family members), and such lineal descendants’ spouses or spousal equivalents (collectively, Family Clients), (2) certain entities and charitable organizations that are owned or funded by Family Clients, and (3) certain key employees of the adviser.
Advisers relying on either the venture capital fund or private fund adviser exemptions will be “exempt reporting advisers” that will be required to file Form ADV Part 1A with the SEC and update it at least annually. In addition, exempt reporting advisers will be subject to SEC examination and will be required to comply with certain SEC recordkeeping requirements.
Regulatory Oversight of “Mid-Sized Advisers”
The Dodd-Frank Act shifted primary responsibility for the regulatory oversight of most investment advisers with assets under management between $25 million and $100 million (each a Mid-Sized Adviser) to the states. Under the Dodd-Frank Act, a Mid-Sized Adviser is prohibited from registering with the SEC unless it (1) is not required to be registered as an investment adviser in its home state, (2) is not subject to examination in its home state (i.e., advisers whose home states are New York, Minnesota, and Wyoming) or (3) would be required to register in 15 or more states. Previously, states had primary responsibility for the regulatory oversight of investment advisers with assets under management of less than $25 million.
Assets Under Management Buffer for Mid-Sized Advisers. The Final Rules create an assets under management “buffer” from the $100 million assets under management threshold. The buffer provides that Mid-Sized Advisers are only required to register with the SEC if they have at least $110 million in assets under management. Likewise, once registered, Mid-Sized Advisers are not required to withdraw their SEC registration until they have less than $90 million of assets under management. This will prevent registered advisers from having to switch between SEC and state registration until they have substantially crossed the $100 million threshold in one or the other direction.
Mid-Sized Adviser Registration Transition Process. In order to facilitate the transition of Mid-Sized Advisers from SEC to state registration, each adviser registered with the SEC on January 1, 2012 will be required to file an amendment to their Form ADV by March 30, 2012 that reports the adviser’s current assets under management. Advisers that are no longer eligible to be registered with the SEC will have until June 28, 2012 to register with any required states and withdraw their SEC registration by filing Form ADV-W.
SEC vs. State Registration
SEC-registered investment advisers are not subject to state registration requirements. Investment advisers that are not SEC-registered, including exempt reporting advisers and investment advisers that qualify for exemptions from SEC registration, are subject to applicable state registration requirements. As a consequence, all advisers not registered with the SEC should review applicable state laws to determine whether they are required to register with one or more states. Those advisers that are required to register in their home state or other states will be required to file Form ADV, develop appropriate compliance policies and procedures required by applicable state laws and otherwise comply with requirements of applicable state laws (e.g., recordkeeping, operations, marketing, etc.).
Timeline for Investment Adviser Registration
Advisers Currently Registered with the SEC. SEC-registered investment advisers need to determine as soon as possible whether they will be permitted to remain registered with the SEC under the Final Rules. If an investment adviser will not be permitted to remain registered with the SEC, it will need to: (1) determine which state or states, if any, with which it must register, (2) register with any such states, and (3) withdraw its SEC registration by June 28, 2012. This process will require a significant amount of preparation and lead time.
Advisers Not Currently Registered with the SEC that will be Required to Register. Investment advisers not currently registered with the SEC need to determine as soon as possible if they are eligible for an exemption from SEC registration under the Final Rules. Advisers that may rely on the venture capital fund adviser or private fund adviser exemption from registration, are exempt reporting advisers that must file Form ADV Part 1A with the SEC between January 1, 2012 and March 30, 2012. Investment advisers that are no longer exempt from SEC registration will be required to file a complete Form ADV with the SEC by February 14, 2012 to ensure that they will be registered by the March 30, 2012 deadline. In addition, advisers registering with the SEC will also need to implement comprehensive compliance programs required under the Advisers Act. This process will require even more preparation and lead time, so advisers should already be preparing for these changes.
Advisers Not Currently Registered with One or More State(s) that will be Required to Register . Investment advisers that determine that they need to become registered with one or more state(s) will need to become registered with the applicable state(s) by the March 30, 2012 deadline. Because the time required to process an application will vary for each state, these advisers should check with their state(s) regarding deadlines. In addition, these advisers will need to implement comprehensive compliance programs like new SEC registrants, so they should already be preparing for these changes.