The Securities and Exchange Commission (“SEC”) adopted new rules and rule amendments under the Investment Advisers Act of 1940 (the “Advisers Act”) to implement certain provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) in a series of three releases issued on June 22, 2011 (the “Final Rules”), available at http://www.sec.gov/rules/final/2011/ia-3222.pdf, http://www.sec.gov/rules/final/2011/ia-3221.pdf, and http://www.sec.gov/rules/final/2011/ia-3220.pdf. The SEC proposed such rules and rule amendments in November 2010, which Fried Frank discussed in “SEC Proposes Investment Advisers Act Rules to Implement Dodd-Frank Act.” The SEC has adopted these rules and rule amendments largely as proposed, with certain modifications, as are discussed in greater detail below. The Final Rules, among other things:
- Create exemptions from registration as an investment adviser for (a) advisers to venture capital funds, (b) advisers to private funds with less than $150 million in assets under management, and (c) certain foreign advisers;
- Amend the Form ADV Part 1 to require additional disclosure;
- Require advisers relying on the exemptions for advisers to venture capital funds, and for advisers to private funds with less than $150 million in assets under management (“Exempt Reporting Advisers”) to make certain periodic reports to the SEC;
- Require a “mid-sized adviser” (an adviser with between $25 million and $100 million in regulatory assets under management) to deregister with the SEC and instead register with the state securities authority in the state where it maintains its principal office and place of business, in most circumstances;
- Define “family office” for purposes of the exception from the definition of investment adviser; and
- Amend the Advisers Act pay-to-play rule.
Significant Modifications from Proposed Rules and Amendments 1
The Dodd-Frank Act repeals the “private adviser exemption” for investment advisers with fewer than 15 clients, effective on July 21, 2011. Although the exemption is repealed this July, the SEC has extended the deadline for registration until March 30, 2012. Advisers applying for registration with the SEC as a result of the Dodd-Frank Act will have to file the Form ADV Parts 1 and 2A on or before February 14, 2012 to ensure registration is effective by the deadline.
The proposed rules would have required all current registrants to file the new Form ADV Part 1A by August 20, 2011. The Final Rules extend this deadline as well, now requiring all advisers registered with the SEC as of January 1, 2012 to file a Form ADV amendment on the new Form ADV Part 1A by March 30, 2012. Additionally, Exempt Reporting Advisers must file their first reports on Form ADV through IARD between January 1 and March 30, 2012.
Venture Capital Exemption:
The SEC has modified its proposed definition of venture capital fund to allow such a fund to have up to 20% of its capital commitments in non-qualifying investments (other than short-term holdings). This modification allows a venture capital fund some investment flexibility. Additional modifications to the definition of venture capital fund include the elimination of the requirement that a venture capital fund hold itself out as such, and instead requires such a fund to represent that it pursues a venture capital strategy. The Final Rules also eliminate the managerial assistance element of the rule, as proposed.
Private Fund Exemption:
Under the Final Rules, an adviser relying on the private fund exemption will calculate its regulatory assets under management to determine eligibility for the exemption on an annual basis, instead of quarterly, as proposed.
Foreign Adviser Exemption:
Unlike the proposed rules, under the Final Rules, non-U.S. advisers seeking to rely on this exemption should not count “knowledgeable employees” towards the 14 U.S. client/private fund investor limit.2 As such, the assets of knowledgeable employees will not count towards the $25 million U.S. regulatory assets under management limitation for reliance on this exemption.
The Final Rules provide a buffer for mid-sized advisers with regulatory assets under management close to $100 million to determine whether and when to switch between state and SEC registration. The Final Rules raise the threshold above which a mid-sized investment adviser must register with the SEC to $110 million. However, once registered with the SEC, an adviser need not withdraw its registration until it has less than $90 million of regulatory assets under management.
Family Office Definition:
Under the Final Rules, the SEC has made several modifications to the definition of family office for purposes of exclusion from the Advisers Act. First, the Final Rules expand the universe of persons who may be considered family members. The Final Rules permit a family to choose a common ancestor (who may be deceased) and define family members by reference to the degree of lineal kinship to that designated relative. Second, the Final Rules allow a family to designate and redesignate the “common ancestor” for purposes of the exclusion, but impose a 10 generation limit between the oldest and youngest generation of family members related to the common ancestor. This “common ancestor” concept differs from the “founder” concept, as proposed.
Amendments to Form ADV:
The Final Rules make certain clarifications and technical changes to the Form ADV amendments, as proposed. Most notably, the Final Rules scale back the level of disclosure under Item 7.B. of Schedule D for each private fund advised by the adviser. Specifically, the Final Rules eliminate the proposed requirements for an adviser: (i) to disclose each private fund’s net assets, (ii) to report private fund assets and liabilities by class and categorization in the fair value hierarchy established under GAAP, and (iii) to specify the percentage of each fund owned by particular types of beneficial owners.
The Final Rules also scale back the disclosure required under new Item 5.J. of the Form ADV Part 1A. The proposed rules would have required advisers to indicate the specific types of investments they provided advice about during the previous fiscal year. The revised Item 5.J., however, only requires general disclosure to identify advisers that disclose to their clients that they provide specialized advice, but not the specific nature of the specialized advice, as the proposed rules required.
The Final Rules amend disclosure relating to an adviser’s other business activities to clarify that an adviser is not required to complete Section 7.A. of Schedule D for any related person if: (1) the adviser has no business dealings with the related person in connection with advisory services it provides to its clients; (2) the adviser does not conduct shared operations with the related person; (3) the adviser does not refer clients or business to the related person, and the related person does not refer prospective clients or business to the adviser; (4) the adviser does not share supervised persons or premises with the related person; and (5) the adviser has no reason to believe that its relationship with the related person otherwise creates a conflict of interest with its clients. The Final Rules make this clarification to alleviate disclosure relating to parties that present little or no conflict of interest.
Finally, the Final Rules require advisers to report the current market value of their regulatory assets under management determined within 90 days of the filing, as opposed to 30 days, as proposed, and call for several technical clarifications to the instructions throughout the Form ADV in an effort to better assist advisers in accurately completely the Form.
The proposing release contemplated analyzing the exemptions from adviser registration on an entity-by-entity basis and requested comment on whether this was the proper approach or whether to allow integration in certain circumstances consistent with the SEC’s historic position on integration taken in the Richard Ellis SEC no-action letter. In the Final Rules, the SEC changed its proposed view and stated they would continue to allow integration in reliance on the Ellis factors.
In the Final Rules, the SEC also generally affirmed the Unibanco line of SEC no-action letters as applicable to foreign advisers which allows, under certain circumstances, interactions between non-U.S. unregistered advisers and its U.S. registered affiliates. Although the SEC generally affirmed reliance on Unibanco, it stated that while nothing in the newly adopted rules is intended to withdraw any prior statement of the SEC or the view of the staff as expressed in Unibanco, the SEC expects that the staff will provide guidance, as appropriate, based on facts that may be presented to it regarding the application of Unibanco in the context of the new foreign private adviser exemption and private fund adviser exemption.
Pay-to-Play Rule Amendments:
The Final Rules adopt amendments to Rule 206(4)-5 of the Advisers Act, which governs political contributions by investment advisers, largely as proposed but with slight modifications. Under the proposed rules, the SEC sought to limit the exception to the third-party solicitation ban to registered municipal advisors. However, the Final Rules retain the approach of the current rule by permitting advisers to compensate persons that are “regulated persons,” including registered broker-dealers and investment advisers, for soliciting government entities if they are subject to pay-to-play rules at least as stringent as Rule 206(4)-5. Further, the Final Rules expand “regulated persons” to include registered municipal advisors. Finally, the Final Rules extend the date by which advisers must comply with the ban on third-party solicitation from September 13, 2011 to June 13, 2012, partially to allow FINRA to adopt a pay-to-play rule for broker-dealers.