On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted final rules and rule amendments implementing the provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) that affect investment advisers regulated under the Investment Advisers Act of 1940 (the “Advisers Act”). These actions are embodied in two lengthy Releases. One defines terms and addresses certain issues with respect to the new exemptions from registration provided to investment advisers. The other implements companion amendments to the Advisers Act. Also, under a separate Release on June 22 the SEC adopted a final rule implementing the provision of the Dodd-Frank Act that provides an exemption from the definition of “investment adviser” for a “family office.”
As anticipated, the SEC granted regulatory relief to allow advisers who have relied upon the “Private Adviser Exemption” (i.e., advisers who have had fewer than 15 clients in a rolling twelve month period), de facto, to continue to do so until March 30, 2012, notwithstanding that the Dodd-Frank Act repealed that exemption, effective July 21, 2011.
The following is a summary of the most significant actions taken by the SEC and their impact on a “Non-U.S. Adviser,” defined for these purposes as an investment adviser that does not have a principal office and place of business in the United States. A detailed overview of the Releases and the new rules and amendments is set forth in our Client Alert, available on the Orrick website.
II. New Rules and Amendments
The new rule and rule amendments that were adopted by the SEC, among other things:
Implement the new exemptions from registration provided to three classes of investment advisers:
- advisers “solely to 1 or more venture capital funds” (each, a “Venture Capital Fund Adviser”);
- advisers that act “solely” as an adviser to funds that would be an “investment company,” as defined in the Investment Company Act of 1940 (the “Company Act”), but for Section 3(c)(1) or 3(c)(7) thereof (each, a “Private Fund”), and has “assets under management in the United States of less than $150,000,000” (each, a “Private Fund Adviser”); and
- advisers that: (i) have no place of business in the United States; J(uiil)yh1a4v,e2,0i1n1total, fewer than 15 clients and investors in the United States in Private Funds advised by the investment adviser; (iii) have aggregate assets under management attributable to clients in the United States and investors in the United States in Private Funds advised by the investment adviser of less than $25,000,000; and (iv) neither (x) hold themselves out generally to the public in the United States as an investment adviser; nor (y) act as (I) an investment adviser to any registered investment company; or (II) a business development company (each, a “Foreign Private Adviser”).
- Implement the requirements of the Dodd-Frank Act with regard to: (i) new recordkeeping and reporting requirements to be imposed on both registered advisers and Venture Capital Fund Advisers and Private Fund Advisers (collectively, “Exempt Reporting Advisers”); and (ii) the reallocation of the primary regulatory responsibility for the oversight of investment advisers (“Mid-Size Advisers”) with $25 million to $100 million of assets under management (“AUM”) from the SEC to applicable state authorities.
- Implement the new exemptions from registration provided to three classes of investment advisers:
The final rules and amendments were adopted substantially as proposed on November 29, 2010 with the following noteworthy exceptions:
- Instead of restricting the permissible holdings of a “Venture Capital Fund” (defined in Appendix A) solely to the ownership of equity securities of a “Qualifying Portfolio Company,” cash and cash equivalents, a Venture Capital Fund can hold a “basket” of non-qualifying investments equal to as much as 20% of such fund’s good faith capital commitments;
- Private Fund Advisers will not be required to calculate AUM more frequently than annually (instead of quarterly).
- The final rule implementing the Family Office Exemption substantially broadened the exemption proposed on October 12, 2010. Most notably, the exemption from registration permits investment advice to be provided to non-profit charitable organizations that initially were not established and funded exclusively by family members. The compliance deadline for the new exemption has been extended to March 30, 2012.
III. Other Notable Items of Interest
- An adviser that qualifies for an exemption from registration may nevertheless elect to register with the SEC if otherwise qualified to do so. For example, a Non-U.S. Adviser might choose to register with the SEC if it determines that, on balance, the restrictions on its business operations of qualifying as a Private Fund Adviser would be more burdensome than being registered with the SEC. Also, as both a legal and practical matter, it would be difficult for a Non-U.S. Adviser that is not registered with the SEC to act as an adviser to individual U.S. employee benefit plans that are subject to the Employee Retirement Income Security Act of 1974 (“ERISA”) or Private Funds that are subject to ERISA.
- The SEC will not abandon the “Unibanco” line of No-Action Letters, as had been a concern of some commenters. These letters provide assurance that the SEC would not recommend enforcement action under the Advisers Act “with respect to a non-U.S. adviser’s relationships with its non-U.S. clients [or] if a non-U.S. advisory affiliate of a registered adviser . . . shares personnel with, and provides certain services through, the registered adviser affiliate, without such affiliate registering under the Advisers Act.”
- Exempt Reporting Advisers will be required to maintain records, file an amended version of Form ADV, and be subject to examination by the SEC. In response to concerns that the regulation of Exempt Reporting Advisers will be excessive, the SEC stated that it will review the scope of the recordkeeping and reporting obligations of Exempt Reporting Advisers under the new rules in light of all filings made by March 30, 2012, the deadline for all such initial filings.
- Exempt Reporting Advisers will not be subject to routine compliance examinations, but might be examined in individual cases, if warranted.
- The Instructions for amended Form ADV, Part 1A, set forth a new methodology for determining AUM for purposes of the new rules. Under the new methodology, an adviser must include, among other things, assets managed for family members, proprietary assets, assets managed without receiving compensation, and assets of non-U.S. clients.
- Mid-Size Advisers maintaining their principal place of business in Wyoming, New York or Minnesota will continue to be subject to the SEC registration requirements because Wyoming does not regulate investment advisers and New York and Minnesota did not advise the SEC that they administer an examination program.
IV. Application of the New Rules and Rule Amendments to Non-U.S. Advisers
If an investment fund is domiciled outside the United States (a “Non-U.S. Fund”) and its adviser is a Non-U.S. Adviser, but “U.S. persons” (as defined in Regulation S under the U.S. Securities Act of 1933 (the “Securities Act”)) are either investors or advisory clients, the Non-U.S. Fund and the Non-U.S. Adviser may be subject to the Company Act and the Advisers Act. Unless such a Non-U.S. Adviser is eligible to rely upon one of the new exemptions, it will be subject to the registration requirements of the Advisers Act and, even if exempt from registration, may nevertheless be subject to certain recordkeeping and reporting requirements, and inspection by the SEC, as an Exempt Reporting Adviser. (The actions taken by the SEC did not directly affect the regulatory treatment of Non-U.S. Funds.)
If a Non-U.S. Fund and a Non-U.S. Adviser do not have any U.S. persons as investors or advisory clients, then, generally, they will not be subject to the Company Act or the Advisers Act. (Of course, a Non-U.S. Fund and a Non-U.S. Adviser may nevertheless be subject to the requirements of the Securities Act, the U.S. Securities Exchange Act of 1934, the U.S. Commodity Exchange Act of 1974 and other U.S. laws with regard to their investment and advisory activities that affect U.S. persons or markets.)
The SEC provided the helpful interpretative guidance regarding the application of the new rules and rule amendments to Non-U.S. Advisers set forth in Appendix A hereto.
IV. Concluding Observations
The adoption by the SEC of the complex final rules and rule amendments set forth in the Releases, arguably, is the most significant regulatory development for advisers to Private Funds since the enactment of the Dodd- Frank Act. Nonetheless, the full scope and manner in which this action will impact the private fund management industry and individual advisers will only become known as further regulatory developments unfold during the remainder of 2011 and beyond. Also, it is important to bear in mind that the application of these rules and rule amendments to any particular set of circumstances is highly fact sensitive. Orrick will be closely monitoring regulatory developments and is available to address any questions that arise.
Click here for Appendix A