On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted final rules implementing new exemptions from registration as an investment adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”).
Many private fund advisers historically have avoided registration with the SEC by relying upon the “private adviser exemption” set forth in Section 203(b)(3) of the Advisers Act (the “Private Adviser Exemption”), which provided an exemption from registration for advisers with fewer than 15 clients. Effective July 21, 2011, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) effectively eliminates the Private Adviser Exemption and replaces it with several much more limited exemptions from registration. Specifically, Section 203 of the Advisers Act now provides exemptions from registration for:
- advisers that provide advice solely to one or more private funds1 that have assets under management in the United States of less than $150 million (the “Private Fund Adviser Exemption”);
- advisers that provide advice solely to one or more “venture capital funds” (the “Venture Capital Exemption”); and
- foreign private advisers that (i) have no place of business in the United States; (ii) have, in total, fewer than 15 U.S. clients and investors in private funds advised by such advisers; (iii) have less than an aggregate of $25 million in assets that are attributable to U.S. clients and investors in private funds advised by such advisers; (iv) do not hold themselves out to the public as investment advisers in the United States; and (v) do not advise any registered investment companies or business development companies (the “Foreign Adviser Exemption”).
Private Fund Adviser Exemption
Rule 203(m)-1 under the Advisers Act provides an exemption from registration for:
- any adviser with its principal office and place of business in the United States (a “U.S. adviser”) if the adviser (i) provides advice solely to one or more qualifying private funds2 and (ii) has assets under management of less than $150 million;3 or
- any adviser with its principal office and place of business outside the United States (a “non-U.S. adviser”) if (i) all of the non-U.S. adviser’s clients that are U.S. persons4 are qualifying private funds and (ii) all assets managed by that adviser from a place of business in the United States are solely attributable to private fund assets, the aggregate value of which is less than $150 million.
For purposes of calculating the value of private fund assets, an adviser must aggregate the value of all assets of the private funds it manages, including proprietary assets, any assets managed without compensation and the amount of any uncalled capital commitments made by fund investors. An adviser must determine the amount of its private fund assets based on the market value of those assets, or the fair value if market value is not available, and must calculate the assets on a gross basis (i.e., without deducting liabilities and leverage). U.S. advisers are required to include the value of all private fund assets that they manage, including private fund assets of any non-U.S. clients, while non-U.S. advisers are required to consider only the private fund assets they manage from a place of business in the United States. An adviser relying upon the Private Fund Adviser Exemption must calculate the amount of the private fund assets it manages on an annual basis and report the amount in its annual updating amendment to Form ADV.
An adviser generally must register with the SEC within 90 days of filing an annual updating amendment to Form ADV reporting private fund assets equal to or exceeding $150 million.5
Advisers qualifying for the Private Fund Adviser Exemption are nevertheless subject to recordkeeping and reporting requirements promulgated under the Advisers Act.6
Venture Capital Exemption
Advisers that provide advice solely to one or more “venture capital funds” also are exempt from registration as investment advisers. For purposes of the Venture Capital Exemption, Rule 203(l)-1 under the Advisers Act defines the term “venture capital fund” as a private fund that:
- immediately after the acquisition of any asset, other than “qualifying investments” (as defined below) and short-term holdings, holds no more than 20% of the amount of the fund’s aggregate capital contributions and uncalled committed capital in assets (other than short-term holdings) that are not “qualifying investments”;
- does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage in excess of 15% of the fund’s aggregate capital contributions and uncalled committed capital and any such borrowing, indebtedness, guarantee or leverage is for a non-renewable term of no longer than 120 days;
- does not offer its limited partners the ability to withdraw contributed capital or redeem their interests (except in “extraordinary” circumstances);
- represents itself as a venture capital fund to its investors; and
- is not registered as an investment company under the Company Act and has not elected to be treated as a “business development company” under the Company Act.
For purposes of the Venture Capital Exemption, “qualifying investments” generally consist of equity securities of “qualifying portfolio companies.” A “qualifying portfolio company” generally is defined as any company that:
- at the time of the venture capital fund’s investment or follow-on investment, is not a reporting or foreign traded company and does not control, or is not controlled by or under common control with, a reporting or foreign traded company;7
- does not borrow or issue debt obligations in connection with the venture capital fund’s investment in such company and distribute to the fund the proceeds of such borrowing or issuance in exchange for the fund’s investment; and
- is not an investment company, a private fund, an issuer that would be an investment company but for the exemption provided by Rule 3a-7 under the Company Act, or a commodity pool.8
Rule 203(l)-1 under the Advisers Act also includes a grandfathering provision that broadens the definition of “venture capital fund” with respect to certain existing funds. The rule grandfathers a private fund that: (i) represented to investors at the time the fund offered its securities that it pursues a venture capital strategy; (ii) has sold securities to one or more investors prior to December 31, 2010; and (iii) does not sell any securities to, including accepting any capital commitments from, any person after July 21, 2011.
A non-U.S.-based adviser may rely on the Venture Capital Exemption only if all of its clients, whether U.S. or non-U.S., are venture capital funds.
As with the Private Fund Adviser Exemption, advisers qualifying for the Venture Capital Exemption are nevertheless subject to recordkeeping and reporting requirements promulgated under the Advisers Act.
Foreign Adviser Exemption
Section 203(b)(3) of the Advisers Act also provides an exemption from registration for “foreign private advisers.” Section 202(a)(30) of the Advisers Act defines a ”foreign private adviser” to mean an investment adviser that:
- has no place of business in the United States;
- has fewer than 15 clients and investors in private funds advised by the adviser in the United States;
- has aggregate assets under management attributable to clients and investors in private funds advised by the adviser in the United States of less than $25 million;
- does not hold itself out generally to the public in the United States as an investment adviser; and
- does not advise any registered investment companies or business development companies.
Rule 202(a)(30)-1 under the Advisers Act clarifies certain terms included in the statutory definition of “foreign private adviser.” For purposes of calculating the number of “clients,” the rule permits advisers to treat as a single client:
- a natural person and (i) his or her minor children (regardless of whether they share the same principal residence), (ii) any other relatives, spouse, spousal equivalent and spouse’s or spousal equivalent’s relatives who have the same principal residence and (iii) related accounts and trusts; and
- multiple legal organizations that have identical shareholders, partners, limited partners, members or beneficiaries.
To avoid “double counting” of private funds and their investors, the rule provides that:
- an adviser need not count a private fund as a client if the adviser counted any investor in that private fund as an investor for purposes of determining the availability of the foreign private adviser exemption; and
- an adviser need not count a person as an investor if the adviser counts such person as a client for purposes of determining the availability of the foreign private adviser exemption.
For purposes of calculating the number of “investors,” Rule 202(a)(30)-1 under the Advisers Act defines an “investor” as any person who would be included in determining (i) the number of beneficial owners under Section 3(c)(1) of the Company Act or (ii) whether the outstanding securities of a private fund are owned exclusively by qualified purchasers under Section 3(c)(7) of the Company Act (including any beneficial owners of short term paper issued by a private fund).9
To avoid “double counting” of investors in multiple funds, the rule clarifies that an adviser may treat as a single investor any person who is an investor in two or more private funds advised by the investment adviser.
In contrast with the Venture Capital Exemption and the Private Fund Adviser Exemption, advisers qualifying for the Foreign Adviser Exemption will not be required to register with the SEC or comply with any of the recordkeeping and reporting requirements applicable to registered advisers or “exempt reporting advisers.”
Other Rules and Amendments
On June 22, 2011, the SEC also adopted final rules and amendments under the Advisers Act that extend the deadline for registration for advisers relying on the private adviser exemption, modify the method advisers use to calculate their assets under management, establish the reporting requirements for exempt reporting advisers and significantly amend Form ADV, a summary of which is available here. The SEC also recently adopted a final rule defining “family offices” that will be excluded from the definition of “investment adviser” under the Advisers Act, a summary of which is available here.