On June 22, 2011, the Securities and Exchange Commission (“SEC”) adopted final rules to implement key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act pertaining to investment advisers. As described in this article, these rules provide guidance on the new exemptions from adviser registration, new reporting requirements for exempt and registered advisers, and certain implementation timelines.
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), Congress eliminated the “private adviser” exemption from registration under the Investment Advisers Act of 1940 (the “Advisers Act”). Previously, this exemption applied to investment advisers with fewer than 15 clients, and was widely relied on by private fund investment advisers. Congress was concerned, however, that the private adviser exemption allowed the advisers of too many large private funds, including hedge funds, private equity funds and certain other pooled investment vehicles, to avoid registration with the SEC.
Congress replaced the private adviser exemption with three, more limited exemptions for: (1) advisers to venture capital funds; (2) advisers to private funds where the adviser has less than $150 million in assets under management; and (3) foreign private advisers. The final rules adopted by the SEC implement these exemptions. Advisers should take note, however, that the new legislation creates annual SEC reporting requirements that apply even to certain exempt advisers, as discussed below.
New Exemptions to Registration.
Venture Capital Exemption. The Dodd-Frank Act created a new exemption from registration for advisers that advise solely venture capital funds. The new SEC rule defines a venture capital fund “as a private fund that (i) holds no more than 20 percent of the fund’s capital commitments in non-qualifying investments (other than short-term holdings) . . . ; (ii) does not borrow or otherwise incur leverage, other than limited short-term borrowing . . . ; (iii) does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances; (iv) represents itself as pursuing a venture capital strategy to its investors and prospective investors; and (v) is not registered under the Investment Company Act and has not elected to be treated as a business development company.”
The new SEC rule and associated materials include extensive guidance regarding the definition of “qualifying investment” to assist advisers in the application of the venture capital exemption, as well as a significant amount of interpretive guidance in applying the exemption. The 20 percent basket for non-qualifying investments was included in the rule in response to extensive commentator feedback on the proposed rules requesting flexibility in deploying capital for venture capital funds that desire to rely on the exemption.
Private Fund Adviser Exemption. The SEC also adopted a rule as directed by the Dodd-Frank Act setting parameters for the new exemption for advisers that advise solely private funds and that have less than $150 million in assets under management in the United States. Under the Advisers Act, a “private fund” is defined as an issuer that would be an investment company but for section 3(c)(1) or section 3(c)(7) of the Investment Company Act of 1940.
The new rule provides that the assets included in the $150 million cap include the fund assets, valued at market value or fair value, and uncalled capital commitments, as well as the adviser’s proprietary assets and assets managed without compensation. Advisers will be required to calculate total asset values annually in accordance with a revised Form ADV provided by the SEC and to report such amount in their annual updating amendments to Form ADV.
Foreign Private Advisers Exemption. In addition, the Dodd-Frank Act provides that foreign advisers are exempt from registration if they, among other things, do not have a place of business in the United States, do not hold themselves out as advisers to the public in the United States, have fewer than 15 clients in the United States and have less than $25 million in assets under management in the United States. The new SEC rule sets forth various definitions for the statutory terms of the exemption.
The Dodd-Frank Act excluded “family offices” from the definition of investment adviser, thus exempting them from registration under the Advisers Act. The SEC adopted a new rule defining a “family office” as a company that: (1) has no clients other than family clients; (2) is wholly owned by family clients and controlled by family members or family entities; and (3) does not hold itself out as an investment adviser. The rule also includes definitions for the terms “family clients,” “family members” and other key terms of the rule. The rule provides that certain key employees of the family office may participate in investment opportunities provided by the family office and may receive investment advice from the family office. Family offices will be not be permitted to advise certain charitable organizations that are funded in part by non-family sources.
Key Implementation Dates.
The amendments to the Adviser Act effectuated by the Dodd-Frank Act, including the three new exemptions and the new family offices rule, became effective on July 21, 2011. Accordingly, all advisers that commence operations on or after July 21, 2011 are required to register with the SEC immediately unless they qualify for an exemption.
However, advisers that were previously exempt under the old private adviser exemption and that do not qualify for any of the new exemptions have until March 30, 2012 to complete their registration with the SEC. Such advisers are encouraged to begin analyzing their internal policies and procedures to ensure that they qualify for federal registration. In addition, such advisers are encouraged to file their applications for registration at least by February 14, 2012 and preferably sooner to ensure timely approval.
Reporting Requirements for Exempt Advisers.
The SEC has also mandated new reporting requirements for advisers who are exempt under the venture capital fund exemption or the exemption for advisers to private funds with less than $150 million in assets under management (“Exempt Reporting Advisers”). Exempt Reporting Advisers are required annually to submit certain portions of Form ADV to the SEC. Exempt Reporting Advisers are required to file their first reports with the SEC in the first quarter of 2012.
Transition of Mid-Sized Advisers to State Regulation.
Prior to the Dodd-Frank Act, any adviser with assets under management of at least $25 million was entitled to register with the SEC on the federal level. The new law raised the threshold required for registration to $100 million. As a result, mid-sized advisers that manage between $25 million and $100 million in assets must register in the state where they are located, provided that the adviser is required to register in that state and is subject to examination in that state. Under the new rules, all advisers registered with the SEC on January 1, 2012, regardless of size, must file an amendment to their Form ADV by March 30, 2012 in order to declare whether they are still entitled to avail themselves of federal registration. Mid-sized advisers that are thereafter required to register with their respective states must withdraw their SEC registrations and register with their respective states by completing the required forms and registration by June 28, 2012.
1 Under the private adviser exemption contained in the Advisers Act, advisers were exempt from registration if during the prior 12 months such adviser had 14 or fewer clients, such adviser did not hold him or herself out as an investment adviser and such adviser did not act as an investment adviser to a registered investment company. Many private equity, venture capital and hedge fund advisers relied on this exemption to avoid registration. This private adviser exemption was repealed effective July 21, 2011; however, advisers operating on the effective date have until March of 2012 to complete their registration, if necessary.
2 The SEC noted that certain states such as New York, Minnesota and Wyoming do not satisfy the state reporting requirements; therefore, advisers in these states that manage $25 million to $100 million in assets remain subject to SEC regulation and registration.