The SEC recently issued proposed rules and rule amendments under the Investment Advisers Act of 1940 (the "Advisers Act") that would give effect to certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). The proposed rules were set forth in two releases. In one release, the SEC proposed rules for the reallocation of responsibility for the oversight of certain mid-sized investment advisers between the states and the SEC, changes to Form ADV, reporting requirements for exempt private advisers, and amendments to the SEC's "pay-to-play" rules. In the other release, the SEC proposed rules to implement the new venture capital, private fund adviser, and foreign private adviser exemptions from investment adviser registration. The key provisions of these proposed rules and rule amendments are summarized below.
Implementation of Amendments to the Advisers Act
Eligibility for SEC Registration
The Dodd-Frank Act raises the threshold for SEC registration of investment advisers to $100 million in assets under management, and creates a new category of "mid-sized advisers" for advisers with assets under management between $25 million and $100 million. Under the Dodd-Frank Act, mid-sized advisers are not permitted to register with the SEC, unless the adviser:
The SEC has proposed rules and rule amendments to clarify the application of the new statutory provisions, modify certain SEC exemptions from the prohibition on registration, and provide for a transitional process for advisers no longer eligible for SEC registration. The SEC has also proposed amendments to Form ADV to identify advisers that must transition to state regulation.
Notably, a mid-sized adviser that relies on an exemption from registration under the law of the state in which it has its principal office and place of business is deemed to be "not required to be registered" with the state. Accordingly, such an adviser would be required to register with the SEC unless the adviser qualifies for another exemption from federal registration. With respect to the examination requirement, the SEC intends to request certification from each state's securities regulator as to whether an adviser registered in the state would be subject to examination, and incorporate a list of states that do not provide for an examination into the Investment Adviser Registration Depository ("IARD").
To determine its eligibility for SEC registration based on its "regulatory assets under management," an adviser must calculate the securities portfolios with respect to which the adviser provides "continuous and regular supervisory or management services." Currently, instructions to Form ADV provide guidance in applying the provision. The SEC proposes to modify the instructions to establish a uniform method in how assets under management are calculated for various regulatory purposes. Changes from the current calculation method are:
Additionally, the SEC proposes to amend Form ADV to require an investment adviser to indicate its basis for registration with the SEC and to report annually its eligibility to remain so registered.
The proposed rules would require advisers that are no longer eligible for SEC registration to withdraw their registrations. Advisers registered with the SEC as of July 21, 2011 would have a 90-day transition period during which (1) to file an amendment to their Form ADV no later than August 20, 2011 to report the market value of their assets under management determined within 30 days prior to the filing; and (2) if no longer eligible to be registered with the SEC, to withdraw their registration with the SEC and register with the applicable state regulators by October 19, 2011, unless they are eligible for a state exemption.
Amendments to Form ADV
The SEC proposes to amend Form ADV to require additional information about an adviser's operations in an effort to enhance the SEC's ability to oversee investment advisers. The amendments would expand the information required to be disclosed with respect to the following:
The amended Form ADV would also require advisers to indicate whether the adviser had $1 billion or more in assets in the prior fiscal year and, therefore, would be subject to the excessive incentive-based compensation regulations of the Dodd-Frank Act. Form ADV information would be publicly available, and the SEC expects it would be used by investors to supplement their due diligence efforts.
Requirements for Exempt Reporting Advisers
The Dodd-Frank Act directs the SEC to create new exemptions for venture capital fund and certain other private fund advisers (discussed below) and subject such "exempt reporting advisers" to recordkeeping and reporting requirements as the SEC determines to be necessary or appropriate in the public interest. The SEC has proposed to require exempt reporting advisers to file, and update, reports electronically on Form ADV that would provide the SEC with the following:
Initial reports would be required to be filed with the SEC no later than August 20, 2011.
As a result of the Dodd-Frank Act, the SEC determined that the "pay-to-play" rule adopted last July should be amended, and has proposed rules to (1) broaden the scope of the rule to apply to exempt reporting advisers and foreign private advisers and (2) permit an adviser to pay a municipal adviser, registered under the Securities Exchange Act and subject to the pay-to-play rules adopted by the Municipal Securities Rulemaking Board, to solicit government entities.
New Exemptions from Investment Adviser Registration
The Dodd-Frank Act eliminates the "private adviser exemption" contained in Section 203(b)(3) of the Advisers Act upon which many hedge fund and other private fund advisers have historically relied. Under the private adviser exemption, an adviser that advised fewer than 15 clients on a rolling 12-month basis and neither held itself out to the public as an adviser nor acted as an adviser to a registered investment company was exempt from registration as an investment adviser.
While removing the private adviser exemption, the Dodd-Frank Act creates new exemptions for private fund advisers, advisers to venture capital funds, and foreign private advisers. The SEC has now proposed rules to implement these new exemptions. The exemptions are not mandatory and an adviser that qualifies for an exemption can still choose to register (unless the adviser is otherwise prohibited from registering with the SEC). However, an adviser that avails itself of one of these federal exemptions may still be subject to state registration. In addition to the exemptions described below, the Dodd-Frank Act also provides exemptions for advisers to family offices and small business investment companies regulated by the Small Business Administration. The SEC previously proposed a rule in a separate release with respect to the family office exemption.
Private Fund Adviser Exemption
The Advisers Act, as amended by the Dodd-Frank Act, directs the SEC to provide an exemption from registration under the Advisers Act to an investment adviser that solely advises "private funds" and has less than $150 million in assets under management in the United States. The Dodd-Frank Act defines the term "private fund" to mean an issuer that would be an investment company under the Investment Company Act, but for section 3(c)(1) or 3(c)(7) of the Investment Company Act.
Under the SEC's proposed rule, an investment adviser with its principal office and place of business in the United States would be exempt from registration if the adviser acts solely as an investment adviser to qualifying private funds and manages private fund assets of less than $150 million. For purposes of the exemption, an adviser would have to aggregate the value of the assets of all the private funds it manages in the United States, including any uncalled capital commitments with respect to such funds, on a quarterly basis using the new calculation method provided in Form ADV. All the private fund assets of a U.S. adviser would be included, even if the adviser has offices outside the United States.
The exemption would also be available to non-U.S. advisers who have their principal office and place of business outside of the United States, as long as all the adviser's clients that are United States persons (in general, as defined in Regulation S of the Securities Act of 1933 (the "Securities Act")) are qualifying private funds. A non-U.S. adviser would only need to count private fund assets it manages from a place of business in the United States toward the $150 million threshold.
The proposed rule provides a transition period of one calendar quarter to register with the SEC after becoming ineligible to rely on the private fund adviser exemption. The safe harbor transition period would only be available to investment advisers who have complied with all applicable reporting requirements.
Venture Capital Fund Exemption
An investment adviser that solely advises venture capital funds is exempt from registration under the Advisers Act. The SEC's proposed rule defines the term "venture capital fund" as a private fund that:
A "qualifying portfolio company" is any company that (i) is not publicly traded, (ii) does not incur leverage in connection with the investment by the fund, (iii) uses the capital provided by the fund exclusively for operating or business expansion purposes rather than to buy out other investors, and (iv) is not itself a fund.
The proposed rule includes a grandfathering provision that includes within the definition of "venture capital fund" any private fund that (i) has sold securities to investors not affiliated with any investment adviser of the fund prior to December 31, 2010, (ii) does not sell any securities to (including accepting any capital commitments from) investors after July 21, 2011, and (iii) represented to investors and potential investors at the time of offering that it is a venture capital fund.
Foreign Private Adviser Exemption
The Dodd-Frank Act creates a new foreign private adviser exemption for an investment adviser that (i) has no place of business in the United States; (ii) has, in total, fewer than 15 clients in the United States and investors in the United States in private funds advised by the investment adviser; (iii) has 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 million; and (iv) does not hold itself out generally to the public in the United Sates as an investment adviser. The Dodd-Frank Act grants the SEC authority to raise the $25 million threshold for such exemption, but the SEC did not modify such threshold in its proposed rule.
In its proposed rule, the SEC has provided the following definitions and safe harbors for several of the terms set forth in the new statutory exemption:
These proposed rules and rule amendments were issued by the SEC on November 19, 2010 and published in the Federal Register on December 10, 2010. The period for submitting comments to the SEC on the proposals will run until January 24, 2011. Day Pitney team members actively monitor legislation that affects our clients and will continue to monitor developments in this area.
Jeffrey A. Clopeck, Henry Nelson Massey and Eliza Sporn Fromberg wrote the article, "SEC's Dating Advice For Internet Platforms And Its Impact," for Law360. The article analyzes how some internet platforms are offering private placements in reliance on Rule 506(b) of Regulation D with approval from the Securities and Exchange Commission. This form of "speed dating" with prospective investors by Internet platforms offering private placements is allowed so long as the platform asks probing questions.
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