Massachusetts Secretary of the Commonwealth Proposes New Regulations on Use of Expert Networks and Private Funds Exemption

April 28, 2011

On April 20, 2011, Massachusetts Secretary of the Commonwealth William Galvin announced several proposed changes to the regulations of the Massachusetts Securities Division (the “Division”), including new proposed requirements for investment advisers that use expert network firms, and the elimination of an exemption from Massachusetts investment adviser registration requirements for investment advisers to hedge funds, private equity funds and other private funds. 

Use of Expert Network Firms

The Division has proposed regulations to address “the rising use of expert network firms by investment advisers to facilitate paid consultations between investment advisers and industry experts.” The proposed regulations, which Secretary Galvin has called a “first in the nation” proposal, would require an investment adviser (whether or not it is registered in Massachusetts) to obtain written certification from each consultant that it uses (i) describing any confidentiality restrictions that the consultant has, or reasonably expects to have, regarding any non-public information that the consultant is bound by a confidentiality agreement or fiduciary duty not to disclose (“Confidential Information”), and (ii) stating that the consultant will not provide Confidential Information to the adviser. The use of paid consulting services (whether the adviser pays a consultant directly or through a “Matching or Expert Network Service”) absent obtaining this certification would be added to the non-exclusive list (the “List”) of dishonest and unethical practices in the securities business that are set forth in the Division’s regulations. The Division’s release states that “[t]he proposed regulations, while not altering investment advisers’ existing duty not to trade on insider information, seek to provide investment advisers with greater clarity as to what is impermissible conduct when paying consultants for information.” The application of the List is fairly broad, and extends both to investment advisers that are registered or exempt from registration as an investment adviser in Massachusetts.

The proposed regulations define a Matching or Expert Network as a firm that, for compensation, matches consultants with investment advisers. As presently drafted, the proposed regulations would apply broadly to any consultants that an adviser retains and compensates, and is not limited to consultants that are specifically used in connection with the provision of investment advice.

The jurisdictional scope of this proposed new regulation is not entirely clear. The definition of “investment adviser” that will apply for purposes of the new regulation is not limited to advisers with a headquarters or office in Massachusetts. It is prudent to assume that the Division will seek to apply the new regulations broadly to advisers with only a limited connection to Massachusetts. For example, the Division might seek to apply the new regulation to a non-Massachusetts adviser whose only connection to Massachusetts is clients in the Commonwealth.

Registration of Advisers to Private Funds

In an effort to promote consistency between Massachusetts investment adviser registration requirements and the expanded federal investment adviser registration rules included in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), Secretary Galvin is proposing to phase out an exemption from Massachusetts investment adviser registration that is commonly relied on by advisers to hedge funds, private equity funds and other private funds.

Currently, any person who, for compensation, engages in the business of providing investment advice in Massachusetts is required to register as an investment adviser with the Division unless such person is specifically excluded from the definition of “investment adviser.” The definition excludes investment advisers that are registered as such with the Securities and Exchange Commission (the “SEC”) pursuant to the Investment Advisers Act of 1940, as amended (the “Advisers Act”). Also currently excluded from the definition is any person whose only clients in Massachusetts are limited to one or more specific types of financial institutions (including banks, insurance companies and broker-dealers) or other “institutional buyers.” “Institutional buyer” includes an investing entity whose only investors are “accredited investors” as defined under the Securities Act of 1933, as amended, each of whom has invested a minimum of $50,000. This exclusion from registration in Massachusetts is often relied on by advisers whose only clients are private funds with underlying investors that meet both of these criteria.

Secretary Galvin has proposed to eliminate this exclusion from registration by phasing out this portion of the “institutional buyer” definition. However, this exclusion would remain in effect for funds that existed prior to the effective date of the new regulations and as of the effective date “ceased to accept beneficial owners or additional funds for existing investors.” Accordingly, advisers to new private funds or to private funds that desire to raise additional capital would not be able to rely on the institutional buyer exemption.

Secretary Galvin has proposed a new exemption from Massachusetts investment adviser registration requirements (as described below) that is intended to mesh with the expanded Advisers Act registration requirements under Dodd-Frank. The “private adviser exemption” currently provided in the Advisers Act for advisers with fewer than 15 clients will soon be eliminated. However, pursuant to Dodd-Frank, the SEC has proposed a new, more limited exemption from Advisers Act registration for an adviser with less than $150 million in assets under management and who only advises private funds (i.e., funds that are excluded from the definition of “investment company” under the Investment Company Act of 1940, as amended (the “1940 Act”), under sections 3(c)(1) or 3(c)(7) thereof) (the “Private Fund Exemption”). Certain other advisers will also be exempt from Advisers Act registration, including persons who only advise “venture capital funds” as defined under proposed Rule 203(l)-1 under the Advisers Act (the “Venture Capital Fund Exemption”). Advisers that rely on the Private Fund Exemption or the Venture Capital Fund Exemption will be subject under the Advisers Act to new rules for “exempt reporting advisers,” including recordkeeping and reporting requirements. In addition, an adviser to private funds and other accounts with assets under management of between $25 million and $100 million will not be permitted to register with the SEC if that adviser is required to be registered in the state in which it maintains its principal office and place of business, and, if so registered, would be subject to examination by such state.

Secretary Galvin’s proposed regulations seek to impose a Massachusetts registration requirement that is intended to work in tandem with the new federal rules, and which, if adopted as proposed, will require the registration in Massachusetts of many advisers who fall below the $100 million threshold of assets under management, and who, absent this change, would be required to register under the Advisers Act.

This proposed new exemption would exempt from Massachusetts registration investment advisers who provide advice only to venture capital funds (as defined under proposed Rule 203(l)-1 under the Advisers Act), or funds that are excluded from the definition of “investment company” under the 1940 Act pursuant to section 3(c)(7) thereof (so called “qualified purchaser” funds). This exemption would be subject to certain limitations, as well as to the payment of specified fees and the filing of certain reports that an exempt reporting adviser would also be required to file with the SEC. The practical effect of this proposed regulation for an adviser to private funds that is relying on the SEC’s Private Fund Exemption is that if one or more of such private funds relies on the Section 3(c)(1) exclusion from the definition of investment company under the 1940 Act, the adviser will have to register as an adviser in Massachusetts. However, an adviser that relies on the Private Fund Exemption and provides advice only to Section 3(c)(7) funds or an adviser that relies on the Venture Capital Fund Exemption might also be exempt from Massachusetts investment adviser registration.

Comment Period

The Division is soliciting comments on the proposed regulations, which also include proposals regarding updates to certain references to forms and fees, and other matters. Any such comments must be received by the Division not later than Friday, June 24, 2011. A public hearing on these proposed regulations will be held at 10:00 a.m. on June 23, 2011. The proposed regulations can be found at:



Please direct any questions to any of the listed lawyers or to any other Bingham lawyer with whom you ordinarily work on related matters.


Investment Management Partners:

Marion Giliberti Barish, 617.951.8801

David C. Boch, 617.951.8485

Lea Anne Copenhefer, 617.951.8515

Steven M. Giordano, 617.951.8205

Michael Glazer, 213.680.6646

Richard A. Goldman, 617.951.8851

Barry N. Hurwitz, 617.951.8267

Roger P. Joseph, Practice Group Leader; Co-chair, Financial Services Area, 617.951.8247

Amy Natterson Kroll, 202.373.6118

Michael P. O’Brien, 617.951.8302

Nancy M. Persechino, 202.373.6185

Paul B. Raymond, 617.951.8567

Toby R. Serkin, 617.951.8760

L. Kevin Sheridan Jr., 212.705.7738

Edwin E. Smith, Co-chair, Financial Services Area, 617.951.8615

Stephen C. Tirrell, 617.951.8833

This article was originally published by Bingham McCutchen LLP.