On June 22, the U.S. Securities and Exchange Commission (SEC) adopted several rules implementing changes to the Investment Advisers Act of 1940 (Advisers Act) made by Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The new rules were adopted under a pair of companion releases: the first implemented changes for "mid-size" advisers and outlined reporting requirements of "exempt reporting advisers" (Implementing Release) and the second promulgated exemptions from SEC registration for venture capital fund advisers, private fund advisers, and foreign private advisers (Exemptions Release).
As a result of the new rules, many previously unregistered advisers, such as advisers to private funds, will have to register with the SEC or one or more state regulators absent an exemption from registration. As set forth in the Exemptions and Implementing Releases, Form ADV will now serve as both a registration and reporting form for registered advisers and a reporting form for exempt reporting advisers. Advisers newly registering with the SEC or reporting as exempt reporting advisers must file Form ADV by March 30, 2012. In this LawFlash, we will discuss the following:
Section 203(m) and Rule 203(m)-1: Exemption for "Private Fund Advisers"
As amended by the Dodd-Frank Act, Section 203(m) of the Advisers Act requires the SEC to provide an exemption from registration to any investment adviser that acts solely as an adviser to private funds and that has assets under management in the United States of less than $150 million. In the Exemptions Release, the SEC adopted Rule 203(m)-1, which brings this private fund adviser exemption into effect.
Section 202(a)(29) of the Advisers Act, as amended by the Dodd-Frank Act, defines a "private fund" as an issuer that would be an investment company under Section 3 of the Investment Company Act of 1940 (1940 Act) but for the exclusions from the definition of "investment company" under Section 3(c)(1) or 3(c)(7) of the 1940 Act. This definition of "private fund" would also include a private fund that invests in other private funds. The SEC explained in the Exemptions Release that a fund organized under the laws of the United States or a state is a "private fund" if it is excluded from the definition of "investment company" pursuant to Section 3(c)(1) or 3(c)(7) of the 1940 Act, and that a non-U.S. fund that offers its securities in the United States and relies on Section 3(c)(1) or 3(c)(7) of the 1940 Act would be a "private fund" under Section 202(a)(29) of the Advisers Act. Thus, a non-U.S. fund may conduct a private offering of its securities in the United States without first obtaining an order permitting registration under Section 7(d) of the 1940 Act if the fund can rely on either Section 3(c)(1) or 3(c)(7) with respect to its U.S. investors. The Exemptions Release also clarified that a private fund that also qualifies for another exclusion from the definition of "investment company" in addition to Section 3(c)(1) or 3(c)(7)—such as certain real estate funds under Section 3(c)(5)—may still be treated as a "private fund" for the purposes of the exemption, so long as the adviser treats such fund as a "private fund" for all other purposes (e.g., Form ADV reporting).
Assets Under Management
Under the new rules, a private fund adviser may advise an unlimited number of private funds and still qualify for the exemption from registration under Rule 203(m)-1, provided that the adviser's U.S. assets under management are less than $150 million. Any uncalled capital commitments, proprietary assets, and assets managed with or without compensation will be counted toward this $150 million threshold. Unlike the proposed rule, which would have required quarterly calculations, the new rule requires a private fund adviser to determine its assets under management annually within 90 days of filing its Form ADV annual updating amendment (as further discussed below), which must be filed within 90 days of its fiscal year-end. This requirement effectively results in a private fund adviser annually calculating and reporting its fiscal-year-end assets under management, but seems to permit an adviser the flexibility of selecting any date within 90 days after its fiscal year-end. Calculations must be on a gross basis using market value or, if market value is unavailable, fair value.
If an adviser exceeds the $150 million threshold in its annual calculation and has otherwise complied with all applicable reporting requirements (as discussed further below), the adviser must apply for SEC registration within 90 days after reporting its assets under management and may continue to act as a private fund adviser until it is registered. A private fund adviser that exceeds the $150 million threshold and has not complied with all applicable reporting requirements will not be given this 90-day grace period and should plan to register prior to reporting its assets under management, thus becoming ineligible for the private fund adviser exemption.
Due to the exemption, an adviser solely to private funds that would otherwise need to register with the SEC once it had reached $100 million of assets under management will not need to register with the SEC until it acquires an additional $50 million of U.S. assets under management or takes on a client that is not a qualifying private fund. Advisers to private funds with less than $150 million of U.S. assets under management will still need to comply with applicable state investment adviser registration requirements.
U.S. and Non-U.S. Advisers
The exemption counts U.S. assets under management differently for advisers with a principal office and place of business in the United States (U.S. advisers) versus advisers with a principal office and place of business outside the United States (non-U.S. advisers). For U.S. advisers, all of the private fund assets managed by an adviser would be counted toward its U.S. assets under management, even if the adviser has offices outside the United States. Non-U.S. advisers would only need to count those assets managed at a place of business within the United States toward the $150 million threshold. In either case, all U.S. assets under management must be attributable to private funds in order for an adviser to fit the private fund adviser exemption.
A non-U.S. adviser may rely on the exemption if all of its clients that are U.S. persons are "qualifying private funds," regardless of the type or number of the adviser's non-U.S. clients. "U.S. persons" is defined by reference to Rule 902(k) of Regulation S under the Securities Act of 1933, which treats legal partnerships and corporations that are organized or incorporated in the United States as U.S. persons and treats trusts with U.S. resident trustees and discretionary accounts with U.S. fiduciaries as U.S. persons. In other words, non-U.S. advisers may advise clients that are not "qualifying private funds" so long as those clients are not U.S. persons. In addition, a non-U.S. adviser may rely on the exemption from registration if it advises U.S. funds so long as all of the funds are "qualifying private funds." Any assets managed by a non-U.S. adviser outside the United States (whether investment funds or managed accounts) do not count toward the $150 million limit. However, if the non-U.S. adviser manages any assets from a U.S. place of business for clients that are not qualifying private funds, the non-U.S. adviser is disqualified from the exemption.
Because Rule 203(m)-1 deems all assets managed by a U.S. adviser to be managed in the United States, a U.S. adviser may rely on the exemption only if all of its clients are qualifying private funds. If a U.S. adviser has any client that is not a qualifying private fund, it cannot rely on the exemption, even if the client is a non-U.S. person.
Offshore Discretionary Accounts
Rule 203(m)-1 also requires that an adviser's discretionary or other fiduciary account be treated as a U.S. person if it is held for the benefit of a U.S. person by a non-U.S. fiduciary that is a related person of the adviser. That is, an adviser will not qualify for the exemption if it establishes offshore accounts for the benefit of U.S. clients held by an offshore affiliate of the adviser and the offshore affiliate then delegates the management of the account back to the adviser, unless the aggregate amount of assets under management by the adviser in such accounts and other accounts of U.S. persons is less than $150 million and all such accounts and other accounts are qualifying private funds. This aspect of Rule 203(m)-1 is aimed at curtailing attempts by non-U.S. advisers to circumvent the exemption. This treatment would not affect U.S. advisers because all assets managed by a U.S. adviser, regardless of client location, would already be counted toward the adviser's $150 million threshold.
Clients That Become U.S. Persons
The adopted version of Rule 203(m)-1 added a note to the definition of "U.S. person" to clarify that a person's status is determined at the time such person becomes a client of the adviser. In other words, a foreign client that later moves to, organizes in, or incorporates in the United States will not later be deemed a "U.S. person."
New Reporting Requirements for Private Fund Advisers as "Exempt Reporting Advisers"
Section 203(m)(2) of the Advisers Act, as amended by the Dodd-Frank Act, mandates that the SEC require private fund advisers that are exempted from registration to nonetheless maintain records and provide the SEC with reports as the SEC determines necessary or appropriate in the public interest, or for the protection of investors. In the Implementing Release, the SEC adopted Rule 204-4 under the Advisers Act, requiring private fund advisers (which, along with venture capital fund advisers, are referred to as "exempt reporting advisers") to complete and electronically file reports using the Investment Adviser Registration Depository (IARD) system on certain amended items set forth in Form ADV, which will be made publicly available on the SEC's website.
New Reporting Requirements
The items in Form ADV on which exempt advisers must report within 60 days of relying on either exemption from registration are the following:
Advisers that use a numerical or alphabetical code on their books and records to preserve the anonymity of private fund clients may report the same code on Schedule D in place of the private funds' names. The amendments to Form ADV set forth in the Implementing Release also put in place certain procedures to avoid dual reporting where a private fund may use subadvisers or is part of a master-feeder structure. In addition, a non-U.S. adviser (i.e., an adviser with a principal office and place of business outside the United States) is not required to complete Schedule D for any private fund that, during the adviser's last fiscal year, was not a U.S. person, beneficially owned by a U.S. person, or offered in the United States. This new regime represents a substantial increase in the reporting requirements of private fund advisers—a fact that led two of the five SEC Commissioners to vote against its adoption.
. See Rules Implementing Amendments to the Investment Advisers Act of 1940, Advisers Act Rel. No. 3221 (June 22, 2011), available at http://www.sec.gov/rules/final/2011/ia-3221.pdf. For the proposing release, see Rules Implementing Amendments to the Investment Advisers Act of 1940, Advisers Act Rel. No. 3110 (Nov. 19, 2010), available at http://www.sec.gov/rules/proposed/2010/ia-3110.pdf.
. See Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers with Less Than $150 Million in Assets Under Management, and Foreign Private Advisers, Advisers Act Rel. No. 3222 (June 22, 2011), available at http://www.sec.gov/rules/final/2011/ia-3222.pdf. For the proposing release, see Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers with Less Than $150 Million in Assets Under Management, and Foreign Private Advisers, Advisers Act Rel. No. 3111 (Nov. 19, 2010), available at http://www.sec.gov/rules/proposed/2010/ia-3111.pdf.
. Section 7(d) of the 1940 Act prohibits a non-U.S. fund from using U.S. jurisdictional means to make a public offering, absent an order from the SEC permitting registration.
. Rule 203(m)-1 does not require private fund advisers to determine fair value in accordance with U.S. generally accepted accounting principles (GAAP). See Implementing Release at n.98.
. The Dodd-Frank Act amended Section 203A(a)(2) of the Advisers Act to increase the assets-under-management threshold for mandatory registration with the SEC from $25 million to $100 million. Rule 203A-1(a) under the Advisers Act permits an adviser with between $25 million and $30 million in assets under management to not register with the SEC if the state in which the adviser maintains its principal office and place of business has enacted an investment adviser statute. Rule 203A-1(a) also includes a $5 million "buffer" that does not require a registered adviser to de-register with the SEC until its assets under management, as annually reported, fall below $25 million. In the Implementing Release, the SEC amended Rule 203A-1 to create a similar voluntary range between $100 million and $110 million and also specified that an adviser need not de-register until its assets under management have dropped below $90 million.
. The SEC noted that, similar to the approach taken under Rules 203A-3(c) and 222-1 under the Advisers Act, an adviser's principal office and place of business would be the location where the adviser controls, or has ultimate responsibility for, the management of private fund assets and the location where it directs, controls, and coordinates its advisory activities, even if day-to-day management of certain assets or some of the advisory activities occur elsewhere. See Exemptions Release at n.385 and accompanying text.
. Rule 203(m)-1(e)(5) defines "qualifying private fund" as any private fund that is not registered under Section 8 of the 1940 Act and has not elected to be treated as a business development company under Section 54 of the 1940 Act. The adopted rule clarifies that a fund that qualifies for exclusion from the definition of "investment company" under the provisions of Section 3 of the 1940 Act, other than Sections 3(c)(1) and 3(c)(7), may still be treated as a "qualifying private fund."
. Part 1A of Form ADV, including Schedules A, B, C, and D, as amended by the Implementing Release, is filed as Appendix D of the Implementing Release, available at http://www.sec.gov/rules/final/2011/ia-3221-appd.pdf.
. Implementing Release at 46.
. See Remarks by Chairman Schapiro: Opening Statement at SEC Open Meeting: Dodd-Frank Act Amendments to the Investment Advisers Act (June 22, 2011), available at http://www.sec.gov/news/speech/2011/spch062211mls-items-1-2.htm ("In addition, although the law enables the Commission to examine these 'exempt but reporting advisers,' we do not intend to conduct routine examinations of them. As many observers know, the Commission has scarce resources, and it is important therefore that we target those resources toward the advisers that are actually registered with us, where the investing public expects us to be focused. At the same time, if there are indications that we should conduct an on-site visit of an exempt but reporting investment adviser, we legitimately and appropriately will have the ability to do so.").
. See Implementing Release at n.163. Section 204(b) of the Advisers Act, as amended by the Dodd-Frank Act, states that the SEC may require registered investment advisers to maintain records and file reports regarding the amount of assets under management, use of leverage (including off-balance-sheet leverage), counterparty credit risk exposure, trading and investment positions, trading practices, valuation policies and practices, types of assets held, and side arrangements.