On November 19, 2010, the United States Securities and Exchange Commission held an open meeting in which the SEC Commissioners voted to propose new rules and rule amendments under the Advisers Act to implement provisions of the Dodd-Frank Act. The proposed rules and rule amendments were set out in two releases, the first addressing Advisers Act registration and reporting requirements and the second addressing exemptions from registration under the Advisers Act. An outline of certain of these proposals follows:
Rules Implementing Amendments to the Advisers Act
Eligibility for Registration With the SEC and Transition to State Registration for Mid-Sized Advisers
The SEC expects that the increase in the general threshold applicable in order for investment advisers to be required to register under the Advisers Act with the SEC from $25 million to $100 million of assets under management that takes effect on July 21, 2011, will require approximately 4,100 mid-sized advisers (i.e., advisers with between $25 million and $100 million of assets under management) to withdraw their SEC registration and register with one or more state securities authorities. There will be a two-step transition process from federal to state registration. All investment advisers registered with the SEC on July 21, 2011 will have 30 days from that date in which to file an amended Form ADV (i) indicating their basis for registration with the SEC; and (ii) reporting the market value of their assets under management, as determined within 30 days prior to the filing. If an adviser is not eligible for SEC registration, the adviser will have an additional 60 days in which to withdraw its Advisers Act registration and, to the extent required by state law, register with one or more states. Each adviser registered under the Advisers Act will be required to report annually whether it remains eligible to be SEC-registered.
If an adviser is not subject to registration and examination by the state in which it has its principal office and place of business, it must register with the SEC if it (i) has assets under management of between $25 million and $100 million and (ii) does not qualify for an exemption from SEC registration. If a mid-sized adviser with $25 million to $100 million of assets under management relies on an exemption under the law of the state in which it has its principal office and place of business such that it is not required to be registered with the state securities authority or if it is not subject to examination by such state, it must register with the SEC unless an exemption is otherwise available. The proposed rules allow the SEC to rely on representations by state securities commissioners as to whether a mid-sized adviser registered with that state would be subject to examination by the state securities commissioner or similar agency.
For purposes of assessing whether an adviser is eligible to register (or whether it qualifies for an exemption from registration), the SEC proposes to continue to require that advisers determine assets under management by calculating “the securities portfolios with respect to which an investment adviser provides continuous and regular supervisory or management services.” The “assets under management” used to determine whether an adviser must register under the Advisers Act would be referred to as its “regulatory assets under management.” Advisers would be required to include in their “regulatory assets under management”: (i) proprietary assets; (ii) assets managed without receiving compensation; and (iii) assets of foreign clients. Advisers would not be permitted to subtract outstanding indebtedness in determining “regulatory assets under management.” All advisers would be required to use the current market value (or fair value of private fund assets) rather than their cost in determining “regulatory assets under management.” These proposed rules are intended to establish a more consistent calculation methodology among advisers and better reflect the Dodd-Frank Act’s objective of monitoring systemic risk.
The SEC proposes to require an adviser to a private fund1 to include in its “regulatory assets under management” (i) the value of any private fund it manages regardless of the nature of the assets held by the private fund; and (ii) the amount of any uncalled capital commitments made to the fund. The SEC noted that advisers to private funds would not under the proposed rules be permitted to value private fund assets at cost.
Amendments to Form ADV
The proposed rules include amendments to Form ADV which are intended to enhance the SEC’s ability to oversee investment advisers. The amendments would require advisers to provide additional information about certain areas of their operations, including:
Reporting by Exempt Reporting Advisers
The Dodd-Frank Act creates a new class of “exempt reporting advisers” that qualify for certain exemptions from Advisers Act registration, such as advisers to solely one or more venture capital funds and private fund advisers with less than $150 million in assets under management. The SEC has the authority to require that exempt reporting advisers file reports with the SEC as it deems necessary or appropriate. The SEC proposes to require exempt reporting advisers to complete some, but not all, of the questions in Part 1A of Form ADV,2 including:
Exempt reporting advisers would file Form ADV through the IARD system and their filings would be made available to the public.
Amendments to the Pay-to-Play Rule
The SEC proposed to amend Rule 206(4)-5, or the “Pay to Play” rule, to apply to exempt reporting advisers and foreign private advisers (defined below). The proposed amendment would also allow an adviser to pay a “regulated municipal advisor,” a new category of registrant under Section 15B of the Securities Exchange Act that is subject to the Municipal Securities Rulemaking Board’s pay to play rules, to solicit business on behalf of an adviser from a state or local government entity.
Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management and Foreign Private Advisers
Exemption for Advisers to Venture Capital Funds
The Dodd-Frank Act provides an exemption from Advisers Act registration for advisers that advise only venture capital funds. However, the Act delegated to the SEC the task of defining “venture capital fund” for purposes of this new exemption. The proposed rules would define a “venture capital fund” as a private fund that:
The proposed definition also includes a grandfathering provision for advisers to funds that have held themselves out as venture capital funds but would not be classified as such under the proposed rules. The grandfathering provision would only apply to funds that sold securities to one or more unaffiliated investors prior to December 31, 2010 and do not sell any securities to, or accept any committed capital from, any person after July 21, 2011.
Advisers that rely on the exemption from Advisers Act registration for advisers to venture capital funds will be exempt reporting advisers and so will be required to file Part 1A of Form ADV. Additionally, under the Dodd-Frank Act those venture capital fund advisers will be subject to certain recordkeeping requirements, to be addressed by the SEC in a subsequent release, and these records would be subject to SEC examination.
Private Fund Adviser Exemption
The Dodd-Frank Act directs the SEC to issue a rule exempting from Advisers Act registration an adviser that acts solely as an investment adviser to one or more qualifying private funds and manages private fund assets of less than $150 million in the United States. The SEC proposes a corresponding rule which would clarify which private fund assets an adviser must count towards the $150 million limit. Advisers with a principal office and place of business (i.e., the place where the adviser controls the management of the private fund assets) in the United States would count all of their private fund assets towards the limit, even if day-to-day management of certain assets may take place outside of the United States. Advisers with a principal office and place of business outside of the United States would only count private fund assets managed from a place of business in the United States toward the limit. Under the proposal foreign advisers may qualify for this exemption if they have non-U.S. clients that are not private funds, as long as (i) all their clients that are U.S. persons, generally as defined in Regulation S under the Securities Act, are private funds; and (ii) all assets of clients that are not private funds are not managed from a U.S. place of business.
Advisers that rely on this exemption will nonetheless be exempt reporting advisers under the Advisers Act.
Foreign Private Advisers
The Dodd-Frank Act established a new exemption from Advisers Act registration for “foreign private advisers.” As defined by section 202(a)(30) of the Advisers Act, a “foreign private adviser” is any investment adviser that (i) has fewer than 15 U.S. clients and private fund investors; (ii) has less than $25 million in aggregate assets under management from U.S. clients and private fund investors; (iii) does not have a place of business in the U.S.; (iv) does not hold itself out generally to the public in the U.S. as an investment adviser; and (v) does not advise an investment company registered under the Investment Company Act or an entity that has elected to be treated as a business development company under the Investment Company Act.
The proposals include definitions or explanations of many of the terms used by the Dodd Frank Act in the “foreign private adviser” definition. The proposals would provide:
Although the Dodd-Frank Act authorizes the SEC to raise the $25 million threshold for registration, the SEC Commissioners and staff did not address raising this threshold in their comments or in the releases.
The SEC has invited comments on the proposals, particularly on the proposed definition of “venture capital fund” and reporting by exempt reporting advisers. The comment period will continue for 45 days after which it is reasonable to expect that the SEC will take further action on these proposals.
Bingham will continue to monitor these proposals and will provide updates on the new rules and rule amendments as they develop. We also plan to provide more detailed alerts on these proposals, including an alert on the impact the proposed rules and rule amendments would, if adopted, have on non-U.S. advisers.
For assistance, please contact the following lawyers:
Thomas John Holton, Partner, Investment Management
1Effective July 21, 2011, “private fund” is defined under Section 202(a)(19) as “an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of that Act.”
2Form ADV would be retitled “Uniform Application for Investment Adviser Registration and Report by Exempt Reporting Advisers.”
3A qualifying portfolio company is any company that (i) is not publicly traded; (ii) does not incur leverage in connection with the fund’s investment; (iii) uses the capital invested by the fund for operating or business purposes (not to buy out other investors); and (iv) and is not a fund itself (i.e., is an operating company).