,
Jonathan Axelrad ,
Paul J. Delligatti ,
Robert S. Fore ,
Elizabeth Shea Fries 
,
Matthew L. Giles ,
Rufus C. King ,
Peter LaVigne ,
Byron C. Pavano ,
Paul Schwartz ,
Paul J. Verbesey and
Heather R. Zuzenak
Daniel Preysman contributed to the preparation of this Alert.
To view Client Alert in full, please click here.
1. SEC ADOPTS NEW ADVISERS ACT RULES AND IMPLEMENTS REGISTRATION EXEMPTIONS - INTRO
Who Will Be Affected?
A wide range of U.S. and non-U.S. investment advisers, particularly managers of hedge, venture capital, private equity, real estate and other privately offered funds.1
When Do the New Rules Take Effect?
In general, obligations under the new rules take effect as of March 30, 2012, but advisers who are required to register with the SEC will need to file their registration paperwork no later than February 14, 2012. Until March 30, 2012, as a practical matter, there will be a registration exemption for any adviser with "fewer than 15 clients" that does not hold itself out to the public as an investment adviser or advise U.S. registered mutual funds or business development companies (i.e., similar to the current exemption). Mid-sized advisers that will be required to switch from federal to state registration will be required to withdraw at the federal level by June 28, 2012. Between January 1 and March 30, 2012 all advisers must file a Form ADV to determine their eligibility for SEC registration, and after January 1, 2012 all filings must be on Form ADV as amended in connection with the new rules. All advisers should pay careful attention to the effective dates and requirements during the upcoming transition period, as discussed here.
2. EXECUTIVE SUMMARY
On June 22, 2011, the Securities and Exchange Commission (the "SEC") adopted final rules under the Investment Advisers Act of 1940 (the "Advisers Act") relating to provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). These new rules implement and clarify the provisions of the Dodd-Frank Act that will require previously exempt advisers, including many advisers to private investment funds, to register as investment advisers or to become "exempt reporting advisers" ("ERAs"), and satisfy new compliance obligations. The new registration obligations result primarily from the Dodd-Frank Act's deletion of the "fewer than 15 clients" adviser registration exemption (Advisers Act Section 203(b)(3)). The SEC adopted the new rules in two rule releases that focused on defining and clarifying the Advisers Act registration exemptions adopted under the Dodd-Frank Act (the "Exemptive Release") and implementing those exemptions (the "Implementing Release").
For the most part, the new rules are similar to the rules proposed November 19, 2010, with four principal modifications: (1) as a practical matter, compliance generally has been delayed from July 21, 2011 to March 30, 2012; (2) venture capital funds will have more flexibility under the new rules, including an ability to make non-conforming investments, subject to a 20% basket; (3) non-U.S. firms that deal with U.S. clients or U.S. fund investors may benefit from the continuing ability to avoid integrating a registered U.S. adviser and an affiliated, unregistered non-U.S. adviser under the Unibanco line of no-action letters (discussed here), although the future application and interpretation of prior guidance under the new rules remains undetermined; and (4) the new rules apply a more uniform test to measure "assets under management" both to make determinations regarding registration and to satisfy other regulatory requirements.
Key elements of the new rules are as follows:
- Foreign Private Adviser Exemption. For non-U.S. advisers, the new rules adopt key definitions and clarifications for the so-called "Foreign Private Adviser Exemption"; however, the exemption likely will be of limited benefit for most non-U.S. advisers dealing with U.S. clients or fund investors. The Foreign Private Adviser Exemption is only available to an adviser that has no place of business in the U.S. and that does not hold itself out to the public in the U.S. as an adviser. Moreover, the adviser must have both (1) fewer than 15 clients (or investors in "private funds"2) in the U.S. and (2) aggregate assets under management attributable to clients (or investors in private funds) in the U.S. of less than $25 million.
- "Exempt Reporting Advisers" or "ERAs". The new rules establish exemptions and key definitions (1) for advisers whose clients are all "venture capital funds" and (2) for certain "private fund advisers" with less than $150 million in assets under management in the U.S. While exempt from registration, these advisers will be ERAs and required to file portions of Part 1 of Form ADV. The SEC will have examination authority over ERAs (although the SEC indicated it does not intend to conduct routine examinations of them).
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- Registration Exemption for "Venture Capital Fund" Advisers. The "Venture Capital Exemption" applies to advisers whose only clients are "venture capital funds." The new rules generally seek to distinguish a venture capital fund from a hedge, private equity or fund-of-funds by imposing limits on a venture capital fund's structure (e.g., limits on redemption provisions and leverage), the type of investments it may make and the type of companies in which it may invest, subject to an overall "basket" for non-conforming investments capped at 20% of fund capital. The rules also require that a venture capital fund represent to current and prospective investors that it pursues a venture capital strategy. Broad "grandfather" relief is provided with respect to pre-existing funds that have made similar representations as to pursuit of a venture capital strategy. The new rules permit venture capital funds much greater flexibility than the proposed rules, with the result that many more advisers are expected to qualify for this exemption. Advisers relying on the Venture Capital Exemption will be ERAs.
- Registration Exemption for "Private Fund" Advisers. U.S.-based advisers with less than $150 million in total assets under management in "private funds" (and no other clients) will be able to use the "Private Fund Adviser Exemption." Non-U.S.-based advisers with less than $150 million in assets under management in the U.S. in private funds (and no other U.S. clients) will also be able to use the Private Fund Adviser Exemption. Accordingly, the exemption's primary beneficiaries will likely be non-U.S. advisers that do not manage any assets at a U.S. place of business and whose only U.S. clients are "private funds." Advisers relying on the Private Fund Adviser Exemption will be ERAs.
- Calculating "Assets Under Management" and Its Implications. The SEC adopted a new methodology for calculating "assets under management" that applies to determine eligibility for the various exemptions and is the basis for certain disclosures under Form ADV. The methodology is based on the gross assets in "securities portfolios" for which the adviser provides "continuous and regular supervisory or management services," and includes both proprietary and non-fee bearing assets.
- State vs. Federal Registration . As advisers determine their obligations to file at the state vs. federal level, new transition rules, assets under management thresholds and other provisions apply. ERAs to venture capital and private funds with total assets under management under $100 million will likely not benefit from state law registration exemptions applicable to "federal covered advisers." Such ERAs may be subject to state adviser registration unless the applicable state law provides an alternative exemption. However, NASAA, the organization for state securities administrators, has proposed a model rule creating an exemption from state registration for certain of these ERAs.
- Other Matters . The SEC also: (1) updated Form ADV primarily to include "private fund" disclosures and "exempt reporting adviser" reporting obligations, which are marginally less detailed than originally proposed; (2) indicated that Form PF will be finalized later this year; and (3) revised the "pay to play" rule to cover ERAs and foreign private advisers, and to add certain municipal advisers as permitted solicitors.
3. TIMING AND EXEMPTIONS DURING THE NEXT YEAR
Effective as of July 21, 2011, the Dodd-Frank Act eliminated Section 203(b)(3) of the Advisers Act (commonly referred to as the "private adviser" exemption), which provided a federal registration exemption for any adviser that: (1) had fewer than 15 clients over the prior 12 months; (2) did not hold itself out to the public as an investment adviser; and (3) did not act as an investment adviser to a registered investment company or a business development company. In place of the private adviser exemption, the Dodd-Frank Act created several new exemptions. Effecting and implementing those new exemptions required the new SEC rules that were adopted last week in the Exemptive and Interpretive Releases (the "new rules").
To provide advisers with additional time to comply with the new rules, the SEC adopted transition rules which generally provide that advisers have until March 30, 2012 to come into compliance with the revised Advisers Act registration and reporting requirements. Generally, these transition rules are most significant for: (1) advisers previously exempt from registration under the private adviser exemption that are no longer exempt under the new rules; (2) currently registered advisers ("RIAs") that have new reporting obligations (particularly with respect to "private funds"); (3) advisers who require a period of time to meet one of the new registration exemptions adopted under Dodd-Frank; and (4) advisers no longer eligible to remain registered with the SEC.
Previously Exempt Advisers. The transition rules permit an adviser relying on the legacy private adviser exemption on July 20, 2011, to delay registering with the SEC until March 30, 2012, so long as the adviser: (1) during the course of the preceding 12 months, had fewer than 15 "clients"; and (2) neither holds itself out generally to the public as an investment adviser, nor acts as an investment adviser to a registered investment company or a business development company. For these purposes, in accord with the 2006 decision in Goldstein v. Securities and Exchange Commission, each "private fund" is generally treated as a single "client."
Existing RIAs. As part of the transition process for the Dodd-Frank Act related changes to Advisers Act exemptions and the implementation of the new rules, all advisers registered on January 1, 2012, regardless of their fiscal year end, will be required to file an amendment to their Form ADV on revised Form ADV by March 30, 2012. After January 1, 2012, any adviser filing an amendment to Form ADV will be required to provide responses to revised Form ADV, which includes more detailed disclosures regarding private funds (as discussed here). After the online IARD registration system is updated to reflect the revised Form ADV (which is currently expected to occur in late 2011), all new registrants must complete the revised form.
Exempt Reporting Advisers or ERAs. ERAs are not required to register as investment advisers with the SEC, but are required to file certain parts of Form ADV Part 1 each year. ERAs must file their initial reports on Form ADV Part 1 through the online IARD system between January 1 and March 30, 2012. The Exemptive Rules are effective July 21, 2011, and ERAs may begin relying on them as of such date.
RIAs No Longer Eligible to Register with the SEC. Mid-sized RIAs (generally, RIAs with assets under management between $25 million and $100 million) must file their amendment to Form ADV no later than March 30, 2012 and, with certain limited exceptions, must withdraw their registration with the SEC by June 28, 2012 and transition their registration to the appropriate state securities authorities in accordance with applicable state laws.
4. FOREIGN PRIVATE ADVISER EXEMPTION
"Foreign private advisers" are exempt from registration under the Advisers Act. A "foreign private adviser" is an investment adviser that: (1) has no place of business in the U.S.; (2) has, in total, fewer than 15 clients and investors in the U.S. in private funds advised by the adviser; (3) has less than $25 million of aggregate assets under management attributable to such clients and investors;3 and (4) neither holds itself out generally to the public in the U.S. as an investment adviser nor advises mutual funds or business development companies.
The new rules, which were adopted substantially as proposed, define or explain the following terms that are central to the definition of "foreign private adviser":
"Place of Business." The "place of business" of an investment adviser is defined as (1) an office at which the adviser regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients; and (2) any other location that is held out to the general public as a location at which the adviser conducts any such activities. This definition leverages an existing regulation but, in response to comments, the SEC clarified that an office at which an adviser regularly communicates with its clients, whether U.S. or non-U.S., or an office where an adviser regularly conducts research, would qualify as a "place of business." However, an office at which the adviser solely provides administrative and back-office activities would not qualify as a "place of business," if such activities are not intrinsic to providing investment advisory services and do not involve communicating with clients. Accordingly, whether an investment adviser has a place of business in the U.S. is dependent on the relevant facts and circumstances, and not all offices will constitute a "place of business."
"Client." The new rules provide a safe harbor for purposes of counting clients of a foreign private adviser. A foreign private adviser may deem the following to constitute a single "client": (1) a natural person, together with such natural person's minor children (regardless of whether they share the same principal residence), relatives, spouse, spousal equivalent or relative of the spouse or spousal equivalent, in each case who has the same principal residence as such natural person, and accounts and trusts for which such natural person and/or the foregoing persons are the only primary beneficiaries; and (2) a partnership, limited liability company, corporation or other legal organization (or two organizations with identical ownership) to which the adviser provides advice based on the organization's investment objectives, rather than the individual objectives of the organization's owners.
An adviser is not permitted to disregard a person as a "client" because the adviser provides services for such person without compensation.
A general partner or managing member or similar person acting as an investment adviser to a partnership or limited liability company is required to count the partnership or limited liability company as a "client."
To avoid double counting: (1) an adviser is not required to count a private fund as a client if it counts an investor in the private fund as a client; (2) an adviser is not required to count a person as an investor in a private fund if it counts the private fund as a client; and (3) an adviser may count an investor in two private funds advised by the investment adviser as a single "investor."
The new rules are non-exclusive safe harbors, and there may be other situations in which multiple persons constitute a single "client."
"Investor." An "investor" of a private fund generally includes a classic "limited partner" or "shareholder" (of an offshore fund), as well as any other person who would be taken into account when determining whether the private fund came within the exclusions from the definition of "investment company" under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940 (the "1940 Act"), except that holders of short-term paper4 issued by a private fund count as "investors" (even if they are not counted for purposes of Section 3(c)(1) or Section 3(c)(7)). In a change from the proposed rules, knowledgeable employees of an adviser do not count as investors. Accordingly, a foreign adviser with senior managers based in the U.S. who qualify as knowledgeable employees does not need to count such managers as investors, but should consider whether it may need to count holders of short-term paper as investors. Advisers should determine the number of investors in a private fund based on the facts and circumstances and in light of the general prohibition on doing indirectly what cannot be done directly. Accordingly, an adviser may be required to "look through" certain intermediate accounts through which investors invest in a private fund. By way of example, holders of interests in feeder entities within a master-feeder structure would be counted as investors in the master fund.
"In the U.S." A place of business is treated as being "in the U.S." if it is treated as located in the "United States" as defined in Regulation S. An investor or client generally is treated as being "in the U.S." if that investor or client is a "U.S. person" for purposes of Regulation S, except with respect to certain discretionary or similar accounts that are held for the benefit of U.S. persons by certain non-U.S. dealers or other non-U.S. professional fiduciaries. However, if a person was not actually in the U.S. at the time the person became an investor or client (including each time that an investor in a private fund acquires securities in such fund), that person may be treated for purposes of this rule as not being in the U.S. Under this exception, if subscriptions for private fund interests were submitted and accepted such that the applicable securities were acquired when the applicable investors were outside the U.S., those investors (and the related subscription amounts) would be excluded from the adviser's assets and investors attributable to the U.S. even if, for example, the investors subsequently relocated to the U.S. (although future subscriptions or future acquisitions of securities would be analyzed by reference to the location of the investors at the time such subscriptions were submitted and accepted). The SEC has indicated that if an adviser reasonably believes that an investor or client is not "in the U.S." at the time that they became an investor or client then the adviser can treat such investor or client as not being "in the U.S."
The chart available here summarizes certain registration and ERA reporting requirements that may be relevant to non-U.S. advisers.
5. "EXEMPT REPORTING ADVISERS" OR "ERAS"
Advisers who elect to be ERAs will not be required to register with the SEC, but they will be subject to reporting, recordkeeping and other obligations, such that their compliance obligations may be material and grow over time. In addition to compliance requirements that apply to advisers regardless of their registration status (e.g., Advisers Act anti-fraud provisions), ERAs must file a portion of Form ADV, have and enforce policies and procedures to prevent the misuse of material, nonpublic information, and comply with the Advisers Act "pay to play" rule, and may be subject to specific recordkeeping requirements. ERAs are subject the SEC's examination authority.
Form ADV Filing Obligation. The Implementing Release provides that ERAs must file their initial Form ADV between January 1, 2012 and March 30, 2012. After March 30, new ERAs must file within 60 days of relying upon the Venture Capital Exemption or the Private Fund Adviser Exemption. ERAs must file the same Form ADV as RIAs, although ERAs need only respond to certain specified items and questions. Notably, an ERA must attest that it qualifies for either the Venture Capital Exemption or the Private Fund Adviser Exemption. Furthermore, the SEC rejected suggestions by commentators that some or all of this information receive confidential treatment – for now at least, the information will be publicly available online.
- Required Information. Although ERAs will not file a full Form ADV, the required ADV filing will disclose significant information regarding the adviser and its business. ERAs will be required to complete Form ADV Items 1 (Identifying Information), 2.B (SEC Reporting by Exempt Reporting Advisers), 3 (Form of Organization), 6 (Other Business Activities), 7 (Financial Industry Affiliations and Private Fund Reporting), 10 (Control Persons) and 11 (Disclosure Information), along with the corresponding sections of Schedules A, B, C and D. Answers to these items will disclose basic information about the adviser, details about the private funds it advises (name, domicile, investment strategy, gross assets, etc.), other business interests of the adviser and its affiliates, and disciplinary history of the adviser and its employees. For more details on the specific disclosure that will be required please see: (1) the discussion below on Amendments to Form ADV; and (2) a version of the Form ADV that has been highlighted to show the provisions most relevant to ERAs, which is available here.
- Public Availability of Reports. In the Implementing Release, the SEC reiterated its decision that, under the Advisers Act, reports filed with the SEC must be made available to the public unless the SEC decides the disclosure of such information is "neither necessary nor appropriate in the public interest or for the protection of investors."5 Therefore, all of the information filed by ERAs on Form ADV will be available to the public through IARD.
- Updating Requirements. An ERA will be required to update its Form ADV on the same timetable and for the same reasons as a registered investment adviser: at least annually within 90 days of the end of the adviser's fiscal year, and more frequently for material developments as required by the instructions to Form ADV.
- Ongoing Reporting Obligations. In Chairman Mary Schapiro's Opening Statement during last week's open meeting, she announced that she has directed the SEC staff to reconsider the information the SEC collects from ERAs after the SEC receives and assesses the first year's ERA filings (although this direction does not appear explicitly in last week's rule releases). During the same open meeting, a majority of the Commissioners voted in favor of the ERA reporting requirements, but the two dissenting Commissioners expressed concern about the extent of ERA reporting obligations and the possibility that, particularly over time, and in light of the SEC's examination authority over ERAs, there may be no meaningful distinction between ERA and RIA reporting obligations .
Recordkeeping Requirements. Section 204 of the Advisers Act requires investment advisers to make and keep such records and to make and disseminate such reports as the SEC may prescribe by rule. There is an express exemption for advisers exempt under Section 203(b) (such as foreign private advisers) but not for ERAs. Accordingly, ERAs could be subject to SEC recordkeeping requirements, and the SEC will have the authority to examine such records. Specific recordkeeping obligations, which could significantly increase ERAs' compliance costs, have not been established, but could be the subject of future SEC rulemaking.
Policies Regarding Material Non-Public Information ("MNPI"). Section 204A of the Advisers Act includes a general requirement that all advisers subject to Section 204 (which now includes ERAs) "establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of such investment adviser's business, to prevent the misuse in violation of this Act or the Securities Exchange Act of 1934, or the rules or regulations thereunder, of material, nonpublic information by such investment adviser or any person associated with such investment adviser." ERAs should consider the nature of their businesses and establish appropriate written policies designed to prevent the misuse of MNPI.
SEC Examination. The new rules do not require ERAs to undergo routine SEC compliance examinations. However, the Implementing Release reiterates the SEC's authority to examine ERAs' records, leaving the door open for more regular and robust non-cause examinations. The SEC expects to conduct cause examinations of ERAs when it believes there have been "indications of wrongdoing, e.g., those examinations prompted by tips, complaints, and referrals."
Transition Period. After March 30, 2012, an ERA relying on the Private Fund Adviser Exemption that has complied with all of its reporting obligations may continue to advise private funds for up to 90 days after filing its annual updating amendment stating that its assets under management in the U.S. equal or exceed $150 million before filing its application for registration. This transition period is not available to an ERA that relies on the Venture Capital Exemption, but anticipates losing the benefit of the exemption. For example, an ERA relying on the Venture Capital Exemption must register with the SEC before advising any client that is not a VC Fund (as defined below) or before making a non-qualifying investment in a VC fund that would cause the VC fund to exceed the 20% basket.
Additional Considerations. ERAs will have a newly created status for regulatory purposes that differs from a simple registration exemption. Accordingly, they may need to give special consideration to various contractual and operational matters. For example, they may wish to consider: (1) whether their existing insurance coverage is sufficient to cover increased regulatory compliance risks or should be upgraded; (2) whether to update undertakings previously made to investors, clients, lenders, landlords or others regarding the availability of registration exemptions; and (3) whether to modify any ongoing disclosure documents that describe such exemptions. They should also monitor regulatory developments under the laws of the states in which they may be doing business, and consider whether other regulations (e.g., non-U.S. regulations and CFTC regulations) may entail different consequences for an ERA than they have for an RIA or an adviser that previously relied on the "fewer than 15 clients" private adviser exemption.
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Footnotes
1 Family offices may also be affected by separate new rules that were discussed in Goodwin Procter's June 23, 2011 Client Alert.
2 Under Advisers Act Section 202(a)(29), the term "private fund" means "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." As discussed elsewhere in this Alert, a fund organized outside the U.S. that does not use U.S. jurisdictional means to conduct an offering (and, in particular, does not offer interests to U.S. persons) generally would not be a "private fund" for this purpose, under the SEC's prior interpretation of the Investment Company Act of 1940. (See Advisers Act Release No. IA-3222 FN 294.)
3 The Advisers Act authorizes the SEC to raise this $25 million threshold if it deems appropriate, and the SEC has indicated that it will evaluate whether it is appropriate to do so in the future.
4 "Short-term paper" means "any note, draft, bill of exchange, or banker's acceptance payable on demand or having a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof payable on demand or having a maturity likewise limited; and such other classes of securities, of a commercial rather than an investment character, as the SEC may designate by rules and regulations."
5 Please see the Implementing Release, page 49.
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