On June 22, 2011, the Securities and Exchange Commission adopted final rules under the Investment Advisers Act of 1940. The new rules implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that removed the registration exemption on which many hedge fund and other private fund advisers relied, effectively requiring SEC registration of these advisers for the first time. The final rules adopted by the SEC follow:
1. create exemptions from registration for venture capital fund advisers, private fund advisers with less than $150 million in assets under management and certain foreign private advisers;
2. increase from $25 million to $100 million the assets under management that an adviser must manage to be eligible for registration with the SEC and require periodic reporting by certain private advisers exempt from registration; and
3. define those "family offices" that will be excluded from the definition of investment adviser and, therefore, not subject to SEC registration.
The new rules were adopted largely as proposed, however, the SEC did modify certain provisions to address industry concerns. Notable changes from the proposed rules are highlighted below.
Private Equity Fund Advisers
Except as noted below, the private fund adviser exemption was adopted largely as proposed, including that advisers must advise solely private funds and manage less than $150 million in assets (including capital commitments, proprietary and family accounts and non-U.S. client accounts).
• The final rules permit private equity fund advisers to calculate their private fund assets annually and not quarterly, as proposed, to determine if they remain under the $150 million threshold for exemption.
Venture Capital Advisers
• The venture capital adviser exemption applies to advisers that solely manage venture capital funds. The definition of venture capital fund includes a private fund that primarily invests in "qualifying investments," incurs no leverage other than limited short term borrowing, does not offer redemption rights to investors and represents itself as a venture capital fund.
• The adopted rule permits a venture capital fund to hold up to 20 percent of the fund's capital commitment in "non-qualifying investments" and still fall within the venture capital fund definition.
• The adopted rule permits a qualifying investment to borrow (or issue debt) in connection with a venture capital fund investment, provided that the company does not distribute the proceeds of such borrowing or issuance to the venture capital fund in exchange for the fund's investment.
• The adopted rule does not require a venture capital fund to offer (or provide) managerial assistance to, or control any, qualifying portfolio company in order to satisfy the venture capital fund definition.
• The adopted rule added shares of registered money market funds to the types of short term investments that a venture capital fund may exclude when determining whether it satisfies the 20 percent limit for non-qualifying investments.
• The adopted rule permits a venture capital fund to acquire securities in connection with the acquisition (or merger) of a qualifying portfolio company by another non-qualifying portfolio company, such as a publicly traded company, and still satisfy the venture capital fund definition.
• A venture capital fund may disregard a wholly owned intermediate holding company formed solely for tax, legal or regulatory reasons to hold the fund's investments in a qualifying portfolio company.
Foreign Private Advisers
• The foreign private adviser exemption remains largely unchanged from the proposed rule. Foreign private advisers refer to an adviser that has no place of business in the United States, has fewer than 15 clients and investors in the United States in private funds advised by the adviser and manages less than $25 million in assets attributable to U.S. clients and investors.
• The adopted rule excludes "knowledgeable employees" of the adviser from being counted as investors for purposes of determining whether an adviser has 14 or fewer U.S. investors.
• The rules increase the asset threshold for SEC registration from $25 million to $100 million and refers to these advisers as "mid-sized advisers." Subject to certain exceptions, mid-sized advisers are ineligible to register, or to remain registered, with the SEC after the effective date of the new rules.
• The SEC identified Minnesota, New York and Wyoming as states that do not subject advisers to examination. Accordingly, mid-sized advisers must register with the SEC if their principal office and place of business is located in one of these states, unless otherwise exempt.
Exempt Reporting Advisers
• Private equity fund advisers with less than $150 million under management and venture capital advisers that qualify for exemption from SEC registration will still be required to report to the SEC certain identifying and disciplinary information as well as information about the funds they manage and the investors in those funds.
• The final rules state that the SEC does not anticipate conducting compliance examinations on a regular basis but will conduct "cause" examinations where there are indications of wrongdoing.
• The final rules noted that the SEC will make clear to the public viewing reports filed by an exempt reporting adviser that the adviser is not registered with the SEC.
• The changes to Form ADV to require greater disclosure regarding private funds, their service providers and investors were adopted largely as proposed.
• The final rules require advisers to complete a Schedule D (containing information about private funds) for each private fund that they manage but not private funds managed by the adviser's related persons, as had been proposed.
• The final rules will not require disclosure in Form ADV of:
(i) each private fund's net assets;
(ii) private fund assets and liabilities by class and categorization; or
(iii) the percentage of each fund owned by particular types of beneficial owners, as had been proposed.
• The rule's "grandfathering provision" for maintaining certain performance-related records by private advisers that are currently exempt from registration but will be required to register was extended to include all periods prior to an adviser's registration. The proposed rule extended the grandfathering provision only until July 21, 2011.
Also, the SEC formally pushed back the registration deadline for unregistered advisers that will be required to register under the new rules from July 21, 2011 to March 30, 2012. Advisers that determine they are no longer eligible to remain SEC registered must withdraw from SEC registration no later than June 28, 2012.
Matthew R. DiClemente is a Partner in the Philadelphia office of Stradley Ronon Stevens & Young, LLP. He focuses his practice on the representation of investment companies, investment advisers, fund fiduciaries and broker-dealers in a wide range of regulatory, corporate and transactional matters. His representation includes counseling boards of directors on governance issues; advising clients through regulatory exams; handling 1940 Act matters, including experience and mutual fund, hedge fund, broker-dealer, board management and compliance issues; counseling investment advisers on matters relating to regulation, marketing, product development, investment restrictions and compliance; handling mergers and acquisitions involving investment companies and investment advisers; and drafting and negotiating U.S. and offshore selling agreements for full-service broker-dealers. Please note that this article summarizes only certain aspects of the SEC's new rules and is not intended to be a summary of all of the aspects of the new rules.