The Securities and Exchange Commission (“SEC”) has proposed investment adviser rules under the Dodd-Frank Act. See SEC Proposes Rules to Improve Oversight of Investment Advisers (November 19, 2010).
Reporting Requirements for Hedge Fund and Other Investment Advisers
Under the proposed rules, advisers to private funds would be required to provide information regarding:
Basic organizational and operational information of funds, such as information about the amount of assets held by the fund, the types of investors in the fund, and the adviser's services to the fund.
Identification of five categories of "gatekeepers" that perform critical roles for advisers and private funds (i.e., auditors, prime brokers, custodians, administrators and marketers).
Types of clients, fund employees, and advisory activities.
Business practices that may present significant conflicts of interest (such as the use of affiliated brokers, soft dollar arrangements and compensation for client referrals).
Certain additional information regarding non-advisory activities and financial industry affiliations.
“Mid-Sized Adviser” State Registration
Under existing law, advisers generally may not register with the SEC unless they manage at least $25 million for their clients.
The Dodd-Frank Act raises the threshold for SEC registration to $100 million by creating a new category of advisers called "mid-sized advisers." A mid-sized adviser, which generally may not register with the SEC and will be subject to state registration, is defined as an adviser that:
Manages between $25 million and $100 million for its clients;
Is required to be registered in the state where it maintains its principal office and place of business; and
Would be subject to examination by that state, if required to register.
Note that advisers subject to state registration will continue to be subject to the Advisers Act's general anti-fraud provisions.
Pay-to-Play
The SEC has also proposed to amend the investment adviser "pay-to-play" rule in response to changes made by the Dodd-Frank Act. The pay-to-play rule prohibits advisers from engaging in pay to play practices.
Under the proposed amendment, an adviser would be permitted to pay a registered municipal advisor, instead of a "regulated person," to solicit government entities on its behalf if the municipal advisor is subject to a pay-to-play rule adopted by the MSRB that is at least as stringent as the investment adviser pay-to-play rule. The MSRB received new authority over municipal advisors under the Dodd-Frank Act.
Registration Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers
The Dodd-Frank Act repealed the section 203(b)(3) 15-client private adviser exemption and created three new exemptions for:
Advisers solely to venture capital funds.
Advisers solely to private funds with less than $150 million in assets under management in the U.S.
Certain foreign advisers without a place of business in the U.S.
Definition of Venture Capital Fund
The Dodd-Frank Act amended the Advisers Act to exempt advisers that only manage venture capital funds from registration under the Advisers Act, and the SEC was directed to define the term "venture capital fund." Under the proposed definition, a venture capital fund is a private fund that:
Represents itself to investors as being a venture capital fund;
Only invests in equity securities of private operating companies to provide primarily operating or business expansion capital (not to buy out other investors), U.S. Treasury securities with a remaining maturity of 60 days or less, or cash;
Is not leveraged and its portfolio companies may not borrow in connection with the fund's investment;
Offers to provide a significant degree of managerial assistance, or controls its portfolio companies; and
Does not offer redemption rights to its investors.
Under a proposed grandfathering provision, existing funds that make venture capital investments would generally be deemed to meet the proposed definition, as long as they have represented themselves as venture capital funds.
Definition of Private Fund Advisers With Less Than $150 Million in Assets Under Management in U.S.
The SEC is also proposing an exemptive rule that would implement the new statutory exemption from registraoin for private fund advisers with less than $150 million in assets under management in the United States.
In order to rely on the exemption, a U.S. adviser would have to meet the conditions of the exemption with respect to all of its private fund assets under management. A foreign adviser would have to meet the conditions with respect to its assets under management in the United States, but generally not with respect to its assets managed from abroad.
Definition of Foreign Private Advisers
The Dodd-Frank Act also amended the Advisers Act to provide for an exemption from registration for foreign advisers that do not have a place of business in the United States, and have:
Less than $25 million in aggregate assets under management from U.S. clients and private fund investors; and
Fewer than 15 U.S. clients and private fund investors.
Reporting Requirements for Exempted Advisers
For advisers solely to venture capital funds, private funds with less than $150 million but at least $100 Million in assets under management in the U.S., and certain foreign advisers without a place of business in the U.S., the SEC can still impose certain reporting requirements.
Under proposed rules, exempt reporting advisers would be required to file, and periodically update, reports with the SEC, using the same registration form as registered advisers. Rather than completing all of items on the form, exempt reporting advisers would fill out a limited subset of items, including:
Basic identifying information for the adviser and the identity of its owners and affiliates.
Information about the private funds the adviser manages and about other business activities that the adviser and its affiliates are engaged in that present conflicts of interest that may suggest significant risk to clients.
The disciplinary history of the adviser and its employees that may reflect on their integrity.
Exempt reporting advisers would file reports on the SEC’s investment adviser electronic filing system (“IARD”), and these reports would be publicly available on the Commission's website.
Public Comments
Comments on the proposal should be received by the SEC within 45 days after publication in the Federal Register.
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Robert Kiggins, Esq. of McCarthy Fingar LLP, is author of the blog, and may be reached at (914) 385-1024 or rkiggins@mccarthyfingar.com.
