The Not-So Exempt “Exempt” Reporting Investment Adviser

Introduction

This will continue my analysis of SEC Release IA-3110 (November 19, 2010)  and its proposed rules implementing amendments wrought by Dodd-Frank to the registration provisions of the Investment Advisers Act of 1940.

Under the proposed rules, with some exceptions, only advisers with $100 Million or more in assets under management (AUM) will need (or even be allowed) to register as investment advisers with the SEC. Below that threshold the general rule is that, if otherwise required, an investment adviser will be registered as such with one more states.  This was discussed in some detail in the immediately prior article on this blog.

The Exempt Reporting Investment Adviser

Beyond that over/under $100M dichotomy,  a new category would be introduced by the proposed rules: the so-called “Exempt Reporting Investment Adviser”. This will be an adviser with $100 Million or more AUM who (i) advises solely one or more “Venture Capital Funds”  or (ii)  acts  solely as an adviser to “Private Funds” and has AUM in the United States of less than $150 million.  

Venture Capital Funds and Private Funds were preliminarily reviewed two articles ago in this blog. Since that time the SEC proposals with regard to these Funds (as well as "Foreign Private Advisers" - such advisers are apparently not  to be treated as Exempt  Reporting Investment Advisers) have been covered in more detail in SEC Release IA-3111.

Suffice it to say for now that this category arises largely out of the demise of the old  Private Adviser (14 or fewer clients) exemption from SEC registration as applied to advisers to pooled investment account clients (i.e. investment fund clients) where each fund, regardless of the number of underlying investors in the fund, counted as only 1 client.

Reporting Requirements

Exempt Reporting Advisers will not generally be required to register as investment advisers with the SEC – although it would seem that they may well have to be state registered.  However, these Exempt Reporting Advisers uniformly will be required to electronically file a considerable slug of data with the SEC through IARD, pay filing fees to do so, and keep the reports to the SEC updated at least annually.

The SEC estimates that 2,000 advisers will require 2 hours each for a first time filing of the paperwork ex the private fund reporting section (Item 7 below). In addition, the SEC estimates that each of these 2,000 will have to spend an additional 1 hour on each on average of 5 funds on the private fund reporting section. That seems like it could be on the light side in terms of time required but I would be interested in reader experiences if the proposals are converted into final rules. In any event, this exposure to SEC supervision will almost surely required many an exempt reporting investment adviser to considerably beef up its compliance infrastructure.

Essentially the data to be filed by an Exempt Reporting Investment Adviser will be a modified version of Form ADV, Part 1 – which will have a host of new questions as well as many of the old ones current SEC investment adviser registrants are familiar with.  However, Part 2 of Form ADV (known as the “brochure”) would not have to be filed or distributed to advisory clients of an Exempt Reporting Investment Adviser.

The proposed rules would require Exempt Reporting Advisers to complete the following items in Part 1A of Form ADV:

•  Item 1 (Identifying Information) - This is basic data on the adviser;
•  Item 2.C. (SEC Reporting by Exempt Reporting Advisers) - Presumably data to show Exempt Reporting Adviser Status;
•  Item 3 (Form of Organization) - Also basic data;
•  Item 6 (Other Business Activities) - Mostly looking for conflicts of interest;
•  Item 7 (Financial Industry Affiliations and Private Fund Reporting) - Discussed in detail below;
• Item  10 (Control Persons) - Also basic data but with some "bad boy" and national security overtones; and
•  Item 11(Disclosure Information) - Mostly to ferret out "bad boy" information.

In addition, Exempt Reporting Advisers would have to complete corresponding schedules to Form ADV, Part 1 regarding their ownership.

The release also queries whether all of Form ADV should be required for exempt reporting advisers.

Private Fund Reporting (Item7).

The heart of the reporting requirements is Item 7 - Private Fund Reporting. The proposed rules set forth the type of information the SEC will require as follows:

•  basic organizational and operational information about the funds the adviser manages, 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;

•  information concerning the service provides to the adviser auditors (hint use a CPA firm of sufficient size and experience to provide a meaningful audit for your size fund), prime brokers, custodians, administrators and marketers (another hint: the SEC will deem it a "red flag" if a listed service adviser is under separate SEC investigation for alleged misconduct).

• This information includes the following for each service provider. 
  • For the auditors, whether they are independent, registered with the Public Company Accounting Oversight Board (PCAOB) and subject to its regular inspection, and whether audited statements are distributed to fund investors.
  • For the prime broker, whether it is SEC-registered and whether it acts as custodian for the private fund.
  •  For the custodian, whether it is a related person of the adviser.
  •  For the administrator, whether it prepares and sends to investors account statements and what percentage of the fund’s assets are valued by the administrator or another person that is not a related person of the adviser.
  • For marketers, whether they are related persons of the adviser, their SEC file number (if any), and the address of any website they use to market the fund.

Per the SEC this information is generally designed to improve its ability to assess conflicts and potential risks, identify funds with service provider arrangements that raise a “red flag,” and identify firms for examination.

In addition, Exempt Reporting Advisers would have to complete corresponding schedules to Form ADV, Part 1 regarding their ownership.

Criticism of the Exempt Reporting Investment Adviser Concept

It certainly can be argued that the exposure to SEC regulation swallows the relief given by the exemption. The lack of legal clarity thus generated has been the subject of comment even within the SEC. For example, see the Criticism of Exempt Reporting Investment Adviser by SEC Commissoner Kathleen L. Casey.  She said, in part:

"This proposing release takes the view that these “exempt reporting advisers” are entirely subject to Section 204, and as a result, are subject to the examination authority of the Commission. Under this reading, Congress would therefore have exempted these advisers from registration, but would have, in the same breath, subjected them to almost all of the burdens of registration: reporting, recordkeeping, and examinations."

Compliance Dates

The SEC proposal would require each exempt reporting adviser to file its initial report with the SEC on Form ADV no later than August 20, 2011, 30 days after the July 21, 2011 effective date of the Dodd-Frank Act.  The SEC’s  ability to effect these dates may be delayed due to the need to re-program IARD. 

Comment Period

None of this is a final rule. There is a 45 day public comment period from the date of publication in the Federal register that must first elapse. I think we can anticipate a lot of comment on whether the exempt reporting investment adviser concept makes sense.

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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.

Nothing is this blog is intended to or may be relied upon as specific legal advice. Securities and related laws are complex and competent counsel should be consulted