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SEC Proposes Rules Implementing Dodd-Frank Act Provisions Pertaining to Investment Adviser Registration

November 30, 2010

On November 19, 2010, the Securities and Exchange Commission ("SEC") proposed new rules and amendments implementing certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act") as it relates to investment adviser registration. Specifically, the new rules (i) clarify eligibility for registration with the SEC; (ii) clarify the scope of new exemptions from registration with the SEC for certain advisers; (iii) establish reporting requirements for certain advisers exempt from registration with the SEC; (iv) require greater disclosure by registered investment advisers and each managed private fund under Form ADV; and (v) propose amendments to the "pay to play" rules of the Investment Adviser's Act of 1940 ("Advisers Act") (collectively, the "Proposed Rules"). 

Many previously unregistered advisers will have to register with the SEC as a result of the Dodd-Frank Act. In releasing the Proposed Rules, the SEC furthers its goal of increasing regulatory oversight and enabling investors and regulators to assess the risk profile of advisers and their private funds.

The SEC is seeking comments to the Proposed Rules for a period of 45 days after their publication in the Federal Register.

A summary of these Proposed Rules, located here and here, is provided below. 

Eligibility for Registration

Currently, Section 203A of the Advisers Act generally (i) prohibits an adviser regulated by the state in which it maintains its principal office and place of business from registering with the SEC unless it has at least $25 million in assets under management and (ii) preempts certain state laws regulating advisers registered with the SEC. Section 410 of the Dodd-Frank Act increases this threshold from $25 million to $100 million by creating a new class of "mid-sized advisers" that are registered as investment advisers in the state in which it maintains its principal office and place of business, and that have assets under management between $25 million and $100 million. Generally, such mid-size advisers may not register with the SEC and will alternatively be subject to state registration. As a result, these proposed amendments effectively reallocate responsibility for oversight of certain investment advisers to the states.

Exemptions From Prohibition on Registration.  Notwithstanding the above, per the Proposed Rules, a mid-sized adviser is not prohibited from registering with the SEC if (i) such adviser is not required to be registered with the applicable state securities authority (or equivalent regulatory agency or office) of the state in which it maintains its principal office and place of business; (ii) if registered, the adviser would not be subject to examination as an investment adviser by that securities commissioner; or (iii) the adviser is required to register in 15 or more states.

In addition, a mid-sized adviser will be required to register with the SEC if it is an adviser to a registered investment company or business development company.

Pursuant to its authority to exempt advisers from the foregoing prohibition on SEC registration, the SEC adopted six adviser exemptions in Rule 203A-2 that now extend to mid-sized advisers. Three of the exemptions have been amended to reflect certain developments since their adoption, including the enactment of the Dodd-Frank Act: (i) nationally recognized statistical rating organizations would no longer be covered by these exemptions; (ii) pension consultants continue to qualify for this exemption, however the minimum value of plan assets necessary in order to qualify  has been increased from $50 million to $200 million; and (iii) the multistate exemption would be amended to permit SEC registration for an investment adviser required to register with 15 or more states.

Assets Under Management.  Often, the amount of assets an adviser has under management determines whether the adviser must register with the SEC or with the states. "Assets under management," as defined in Section 203A(a)(2) of the Advisers Act, are "securities portfolios" with respect to which an adviser provides "continuous and regular supervisory or management services." Pursuant to such determination, and in order to facilitate a more consistent application of this amount in various reporting contexts in which it is required, the Proposed Rules contemplate a uniform method of calculating assets under management, known as "regulatory assets under management" for (i) reporting assets under management on Form ADV; (ii) the new exemptions from registration under the Advisers Act (discussed below); and (iii) for purposes of determining eligibility for registration with the SEC. The calculation includes the value of securities portfolios or private funds for which they provide continuous and regular supervisory management services (regardless of the nature of the assets), and does not permit subtraction of outstanding indebtedness and other accrued but unpaid liabilities that remain in a client's account and are managed by the adviser. The calculation also includes the amount of any uncalled capital commitments made to the fund, and requires the use of the fair value in determining assets under management.

Exemptions From Registration

Three new exemptions from registration were created under the Proposed Rules: (i) advisers solely to venture capital funds; (ii) advisers solely to private funds with less than $150 million in assets under management in the U.S. (together with advisers falling within the exemption set forth in clause (i), "exempt reporting advisers"); and (iii) certain foreign advisers with no place of business in the U.S. and minimal assets under management attributable to U.S. clients and investors. The Proposed Rules implement and define each of these exemptions, and clarify the meaning of certain terms included in the exemption for foreign private advisers, as further provided below.

Definition of Venture Capital Fund. For purposes of exemption from registration, Proposed Rule 203(l)-1 (the "venture capital fund exemption") defines the term "venture capital fund" as a private fund that: (i) invests solely in equity securities of private companies to provide operating and business expansion capital (not to buy out other investors) ("qualifying portfolio companies") and certain short-term (60 days or less) U.S. Treasury securities or cash; (ii) offers to provide significant managerial assistance to, or otherwise control, its qualifying portfolio companies; (iii) does not borrow or otherwise incur debt (except for limited short-term borrowing); (iv) does not offer redemption rights or other liquidity rights, other than in extraordinary circumstances; (v) represents itself as a venture capital fund; and (vi) is neither registered under the Investment Company Act of 1940 ("Investment Company Act") nor has elected to be treated as a business development company. It would be difficult to conform existing funds (generally with terms in excess of ten years) to the new definition; therefore, existing funds not meeting all of the conditions (yet which represent themselves as venture capital funds) fall within a proposed grandfathering provision exempting them from registration.   

Definition of Private Fund Advisers with Less than $150 Million in Assets Under Management in the U.S.  Section 203(m) of the Advisers Act directs the SEC to exempt from registration any investment adviser solely to private funds that have less than $150 million in assets under management in the U.S. (the "private adviser exemption"). Proposed Rule 203(m)-1 provides that a U.S. adviser must aggregate the value of all assets of the private funds it manages, regardless of where the funds are organized, to determine whether the adviser remains below the $150 million threshold. Each adviser must determine the amount of its private fund assets quarterly, and the valuation will be based on the fair value of assets at the end of each quarter.  In the case of sub-advisers, only that portion of the private fund assets for which it has responsibility will be considered in this valuation.

Transition Rule.  Under the Proposed Rules, an adviser has one calendar quarter after it exceeds $150 million in private fund assets to register as an investment adviser with the SEC.  This grace period is available only to advisers that are in compliance with all applicable SEC reporting requirements.

Additionally, foreign advisers, who are also subject to the foregoing calculations, definitions and the transition rule, must meet these conditions in regard to assets under management in the U.S., but generally not with respect to assets managed from abroad. As a result, non-U.S. advisers without U.S. operations are exempt from registration unless they have U.S. clients that are not private funds.

Definition of Foreign Private Advisers.  Section 403 of the Dodd-Frank Act replaces the current private adviser exemption with a new exemption for "foreign private advisers", defined as any investment adviser that: (i) has no place of business in the U.S.; (ii) has less than $25 million in aggregate assets under management from U.S. clients and private fund investors; (iii) has fewer than 15 U.S. clients and private fund investors; and (iv) neither holds itself out to U.S. investors as an investment adviser nor acts as an investment adviser to any investment company registered under the Investment Company Act or any company that has elected to be a business development company. The SEC is also proposing a new rule that defines certain terms in this statutory definition for use by advisers seeking to take advantage of this exemption (i.e. "investors" and "assets under management"). Unlike the private adviser exemption defined above, foreign advisers relying on this exemption are not given any time period within which to register with the SEC upon becoming ineligible to rely on this exemption due to an increase in the value of private assets attributable to U.S. clients and investors in the U.S. Foreign private advisers also do not need to comply with the reporting and examination requirements for exempt reporting advisors, as discussed below.

Reporting Requirements for Exempt Reporting Advisers

While certain advisers are exempt from registering with the SEC per the Proposed Rules, (i.e. advisers to solely one or more venture capital funds and to any adviser solely to private funds with less than $150 million in assets under management) Rule 204-4 would require exempt reporting advisers to nonetheless file reports electronically with the SEC on Form ADV through the Investment Adviser Registration Depository.

Exempt reporting advisers would be required to complete a limited subset of Form ADV items that provide the SEC and the public with basic information about the adviser and its business. These items are in Part 1A of Form ADV, which require, among other things:

  • Basic identifying information about the adviser and its owners/affiliates (Item 1);
  • SEC reporting by exempt reporting advisers (Item 2.C);
  • Form of organization (Item 3);
  • Its financial industry affiliations and private funds it manages (Item 7);
  • Its control persons (Item 10); and
  • Its disciplinary history (Item 11).

The Proposed Rules do not require exempt reporting advisers to prepare Part 2 of Form ADV. Exempt reporting advisers are required to file an initial Form ADV with the SEC no later than August 20, 2011.

Furthermore, exempt reporting advisers are still subject to examination by the SEC, though the details have not yet been specified.

Greater Disclosure Under Form ADV

Form ADV.  A new Proposed Rule, Rule 203A-5, requires that each investment adviser registered with the SEC on July 21, 2011 file an amendment to its Form ADV no later than August 20, 2011, or 30 days after the effective date of the amendments, and to report the market value of its assets under management determined within 30 days of the filing.  An adviser must report whether it is eligible to remain registered and, if so, must identify seven different eligibility requirements that it relies on to remain so registered (i.e. it is a large adviser having $100 million or more regulatory assets under management).  An adviser no longer eligible for SEC registration must withdraw its SEC registration by filing Form ADV-W no later than October 19, 2011 (60 days after the required refiling of Form ADV).

Furthermore, if an adviser is no longer eligible for SEC registration at the end of its fiscal year (which is determined on an annual basis), the adviser has 180 days from its fiscal year end to withdraw from SEC registration and switch to state registration.

Proposed Form ADV Amendments.  In an attempt to further the theme of transparency advocated in the Dodd-Frank Act, the SEC may require the disclosure of additional information as part of their enhanced ability to oversee investment advisers. Pursuant to the Proposed Rules, investment advisers would be required to provide additional information regarding: (i) private funds they advise, including identifying the amount of assets held by the fund, the nature of the investors in the fund and the fund's service providers, such as auditors, prime brokers, custodians, administrators and marketers; (ii) their advisory business, including data about the types of clients they have and about business practices that may present significant conflicts of interest; and (iii) additional information about an adviser's non-advisory activities and any financial industry affiliations.  These Proposed Rules provide amendments to Form ADV that apply to both exempt reporting advisers and registered investment advisers.

Filing Updating Amendments to Form ADV.  The SEC also proposes to require exempt reporting advisers to file updating amendments to reports filed on Form ADV at least annually and to file an amendment to Form ADV when an adviser ceases to be an exempt reporting adviser.

Amendments to "Pay to Play" Rule

In July of 2010, the SEC adopted Rule 206(4)-5 of the Advisers Act to address the selection of advisers to manage assets of U.S. state and local government entities in response to changes made by the Dodd-Frank Act. The rule generally prohibits (i) registered and certain unregistered advisers from providing advisory services for compensation to a government client for two years after the adviser or certain of its executives or employees makes certain political contributions; (ii) paying third parties to solicit advisory business from any government entity unless the person is a "regulated person" subject to similar pay to play restrictions (i.e. regulated broker-dealers subject to such restrictions or registered investment advisers); and (iii) soliciting others, or coordinating contributions to elected officials or candidates or payments to political parties, where the adviser is providing or seeking government business. 

The SEC proposed three amendments to the aforementioned pay to play rule in the Proposed Rules. Specifically, (i) the scope of the rule would be expanded to apply to exempt reporting advisers and foreign private advisers; (ii) the provision prohibiting advisers from paying persons to solicit government entities unless such persons are "regulated persons" would be amended to permit an adviser to pay any "regulated municipal adviser" (a person registered under section 15B of the Securities Exchange Act of 1934 and subject to pay to play rules adopted by the Municipal Securities Rulemaking Board) to solicit government entities on its behalf; and (iii) the definition of a "covered associate" of an investment adviser would be amended to clarify that it includes a legal entity, not just a natural person, that is a general partner or managing member of an investment adviser.

Navigating the Proposed Rules presents a challenge for advisers. Please contact your Bracewell & Giuliani attorney or one of the attorneys listed on this update if you require assistance in (i) assessing potential exemptions from SEC registration, (ii) analyzing state and federal registration requirements, and/or (iii) preparation of initial or amended Form ADV filings.

Bracewell & Giuliani will continue to monitor the Proposed Rules and will provide updates as they become available. We will also continue to provide information as additional rulemaking under the Dodd-Frank Act unfolds.