The SEC yesterday adopted rules that will implement the
Dodd-Frank Act’s repeal of the private fund adviser
exemption, thereby requiring hedge fund advisers and
advisers of other private funds to register with the
Commission by March 30, 2012. Commissioner Elisse Walter
said the rules are a long overdue step toward bringing
transparency to the private fund industry. Commissioners
Kathleen Casey and Troy Paredes dissented, saying that
the rules will hinder capital formation without a clear
benefit to investors.
The Commission also approved several
related rules, including ones to establish new
exemptions from registration and reporting for certain
advisers and reallocating regulatory responsibility for
advisers between the SEC and states. The Commission
voted to amend its rules to require more detailed
disclosure by investment advisers, particularly with
respect to the private funds they manage, and agreed to
revise the pay-to-play rule.
Private fund advisers generally have
avoided registering with the SEC based on an exemption
for advisers with fewer than 15 clients. The advisers
counted each fund as one client, even though the fund
might have had hundreds of investors. The exemption,
which was eliminated by the Dodd-Frank Act, enabled
advisers handling large sums of money to avoid SEC
oversight.
The staff said that the new rules
and amendments are intended to enhance its ability to
regulate private fund advisers by eliciting important
information from them. Under amended Form ADV, advisers
to private funds will have to provide basic
organizational and operational information about each
fund they manage, general information about the size and
ownership of the fund, general fund data, and the
adviser’s services to the fund. They also will have to
identify five categories of “gatekeepers”—auditors,
prime brokers, custodians, administrators and
marketers—that perform critical roles for advisers and
the funds they manage.
All registered advisers will have to
disclose more information about their advisory business,
including the types of clients they advise, their
employees and their advisory activities. Business
practices that may present significant conflicts of
interest, such as the use of affiliated brokers and soft
dollar arrangements, also must be disclosed.
Certain advisers will not have to
register if they qualify for one of three new exemptions
specified in the Dodd-Frank Act. They include advisers
solely to venture capital funds, advisers solely to
private funds with less than $150 million in assets
under management in the U.S., and foreign advisers with
fewer than 15 U.S. clients, without a place of business
in the U.S., and with less than $25 million in aggregate
assets under management from U.S. clients and private
fund investors.
The Commission unanimously approved
new rules to implement these exemptions. The rules
define “venture capital fund” as a private fund that
invests primarily in “qualifying investments”
(generally, private, operating companies that do not
distribute proceeds from debt financings in exchange for
the fund’s investment in the company), but may hold
certain short-term investments. It also states that a
venture capital fund is one that is not leveraged except
for a minimal amount on a short-term basis, does not
offer redemption rights to its investors and represents
itself to investors as pursuing a venture capital
strategy.
The definition also states that the
fund may invest in a “basket” of non-qualifying
investments of up to 20 percent of its committed
capital. Casey praised the 20 percent basket provision,
saying that it will help ensure that funds are not
unjustifiably prevented from making the most
advantageous investments and from responding to changing
market conditions efficiently.
Under a grandfathering provision,
funds that began raising capital by the end of 2010 and
represented themselves as pursuing a venture capital
strategy will be considered venture capital funds. The
Commission recognized that advisers may have difficulty
conforming pre-existing funds, which generally have
terms in excess of 10 years, to the new definition.
The Commission can still impose
certain reporting requirements upon advisers relying
upon either of the first two of the new exemptions
(“exempt reporting advisers”). The new rules provide
that exempt reporting advisers will be required to file,
and periodically update, reports with the Commission,
using the same registration form as registered advisers.
However, they will only have to disclose a limited
subset of the information that must be provided by
registered advisers.
The new rules also address the
allocation of regulatory responsibility between the
Commission and the states. Regulation of investment
advisers is divided between the two based primarily on
the amount of money an adviser manages for its clients.
Prior to Dodd-Frank, advisers could not register with
the Commission unless they managed at least $25 million
for their clients.
The Dodd-Frank Act raised the
threshold for Commission registration to $100 million by
creating a new category of advisers called “mid-sized
advisers.” A mid-sized adviser, which will not have to
register with the SEC and will be subject to state
registration, is one 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.
The SEC estimates that because of
this amendment, about 3,200 of the 11,500 registered
advisers will switch to state registration. The rules
adopted yesterday reflect the higher threshold required
for Commission registration and clarify when an adviser
will be a mid-sized adviser. Registered advisers will
have to declare that they are permitted to remain
registered in a filing in the first quarter of 2012, and
those no longer eligible for Commission registration
will have until June 28, 2012 to complete the switch to
state registration.
The Commission also voted
unanimously to adopt a new rule to provide that “family
offices” are excluded from the Investment Advisers Act.
Family offices are entities established by wealthy
families to manage their wealth and provide other
services to family members, such as tax and estate
planning services.
Family offices typically are
considered to be investment advisers, and are subject to
the Investment Adviser Act’s registration requirements.
However, most family offices claim the exemption
available to firms that advise fewer than 15 clients and
meet certain other conditions. The Dodd-Frank Act
repealed the 15-client exemption to enable the SEC to
regulate hedge fund and other private fund advisers, and
required the SEC to define “family offices.”
Under the final rule, a “family
office” is any company that provides investment advice
only to family clients, is wholly owned by family
clients and is exclusively controlled by family members
and/or family entities, and does not hold itself out to
the public as an investment adviser. The rule sets out
which family members and employees can be advised under
the new exemption. Family offices that do not meet the
terms of the exemption will have to register with the
Commission by March 30, 2012.