Tag: Release No. IA-3110

Regulation of Private Fund Advisers at the State Level

The Dodd-Frank Wall Street Reform and Consumer Protection Act raised the level for registration with the SEC and removed the commonly used exemption from registration used by private fund advisers. That means smaller traditional investment advisers will be kicked out of the SEC registration and into the state registration systems. That also means that advisers to funds with less than $150 million are potentially subject to state-level registration and regulation.

In general, advisers to private funds with less than $150 million in assets under management will be exempt from SEC registration but still must submit reports to the SEC and maintain certain books and records. This, along with venture capital fund advisers are the new “exempt reporting advisers” category. They are not excluded from the definition of “investment adviser” under the Investment Advisers Act and are not required to register under the Investment Advisers Act.

That means states are not preempted by Section 203A of the Investment Advisers Act from requiring “exempt reporting advisers” to register.

Advisers to private funds with more than $150 million under management are federal covered advisers and merely have to notice file in the states in which they maintain a place of business. (Investment adviser representatives for private fund advisers are required to register with the states if they meet the definition of investment adviser representative under SEC Rule 203A-3.)

The North American Securities Administrators Association has begun looking at the issue of how states with regulate private fund advisers under the $150 million level. They have issued their Proposed NASAA Model Rule on Private Fund Adviser Registration and Exemption.

The model rule would provide the basis for an exemption from state registration only for advisers only to 3(c)(7) funds, including venture capital funds formed under 3(c)(7). Presumably funds falling under the 3(c)(1) exemption would be subject to state registration.

Under the proposed model rule, an investment adviser solely to one or more private funds will be exempt from state registration requirements if the adviser satisfies certain specified conditions:

  • The adviser cannot be subject to a disqualification under 230.262 of title 17, Code of Federal Regulations.
  • The adviser’s clients must be limited to private funds that that qualify for the exclusion from the definition of “investment company” under Section 3(c)(7) of the Investment Company Act of 1940.
  • The adviser must file with the state the report required by the SEC for exempt reporting advisers.
  • The adviser must pay the fees specified by the state.

The proposed rule could change depending on how the SEC changes its proposals for implementing the new registration and reporting requirements in Release No. IA-3110 and Release No. IA-3111. Once the NASAA finalizes the proposed rule, it would be up to the states to adopt the rule. They may not adopt it all or may change it significantly.

NASAA is seeking comments on their proposed rule. Comments should be submitted electronically to [email protected], but written comments may be mailed to NASAA, Attn. Joseph Brady, 750 First Street, NE, Suite 1140, Washington, DC, 20002. The deadline for submission of comments is January 24, 2011.

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Placement Agents and the MSRB

In addition to laying out the changes to Form ADV, in Release No. IA-3110 the SEC also took a slightly different course on regulating placement agents. Rule 206(4)-5, released in July 2010, required placement agents to either be registered with the SEC as an investment adviser and subject to the limitation on campaign contributions, or register with FINRA. The FINRA registration was subject to enactment of a similar pay-to-play rule by FINRA.

The SEC has abandoned FINRA for the MSRB when it comes to regulating placement agents that interact with government sponsored plans.

Section 975 of Dodd-Frank Wall Street Reform and Consumer Protection Act created a new category of regulated persons called a “municipal adviser.” This new category will regulated by the Municipal Securities Rulemaking Board.

The MSRB is undertaking a rule-making to subject municipal advisers to the pay-to-play rules in place for municipal securities dealers under MSRB Rule G-37.

“Municipal advisors” include businesses and individuals that advise municipal entities concerning municipal financial products and municipal securities, as well as businesses and individuals who solicit certain types of business from municipal entities on behalf of unrelated broker-dealers, municipal advisors, or investment advisers.

In comparing the de minimis amounts under Rule 206(4)-5 and MSRB Rule G-37, the MSRB only allows for contributions up to $250 for candidates the person can actually vote for. The SEC rule is $350 for a candidate you can vote for and $150 for a candidate you can’t vote for. Both have a two-year ban for violation of the rules.

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Calculating Regulatory Assets Under Management for Private Funds

For private fund managers, one troubling aspect of Form ADV had been the calculation of  “assets under management” in item 5.F. If securities are less than 50% of the portfolio then the portfolio would not be a securities account.

Except for real estate debt funds, most real estate funds would end up with $0. (I’m not sure whether that would mean you do not have to register since you are then not giving advice for a securities portfolio or whether that would push you into state registration.)

As a private equity fund or real estate fund purchased assets and sold assets, the manager could be ping-ponged in and out of SEC registration.

In the Proposed Changes to Form ADV published on November 19, the SEC has  proposed revisions to Form ADV that better addresses the reality pf private funds.

In the proposed changes, the SEC has come up with a new method for calculating values that makes much more sense for private funds.

5(b)(4). Determine your regulatory assets under management based on the current market value of the assets as determined within 90 days prior to the date of filing this Form ADV. Determine market value using the same method you used to report account values to clients or to calculate fees for investment advisory services.

In the case of a private fund, determine the current market value (or fair value) of the private fund’s assets and the contractual amount of any uncalled commitment pursuant to which a person is obligated to acquire an interest in, or make a capital contribution to, the private fund.

In the release, the SEC states the an adviser should include “in its regulatory assets under management the value of any private fund over which it exercises continuous and regular supervisory or management services, regardless of the nature of the assets held by the fund.”

This calculation makes it very clear that private fund managers with even a small amount of securities in their funds are going to be forced to register with either the SEC or their state regulators as an investment adviser.

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Yes, the SEC Wants Real Estate Fund Managers to Register

Earlier I had pointed out how a real estate fund manager could be considered an investment adviser and have to register with the SEC under the Investment Advisers Act.

In the Proposed Changes to Form ADV published on November 19, the SEC has made it clear that real estate funds are part of the mix.  They have proposed  revisions to Form ADV that better deal with more private funds being covered by the Investment Advisers Act.

In the proposed new Schedule D to Form ADV, the SEC requires you to designate the type of fund.  If you are still wondering if a real estate fund might need to register, look through the list of fund types:

Question 10: Type of Private Fund: For purposes of this question the following definitions apply:

“Hedge fund” means any private fund that:

a. Has a performance fee or allocation calculated by taking into account unrealized gains;
b. May borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or
c. May sell securities or other assets short.

A commodity pool is categorized as a hedge fund solely for purposes of this question. For purposes of this definition, do not net long and short positions. Include any borrowings or notional exposure of another person that are guaranteed by the private fund or that the private fund may otherwise be obligated to satisfy.

“Liquidity fund” means any private fund that seeks to generate income by investing in a portfolio of short term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investors.

“Private equity fund” means any private fund that is not a hedge fund, liquidity fund, real estate fund, securitized asset fund, or venture capital fund and does not provide investors with redemption rights in the ordinary course.

“Real estate fund” means any private fund that is not a hedge fund, that does not provide investors with redemption rights in the ordinary course and that invests primarily in real estate and real estate related assets.

“Securitized asset fund” means any private fund that is not a hedge fund and that issues asset backed securities and whose investors are primarily debt-holders.

“Venture capital fund” means any private fund meeting the definition of venture capital fund in rule 203(l)-1 under the Advisers Act.

“Other private fund” means any private fund that is not a hedge fund, liquidity fund, private equity fund, real estate fund, securitized asset fund, or venture capital fund.

“Real estate fund” made the list. I take that as a clear sign that the SEC wants real estate fund managers to register under the Investment Advisers Act.

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Image of the Empire State Building is by Christian Mehlführer

Proposed Changes to Form ADV

The SEC has released its proposed changes to Form ADV to better deal with private fund registration and the exempt, but reporting required of venture capital funds: Release No. IA-3110

The Securities and Exchange Commission is proposing new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to give effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration by investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and require reporting by certain investment advisers that are exempt from registration. In addition, we are proposing rule amendments, including amendments to the Commission’s pay to play rule, that address a number of other changes to the Advisers Act made by the Dodd-Frank Act.