On 21 July, 2010, President Obama signed the Dodd-Frank Act into law, resulting in sweeping changes to the regulatory regime applicable to the financial industry. In particular, the Dodd-Frank Act included a section entitled the ‘Private Fund Investment Advisers Registration Act of 2010 ‘ (Registration Act), which substantially alters the registration and reporting schemes under the Investment Advisers Act of 1940 for private fund managers.
Prior to passage of the Registration Act, most private fund managers doing business in the US, whether based in the US or elsewhere, could rely on the private advisor exemption under Advisers Act Section 203(b)(3) in order to avoid registration as an investment advisor with the SEC. The private advisor exemption generally exempted from SEC registration investment advisors that did not hold themselves out to the public as investment advisors and had fewer than 15 clients for the purposes of the Advisers Act.
The exemption for venture capital fund advisers could be relied on by non-US venture capital fund managers.
Each private fund (including private equity funds, venture capital funds, hedge funds, real estate funds and private funds of funds) typically counted as a single client for purposes of this exemption, and most non-US private fund managers did not need to count funds organised outside of the US. As a result, historically, non-US investment advisors could advise private funds managed in, organised and/or offered in the US without regard to any limitation on total AUM, so long as the total number of funds in the US did not exceed 14 and the advisor was not engaged in other investment advisory activities, such as management of separately managed accounts for US clients or US registered investment companies.
The Registration Act repealed the private advisor exemption effective 21 July, 2011 and, in its place, the Registration Act introduced three new, more narrowly tailored exemptions:
1. A private fund advisor exemption solely for advisors to private funds with less than $150 million in AUM in the US, without regard to the number or type of private funds (private fund advisor exemption)
2. A foreign private advisor exemption for non-US advisors with no place of business in the US and minimal AUM attributable to US clients and investors (foreign private advisor exemption)
3. An exemption for advisors solely to venture capital funds, as defined by the SEC
The exemption for venture capital fund advisors could be relied on by non-US venture capital fund managers. However, the SEC has proposed a narrow definition of a venture capital fund. Among other things, under the SEC’s proposed definition, a venture capital fund can only invest in equity securities of qualifying portfolio companies and certain short-term debt instruments; the advisor to a venture capital fund must offer or provide significant managerial assistance to qualifying portfolio companies; the fund cannot be leveraged and cannot offer redemption rights; and the fund must represent itself as a venture capital fund to investors. Consequently, most non-US private fund managers will likely seek to rely on one of the other two exemptions from SEC registration established by the Registration Act. Further details on the private fund advisor exemption and foreign private advisor exemption are set forth below.
Under proposed Rule 203(m)-1, non-US advisors – defined as those with their principal office and place of business outside of the US – are exempt from registration (a so called exempt reporting advisor) if:
i. the advisor has no client that is a US person, except for one or more private funds; and
ii. all assets managed by the advisor from a place of business in the US are attributable solely to private fund assets, the total value of which is less than $150 million.
A private fund for these purposes means any private fund (that is, a fund exempted from registration under the Investment Company Act of 1940 (1940 Act) pursuant to Section 3(c)(1) or 3(c)(7) of the 1940 Act) that is not registered under Section 8 of the 1940 Act and has not elected to be treated as a business development company. The proposed rules require an advisor to calculate its AUM on a quarterly basis in accordance with the methodology set forth in the boxed text entitled ‘Calculation of assets under management’ below. Under the proposed rules, an advisor will have one calendar quarter after it exceeds $150 million in private fund assets (and therefore becomes ineligible to rely on the private fund advisor exemption) to register as an investment advisor with the SEC. However, this three-month grace period is only available to advisors that have complied with all applicable SEC reporting requirements prior to registration.
This partial chapter is one of 14 in The European Private Equity Compliance Guide: How to prepare for the AIFMD and wider compliance issues for European fund managers, a new book from Private Equity International.