Registered Investment Advisers

Investment advisers, whether already registered or not, are facing a highly complex and uncertain regulatory regime as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  More than ever, investment advisers must ensure that they comply with federal and state securities laws, rules and regulations.

The following summarizes recent action taken by the Securities and Exchange Commission in regards to implementing the Dodd-Frank Act.  This information is provided only for information purposes to raise awareness of the changing landscape.

Background

Since 1996, regulatory responsibility for investment advisers has been divided between the Commission and the states, primarily based on the amount of money an adviser manages for its clients. Under lawin existence prior to the implementation of the Dodd-Frank Frank Act, investment advisers generally may not register with the Commission unless they manage at least $25 million for their clients.

The Dodd-Frank Act raises the threshold for Commission registration to $100 million by creating a new category of advisers called “mid-sized advisers.” A mid-sized investment adviser, which generally may not register with the Commission and will be subject to state registration, is defined as an investment adviser 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.

•    Would be subject to examination by that state, if required to register.

•    As a result of this amendment to the Investment Advisers Act, about 3,200 of the current 11,500 registered investment advisers will switch from registration with the Commission to registration with the states. These investment advisers will continue to be subject to the Advisers Act’s general anti-fraud provisions.

The Rules

The Commission adopted amendments to several of its current rules and forms to:

•    Reflect the higher threshold required for Commission registration.

•    Provide a buffer to prevent advisers from having to frequently switch between Commission and state registration.

•    Clarify when an investment adviser will be a mid-sized adviser.

•    Facilitate the transition of advisers between federal and state registration in accordance with the new requirements. Investment advisers registered with the Securities and Exchange Commission 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 Securities and Exchange Commission registration will have until June 28, 2012 to complete the switch to state registration.

Pay-to-Play

The Securities and Exchange Commission also amended the investment adviser “pay-to-play” rule in response to changes made by the Dodd-Frank Act. The pay to play rule is designed to prevent an adviser from seeking to influence government officials’ awards of advisory contracts through political contributions.

Under the amendment, an investment adviser will be permitted to pay a registered municipal advisor to act as a placement agent to solicit government entities on its behalf, if the municipal advisor is subject to a pay-to-play rule adopted by the MSRB that is at least as stringent as the investment adviser pay-to-play rule. The MSRB received new authority over municipal advisors under the Dodd-Frank Act. Advisers will also continue to be permitted to hire as a placement agent an SEC-registered investment adviser or a broker-dealer that is subject to a pay-to-play rule adopted by FINRA that is at least as stringent as the investment adviser pay-to-play rule.

Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers

As previously described, the Dodd-Frank Act eliminated the private adviser exemption and created three new exemptions for:

•    Advisers solely to venture capital funds.

•    Advisers solely to private funds with less than $150 million in assets under management in the United States.

•    Certain foreign advisers without a place of business in the United States.

•    The Commission is adopting rules that would implement these exemptions and define various terms.

New Exemptions

Definition of Venture Capital Fund

The Dodd-Frank Act amended the Investment Advisers Act to exempt from registration advisers that only manage venture capital funds, and directed the Commission to define the term “venture capital fund.” The Securities and Exchange Commission adopted a definition of “venture capital fund” that is designed to effect Congress’ intent in enacting this exemption.

Under the definition, a venture capital fund is 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); may invest in a “basket” of non-qualifying investments of up to 20 percent of its committed capital; and may hold certain short-term investments.

•    Is not leveraged except for a minimal amount on a short-term basis.

•    Does not offer redemption rights to its investors.

•    Represents itself to investors as pursuing a venture capital strategy.

Under a grandfathering provision, funds that began raising capital by the end of 2010 and represented themselves as pursuing a venture capital strategy would generally be considered venture capital funds. The Securities and Exchange Commission adopted this approach because it could be difficult or impossible for advisers to conform these pre-existing funds, which generally have terms in excess of 10 years, to the new definition.

Private Fund Advisers With Less Than $150 Million in Assets Under Management in U.S.

The Securities and Exchange Commission also adopted a rule that would implement the new statutory exemption for private fund advisers with less than $150 million in assets under management in the United States. The rule largely tracks the provision of the statute.

Foreign Private Advisers

The Dodd-Frank Act also amended the Investment Advisers Act to provide for an exemption from registration for foreign advisers that do not have a place of business in the United States, and have:

•    Less than $25 million in aggregate assets under management from U.S. clients and private fund investors.

•    Fewer than 15 U.S. clients and private fund investors.

The Securities and Exchange Commission adopted rules to define certain terms included in the statutory definition of “foreign private adviser” in order to clarify the application of the foreign private adviser exemption and reduce the potential burdens for advisers that seek to rely on it. The rule incorporates definitions set forth in other Securities and Exchange Commission rules, all of which are likely to be familiar to foreign advisers active in the U.S. capital markets.

Please contact Wittenberg Law to help navigate the new (and changing) legal landscape facing investment advisers.