Small Business Capital Access and Job Preservation Act Moves Toward Vote
The SEC recently finalized the new investment adviser registration regulations and under those regulations private equity fund managers will be required to be registered with the SEC. However, Congress has recently been taking steps that may ultimately mean that private equity fund managers will escape registration requirements.
The Small Business Capital Access and Job Preservation Act (the “Bill”) proposed in March, would amend the Investment Advisers Act to provide an exemption from registration for some private equity fund managers. Recently the House Committee on Financial Services (“Committee”) amended and approved the Bill which will ultimately need to be passed by the full House and Senate before being presented to the President for signature. The amended text makes an exemption from registration available to advisers of private funds that have outstanding debt that is less than twice the amount investors have committed to the private funds (less than a 2-1 leverage ratio).
Proposed Requirements for Private Equity Fund Managers
The amended Bill would require the SEC to define “private equity fund” and to promulgate reporting and record-keeping requirements for those private equity fund managers who utilize the exemption. Specifically, the SEC would have to enact rules that require the managers “to maintain
such records and provide to the Commission such annual or other reports as the Commission taking into account fund size, governance, investment strategy, risk, and other factors, as the Commission determines necessary and appropriate in the public interest and for the protection of investors….” The SEC will be required to issue any regulations within 6 months of the date the Bill is signed into law.
This means that while PE fund managers would be exempt from registration, there would still be fairly significant compliance responsibilities. Essentially these managers would face a regulatory regime similar to exempt reporting advisers.
Support for the Bill
Supporters of the Bill essentially assert that because private equity funds neither caused nor contributed to the financial crisis, it would be unduly burdensome for these fund managers to register with the SEC. Specifically, supporters point to the costs associated with registration, the jobs created by the funds, and the general lack of systemic risk posed by the funds.
According to the Committee report, registration would be burdensome because:
“advisers to private equity funds will be required to calculate the value and performance of each of their funds on a monthly basis, which will in turn require advisers to private equity funds to calculate the value of each company in which the fund has invested on a monthly basis as well. Such valuations are time consuming and costly, and they divert much-needed capital and effort away from job creation and investment activities.”
The Committee received testimony stating:
“As of June 30, 2009, companies that received backing from private equity investment funds employed more than 6 million people. Studies show that the workforces of companies acquired by private equity firms increased by an average annual rate of 5.7 percent, compared to 1.1 percent for all U.S. companies. The Committee also received testimony about the costs of registering with the SEC, which some have estimated to be as high as $500 million industry-wide…”
The concerns were primarily that the burden imposed by the registration requirements could inhibit the creation of more jobs, with struggling or growing companies receiving less capital from such funds. The amended Bill would provide relief from registration for advisers to private equity funds that are levered by less than a 2-1 ratio.
Private equity fund managers should not stop beginning preparations to register as investment advisers with the SEC.
The Bill is a long way from being enacted into law – it still must be passed by the full House, the full Senate, and signed by the President. It will then take (at least) another 6 months for the SEC to issue final rules regarding record-keeping and reporting and to clarify the definition of “private equity fund.” Even with the Dodd-Frank registration deadline pushed back to March 30, 2012, waiting until the Bill and its accompanying rules and regulations are finalized would leave managers of these funds with little time to register in the event they ultimately do not fall within the exemption in its final form.
The Committee’s report is available here.
The full text of the Bill is available here.
Cole-Frieman & Mallon LLP is a law firm which provides adviser registration, compliance and legal support to SEC registered fund managers. Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.
Registration required by March 30, 2012
We are obviously a bit late on reporting that the hedge fund registration regulations were finalized by the SEC recently (see releases at end of the post). We are not going to detail all aspects of the regulations in this post, but we will be examining some of the more important issues related to the release over the coming weeks and months.
We do want to provide a quick overview of some of the more important items with respect to the new regulations. These include:
- registration for many hedge fund managers will be required by March 30, 2012 [note: managers will need to file Form ADV with the SEC no later than February 14, 2012 to meet this deadline]
- Form ADV has been amended in a number of ways which provide more information regarding a fund’s activities and counterparties
- Exempt Reporting Advisers (“ERAs”) will need to complete and file a truncated version of Form ADV by March 30, 2012 [note: ERAs will be subject to recordkeeping requirements and will be subject to SEC examination]
- many currently registered fund managers will need to switch from SEC registration to state registration during the first part of 2012
IA Registration Overview and Exemptions
After the passage of the Dodd-Frank Act it was clear than many fund managers would be required to register as investment advisers with the SEC. In general the following are the registration requirements/exemptions for asset managers:
- managers to only hedge funds (no managed accounts) must register as an IA with the SEC if Regulatory AUM (discussed below) is over $150M
- managers to hedge funds and managed accounts must register as an IA with the SEC if Regulatory AUM is over $100M
- mid-sized advisers ($25M to $100M) will be subject to state registration, if applicable [note: some mid-sized advisers will be subject to SEC registration regardless]
- managers to only VC funds are exempt from registration;
- VC funds may have up to 20% of their assets in non-VC investments
- while managers to VC funds will not be required to register as IAs with the SEC, they will still be Exempt Reporting Advisers and will thus need to completed the truncated Form ADV by March 30, 2012
- non-U.S. managers who have a place of business in the U.S. and have U.S. clients (either directly or as investors in their fund) will generally be required to register as an IA with the SEC or will be deemed to be an ERA [note: non-U.S. managers with U.S. clients or investors will only be exempt from IA registration with the SEC in only limited circumstances]
- private equity fund managers are generally going to be treated the same as hedge fund managers according to these regulations
The following are some of the important items from the releases:
The SEC press release announcing the new regulations and providing an overview of the new regulatory requirements can be found here.
The full releases are below:
- Release IA-3222 [Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers]
- Release IA-3221 [Rules Implementing Amendments to the Investment Advisers Act of 1940]
- Release IA-3220 [Family Offices]
Cole-Frieman & Mallon LLP provides registration, compliance and other legal services for hedge fund managers. Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.
Emergency Action “Necessary” because of SEC Inaction
The California Department of Corporations has provided a temporary six-month extension of Section 260.204.9 which exempts hedge fund managers from registration in California if the manager has more than $25M of AUM. The exemption will be slightly modified to account for the changes to federal law as a result of the Dodd-Frank Act. The exemption is also scheduled to become inoperative on January 21, 2012.
The emergency action was taken by California because the SEC recently announced that they intended to delay implementation of the federal hedge fund registration regulations until 2012. The SEC is expected to formally announce that registration will be delayed until next year in an Open Meeting on June 22. On such date we are expected to have a better timeline of when registration might be required.
Reasons for the Emergency Action
California provides the following background on the emergency action and why the state decided to move forward with extending the exemption:
… persons that may be required to register under final SEC rules would have a very limited time period in which to prepare their registration documents. In order to allow such persons to determine how SEC rules will ultimately affect their registration status, it is necessary to provide sufficient time for regulated persons to analyze the final rules and prepare any required application materials.
Additionally, the extension is necessary to allow the Department to study how best to regulate advisers to alternative investment vehicles, while balancing the regulatory burden on such advisers, with any corresponding investor protections issues.
Lastly, this extension is necessary to ensure the stability of California capital and labor markets. Alternative investment vehicles, including venture capital funds, have historically provided a crucial source of financing for California businesses.
These emergency regulations address the marketplace uncertainty that exists as a consequence of the operative date of the change in federal law, by temporarily continuing the existing California registration exemption for private advisers. The emergency regulations further will provide the Department and industry the opportunity for thoughtful dialogue on the appropriate measure of state oversight after the federal adoption of rules. These emergency regulations are intended to prevent a marketplace reaction of seeking registration in the face of uncertainly; resulting in businesses prematurely incurring costs to comply with a regulatory scheme that ultimately may prove unnecessary for some private advisers. Moreover, it is likely that most private advisers would not be able to secure registration prior to July 21, 2011, thus requiring that they immediately cease providing investment advisory services for compensation in California.
Other States Next?
There are a number of other states which have IA registration exemptions which are similar to the California exemption. We expect to see similar pronouncements in the coming weeks from other states. Then, after the SEC finalizes the registration regulations, we will see states drafting new laws that better integrate with the
new federal regulations.
The modified exemption can be found here: Section 260.204.9 (Effective July 21, 2011)
Background information and the finding of emergency can be found here: California Finding of Emergency
The notice can be found here: Notice of Emergency Action
Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration. He can be reached directly at 415-868-5345.
Will Wait for SEC Final Registration Regulations to Propose New Rules
California currently has an exemption from the registration requirements for certain fund managers with more than $25M of AUM (Rule 260.204.9). Back in March California requested input from the investment management community on how they might change the registration requirements when the SEC finalizes its IA registration rules as a result of the Dodd-Frank act. At that time it was expected that the SEC would finalize its IA registration rules in time for managers to register before the July 21, 2011 registration deadline. However, the SEC subsequently indicated that it would likely extend the registration deadline until the first quarter of 2012. From this story by IA Watch, it looks like the Division of Investment Management is moving closer to officially moving the registration deadline to next year.
Because of the uncertaintly of rulemaking at the federal level, the states are left in limbo as to how to proceed with respect to fund managers who may or may not fit under certain exemptions after the federal laws
become effective (even if new federal rules are not yet effective). California is addressing this exact scenario in a letter it addressed the investment management community on May 13, 2011. The letter states:
“some uncertainty may exist about the need to become registered after July 21, 2011, for California IAs who are currently unregistered, in reliace on the existing exemption set forth in Rule 260.204.9.”
The letter goes on to state:
“The Department will soon issue emergency regulations to address this potential uncertainty. These emergency regulations will amend Rule 260.204.9, but have the effect of preserving the status quo. Therefore, California IAs who currently rely on the exemption from registration for private advisers, will be able to continue to rely on that exemption until such time as the Deparment adopts final rules related to private fund advisers.”
This is good news for current managers located in California and relying on the exemption from registration in California. We believe that other states (such as Connecticut which has a similar exemption) will soon follow California and release emergency regulations to deal with issues related to the failure of the SEC to finalize the IA registration regulations. Until the SEC does issue final regulations, it would seem that states would (or probably should) stop proposing changes to state regulations (see previous post on Massachusetts proposed changes).
Cole-Frieman & Mallon LLP is a law firm focused on the investment management industry. The firm provides investment adviser registration services to hedge funds and other investment managers. Bart Mallon can be reached directly at 415-868-5345.
Massachusetts Proposes Registration Requirement for 3(c)(1) Fund Managers
As we discussed earlier in our post of state regulation of expert networks, the states are beginning to propse rules for investment advisers based on changes to the federal securities laws as a result of the Dodd-Frank Act (see California Request for Comments). The purpose of the rule changes at the state level are to create a uniform system of regulatory oversight of advisers and to avoid a form of regulatory arbitrage. That is, if the state laws remained the same after the federal laws go into effect, many smaller fund managers could remain unregistered.
Massachusetts, which has a current investment adviser registration exemption for certain hedge fund managers, is proposing to essentially eliminate any registration exemption for hedge fund managers, except for those managers to Section 3(c)(7) funds. This means that if the Massachusetts proposed regulations (reprinted below) are adopted as proposed, all Section 3(c)(1) hedge fund managers in Massachussets will need to register as investment advisers in order to continue accepting assets.
Proposed Regulations Overview
There are two main parts of the new proposed rules:
1. Change in the definition of “institutional buyer”. The current MA regulations exempt managers from the registration requirements if they only provide investment advice to “institutional buyers”. The term “institutional buyer” currently includes hedge funds with only accredited investors who contribute at least $50,000 to the fund. The new definition will essentially erase hedge funds from the definition of institutional buyer. There is a grandfathering provision for managers which currently rely on the exemption; however, those managers will not be able to accept any new investors into their funds
and they will not be able to allow existing investors to add additional subscription amounts (unless the manager subsequently registers as an investment adviser).
2. Exemption for Certain Exempt Reporting Advisers. An Exempt Reporting Adviser is a fund manager which is not registered with the SEC becasue the manager has less than $150M of AUM. For managers that are (i) exempt reporting advisers, (ii) located in Massachusetts and (iii) provide investment advice to one or more Section 3(c)(7) funds, an exemption from registration in Massachusetts is available if:
- The firm and the representatives are not subject to certain “disqualification” provisions
- The firm files the Exempt Reporting Adviser form with the commonwealth of Massachusetts (probably electronically through the IARD)
- The firm pays a fee to the Securities Division
What This Means
Essentially fund managers who are located in Massachussets will need to register with the Securities Division (unless the manager provides advice only to Section 3(c)(7) funds). Registration generally will take about two months and the firm and representatives will face certain regulatory requirements such as maintaining a bond and taking certain proficiency exams (generally the Series 65 exam).
For other state managers, this likely means that other states will follow suit and begin to propose new regulations requiring investment adviser registration.
The Division of Securities is accepting comments on the proposed rules prior to promulgating final regulations. Interested persons have until June 24 to file comments with the Division.
Below we have provided the Division’s stated reason for proposing these regulations (which can also be found here) and we have also printed the full proposed changes.
Change in Exclusion/Exemption Requirements for Hedge Funds and other “Private Funds”
On July 21, 2010, Congress passed the most sweeping financial legislation enacted since the 1930s: the Dodd-Frank Consumer Protection and Regulatory Reform Act. The proposed amendments to the Massachusetts regulations referenced in this section are necessary to promote consistency between state and new federal requirements concerning investment adviser regulation, including regulation of “private funds.”
In part to address the elimination of the exemption for advisers with fewer than fifteen clients, the Securities and Exchange Commission (“SEC”) has proposed to exempt: 1) advisers solely to private funds with less than $150 million in assets under management, and 2) venture capital funds regardless of the amount of assets under management. The SEC has proposed to define a “private fund” as a fund that would be Investment Company under the Investment Company Act of 1940, but for section 3(c)(1) or 3(c)(7) of the Act. This new category of “exempt reporting” advisers must submit reports to the SEC and are subject to other regulatory requirements.
Exempt reporting advisers at the federal level will still be required to either register with the individual states in which they do business, or claim an available exclusion or exemption. The North American Securities Administrators Association (“NASAA”) has proposed a private funds model rule consistent with the new Dodd-Frank requirements.
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erline;”>12.205(1)(a)(6) – Definition of Institutional Buyer
The proposed amendment to 12.205(1)(a)(6) will phase out existing subsection (b), which defined institutional buyer as including “an investing entity whose only investors are accredited investors as defined in Rule 501(a) under the Securities Act of 1933 (17 CFR 230.501(a)) each of whom has invested a minimum of $50,000.” Following the date of implementation, investment advisers will no longer be able to rely on this exemption for new beneficial owners or additional funds for existing investors. However, advisers can continue to rely upon the exemption for business that existed prior to the implementation date.
12.205(2)(c) Exemption for Exempt Reporting Advisers
The Division proposes to remove the institutional buyer exemption located in 12.205(b), and adopt an exemption in order to ensure proper regulation of investment entities whose regulatory oversight has come within the ambit of state responsibility. In its place, the Division proposes to adopt a regulation consistent with the Dodd-Frank requirements.
The proposed addition to 12.205(2) creates a registration exemption for “exempt reporting advisers.” The proposal would exempt advisers to 3(c)(7) and venture capital funds from Massachusetts registration requirements, subject to certain limitations. These exempt advisers will file the same report and amendment thereto that an exempt reporting adviser is required to file with the SEC.
Change in Exclusion/Exemption Requirements for Hedge Funds and other “Private Funds”
Changes to the “Institutional Buyer” Exclusion in 950 CMR 12.205(1)(a)(6)
Delete the current language of 950 CMR 12.205(1)(a)(6) and replace with the following:
6. Institutional Buyer shall include any of the following:
a. An organization described in Section 501(c)(3) of the Internal Revenue Code with a securities portfolio of more than $25 million.
b. An investing entity:
i. whose only investors are accredited investors as defined in Rule 501(a) under the Securities Act of 1933 (17 CFR 230.501(a)) each of whom has invested a minimum of $50,000; and
ii. which existed prior to [effective date]; and
iii. which, as of [effective date], ceased to accept beneficial owners or additional funds for existing investors.
c. An investing entity whose only investors are financial institutions and institutional buyers as set forth in M.G.L. c. 110A, § 401(m) and 950 CMR 12.205(1)(a)6.a. and b.
Registration Exemption for Exempt Reporting Advisers
Insert a new subsection (c) into 950 CMR 12.205(2) as follows:
(c) Registration Exemption for Exempt Reporting Advisers.
1. An investment adviser who provides advice solely to one or more 3(c)(7) funds or venture capital funds shall be exempt from the registration requirements of Section 201 of the Act if the investment adviser satisfies the following conditions:
a. Neither the investment adviser nor any of its advisory affiliates are subject to a disqualification as described in Rule 262 of SEC Regulation A, Section of title 17 CFR § 230.262.
b. The adviser files with the Commonwealth each report and amendment thereto that an exempt reporting adviser is required to file with the Securities and Exchange Commission pursuant to SEC Rule 204-4, 17 CFR 275.204-4.
c. The adviser pays the fee specified in 950 CMR 12.205(2)(b)1.b.
2. A Federal Covered Adviser shall not be eligible for this exemption and shall comply with the state notice filing requirements applicable to such advisers pursuant to 950 CMR 12.205(2)(b).
3. An investment adviser representative is exempt from the registration requirements of 950 CMR 12.205(2)(d) if registration would be required solely because of employment or association with an adviser exempt from registration under this subsection (c).
4. The report filings described in paragraph 1.b. above shall be made electronically through the IARD. A report shall be deemed filed when the report required by 950 CMR 12.205(2)(a)(1) and the fee are filed and accepted by the IARD on the state's behalf.
5. This exemption shall not be available to any investment adviser when one or more of the investment adviser's private funds accepts investments from non-natural persons for the purposes of evading registration or the conditions or limitation explicitly stated in this section.
a. “Private fund” means an issuer that would be an investment company as defined in section 3 of the Investment Company Act of 1940, 15 U.S.C. 80a-3, but for sections 3(c)(1) or 3(c)(7).
b. “3(c)(7) fund” means a private fund that is excluded from the definition of an investment company under section 3(c)(7) of the Investment Company Act of 1940, 15 U.S.C. 80a-3(c)(7).
c. “Venture capital fund” means a private fund that meets the definition of a venture capital fund in SEC Rule 203(l)-1, 17 C.F.R. § 275.203(l)-1.
Renumber the current subsection (c) of 950 CMR 12.205(2) as subsection (d) Registration of Investment Adviser Representatives.
Cole-Frieman & Mallon LLP is a boutique hedge fund law firm which provides state and SEC investment advisor registration services for hedge funds. Bart Mallon can be reached directly at 415-868-5345.