Speech by SEC Commissioner:
Statement at SEC Open Meeting — Rules Implementing Amendments to the Investment Advisers Act of 1940; Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers with Less than $150 Million in Assets Under Management, and Foreign Private Advisers
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
November 19, 2010
I’d like to join the Chairman in thanking the Staff of the Division of Investment Management for its work in developing these Proposing Releases, as well as all the other Divisions that participated in the process.
And, as has been noted, this is Buddy’s last open meeting here at the Commission and I would like to join my colleagues in thanking you for your extraordinary work over the past several years. It has been a sincere pleasure to work with you. I know that you must be looking forward to spending more time with your family, particularly your grandchildren. In this, you are truly blessed and I wish you the best.
As an initial matter, it is important to step back and consider Congress’s goals in enacting the provisions of Title IV of the Dodd-Frank Act relating to the regulation of Advisers to Hedge Funds and Others that the Commission is addressing in these proposals. As reflected in the legislation itself and the accompanying legislative history, Congress made the considered decision to alter the scope of the exemptions from registration under the Advisers Act in an effort to ensure that advisers to certain larger, more interconnected, private funds — such as hedge funds — would be registered with the Commission. As the testimony and legislative history make clear, one of the goals of the expansion of the registration requirements to include these private funds was to enable the Commission to monitor the greater risks potentially presented by these funds and to enhance its ability to protect private fund investors.
But even as Congress expanded the Commission’s registration authority over certain private funds, it carved out several exemptions from registration. Today, we are proposing rules that will define the contours of three exemptions: exemptions for venture capital fund advisers; private fund advisers with between $100 and $150 million assets under management; and foreign private advisers. Our proposed rules, I believe, do a good job of delineating these exemptions, and are neither unduly restrictive nor inappropriately lax in seeking to meet Congress’s objectives in providing such exemptions.
Congress focused particular attention on the exemption from registration for venture capital fund advisers. As the legislative history explicitly states, venture capital funds “do not present the same risks as the large private funds whose advisers are required to register with the SEC under this title” and concludes that Section 407 of the Act, directing the Commission to define “venture capital fund,” “provides that no investment adviser shall become subject to registration requirements for providing investment advice to a venture capital fund.”1 Moreover, as the testimony presented to Congress made evident, venture capital funds play a vital role in our markets by providing critical seed capital that drives innovation, creates wealth, and promotes economic growth. As Congress recognized, encouragement and support of capital formation is particularly important in today’s economic climate.
I believe that our proposed rule defining “venture capital fund” makes a good effort to respect the important function that venture capital funds serve in the markets. It strikes the right balance between an unduly restrictive or static definition that would unnecessarily constrict the scope of the exemption and an over-inclusive definition that would undermine Congress’s goal of ensuring the registration of other types of private funds. Our proposed definition attempts to capture the way that venture capital funds operate, with specific attention paid to those attributes that distinguish venture capital funds from those larger private funds that could present systemic risk concerns, such as a fund’s use of leverage. Moreover, the proposed rule provides a grandfathering clause that is intended to ensure minimal disruption in investment by and the operation of current venture capital funds.
But while I applaud the Commission’s proposal to define the parameters of these exemptions so thoughtfully, the other release we are proposing today — implementing a variety of changes to the rules under the Advisers Act and to Form ADV — raises significant issues for me.
I fear that the exemptions from registration for venture capital fund advisers and advisers to private funds with between $100 and $150 million assets under management are effectively rendered empty by our parallel proposal imposing reporting requirements on these advisers. I believe that the regulatory framework articulated in support of the proposed reporting requirements for these so-called “exempt reporting advisers” has collapsed the carefully wrought distinction between registered advisers and exempt advisers and as a result, I cannot support this proposing release.
I am concerned that despite Congress’s attempt to recognize the need to exempt certain advisers from the registration requirements of the Advisers Act, it has presented ambiguous and unclear statutory provisions for the Commission to administer that lends itself to such an effect.
Sections 407 and 408 of the Dodd-Frank Act, which amend Section 203 of the Advisers Act, specifically exempt certain advisers from the registration requirements of that Act. These sections also provide that the Commission shall require those exempt advisers to maintain records and provide reports “as the Commission determines are necessary or appropriate in the public interest or for the protection of investors.” Because of the way these new exemptions have been added to the Advisers Act, however, under one reading of the amended statute, these exempt advisers appear to remain subject to Section 204 of the Advisers Act, which also requires certain reporting and recordkeeping by investment advisers, and, furthermore, subjects them to examinations by the Commission.
As a result, the Commission is left with a choice: to decide that these exempt advisers are subject to the same panoply of requirements as registered advisers under Section 204 — which renders the language in Sections 407 and 408 of Dodd-Frank allowing for reporting and recordkeeping entirely superfluous — or to determine that Section 204 of the Advisers Act does not apply to these exempt advisers.
This proposing release takes the view that these “exempt reporting advisers” are entirely subject to Section 204, and as a result, are subject to the examination authority of the Commission. Under this reading, Congress would therefore have exempted these advisers from registration, but would have, in the same breath, subjected them to almost all of the burdens of registration: reporting, recordkeeping, and examinations.
Given the ambiguity in the statutory language, I believe a better reading is that Congress sought to exempt these advisers from the registration framework, but then provided the Commission with the limited authority to require reporting and recordkeeping, as we determined was necessary and appropriate. Such a reading, in my view, would be more faithful to Congress’s stated recognition that venture capital funds in particular do not pose the same risks to the public markets and to investors as do other private funds now included within the registration provisions and should be treated differently from registered advisers.
While I believe that the more limited approach I have articulated above — subjecting these exempt advisers only to reporting and recordkeeping requirements as provided for in Sections 407 and 408 of the new law — is the more plausible and reasonable one, I acknowledge that the statute is ambiguous and subject to multiple interpretations.
But what is beyond debate is that the Commission has discretion in developing the reporting requirements for these exempt advisers. I believe that the release offers inadequate justification for its decision to subject these exempt advisers to many of the broad reporting requirements of Form ADV, and the consequent blurring of the distinction between registered advisers and exempt advisers.
The release proposes to extend the existing regulatory framework under Form ADV to exempt reporting advisers so that it serves as a both a registration form for non-exempt advisers and a reporting form for exempt reporting advisers. And while it can be appreciated that it may be efficient from the Commission’s perspective to have a common reporting framework for both exempt and non-exempt advisers, the result is to effectively diminish the difference between regulatory schemes anticipated by Congress in drawing these distinctions.
Some of the changes to Form ADV can be justified as necessary to gather information from the larger private funds that now must register with the Commission. These changes are likely appropriate, given our expanded authority over these new registrants. But the release makes minimal effort to distinguish between the reporting requirements imposed on registrants who may pose systemic risk and investor protection issues and those exempt reporting advisers who do not. Indeed, the release’s approach appears designed to avoid having to make such judgments. Further, although only proposing certain items on Form ADV at this time, the release queries whether all of Form ADV should be required for exempt reporting advisers.
Consistent with the regulatory approach for registered advisers, the release also goes on to propose the public availability of reporting information from exempt reporting advisers via the IARD website. I similarly have concerns about the sufficiency of the rationale offered to extend this requirement to venture capital fund advisers given that investors in these funds are almost exclusively institutional investors or high-wealth individuals.
While it may be possible to be satisfied that responding to some of the Form ADV items currently proposed will not impose significant costs, that misses the broader concern I have: A proposed regulatory regime that contemplates exams and active oversight will inevitably require these exempt advisers to absorb the additional costs of robust compliance functions and associated compliance personnel.
This is particularly concerning given the significance venture capital funds have for capital formation. This overall approach threatens to make it more costly and burdensome to advise a venture capital fund without a strong corresponding regulatory purpose or rationale. Indeed, as a 2009 Group of Thirty report explicitly recognized, “venture capital funds, dealing by their nature with small companies and providing essential capital and managerial support for entrepreneurial innovation, need to be free of inhibiting oversight.”2
I believe that with this release we have eroded the significance of being exempted from registration so far as to make it a distinction without a difference. This seems a rather odd result given Congress’s apparent interest in exempting these advisers from the regulatory burdens associated with registration under the Advisers Act.
At a minimum, I hope that Congress will look closely at the rules we are proposing and the implications of the statute as written. Clarification in this area would be extremely useful to the Commission and would provide clarity and certainty to our markets, which is important to encourage future investments and capital formation.
In conclusion, I wish briefly to note a few areas in which I am particularly interested in the views of commenters. First, as a general matter, I would be interested in whether commenters believe that the proposed definition of venture capital fund will allow for innovation in this space, while keeping in mind Congress’s goal to limit the exemption to those funds that do not pose the same potential systemic or regulatory risks as other private funds. Second, I encourage feedback on whether the proposed rule’s approach to bridge financing offers sufficient flexibility to funds and portfolio companies. And third — and this is relevant to both releases — I hope the Commission will receive robust comment on the proposed requirement that advisers use the fair valuation method to value regulatory assets under management for purposes of Form ADV.
Thank you again, and I have no questions.
1 See S. Rep. No. 111-176, at 74, 75 (2010).
2 See Group of Thirty, Financial Reform: A Framework For Financial Stability, January 15, 2009, at 30 (available at http://www.group30.org/pubs/reformreport.pdf).