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U.S. Securities and Exchange Commission

SEC Proposes Rules to Improve Oversight of Investment Advisers


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Washington, D.C., Nov. 19, 2010 — The Securities and Exchange Commission today voted to propose new rules to strengthen the SEC's oversight of investment advisers and fill key gaps in the regulatory landscape.

The SEC's proposed rules would implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that, among other things:

  • Facilitate registration of advisers to hedge funds and other private funds with the SEC.
  • Implement the Dodd-Frank Act's mandate to require reporting by certain advisers that are exempt from SEC registration.
  • Increase the asset threshold for advisers to register with the SEC.
  • Define "venture capital fund" and provide clarity regarding certain exemptions to investment adviser registration.

The SEC also proposed amendments to rules that would require disclosure of greater information by investment advisers and the private funds they manage, as well as amendments that would revise the Commission's pay-to-play rule.

"The enhanced information envisioned by these proposed rules would better enable both regulators and the investing public to assess the risk profile of an investment adviser and its private funds," said SEC Chairman Mary L. Schapiro.

The SEC is seeking public comment on the proposed rules for a period of 45 days following their publication in the Federal Register.

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A large number of individuals and institutions invest a significant amount of assets in private funds, such as hedge funds and private equity funds. However, until the passage of the Dodd-Frank Act, advisers managing those assets were subject to little regulatory oversight.

With the Dodd-Frank Act, Congress closed this regulatory gap by generally extending the registration requirements under the Investment Advisers Act to the advisers of these funds. The new law also provided the Commission with the ability to require the limited number of advisers to private funds that will not have to register to file reports about their business activities.

Further, in acknowledging the Commission's limited examination resources — and in light of the new responsibilities for private fund advisers — the Dodd-Frank Act reallocated regulatory responsibility for smaller investment advisers to the state securities authorities.

Private Fund Advisers and Commission Registration

For many years, advisers to private funds have been able to avoid registering with the Commission because of an exemption that applies to advisers with fewer than 15 clients — an exemption that counted each fund as a client, as opposed to each investor in a fund. As a result, some advisers to hedge funds and other private funds have remained outside of the Commission's regulatory oversight even though those advisers could be managing large sums of money for the benefit of hundreds of investors.

Title IV of the Dodd-Frank Act eliminated this private adviser exemption. Consequently, many previously unregistered advisers, particularly those to hedge funds and private equity funds, will have to register with the Commission and be subject to its regulatory oversight, rules and examination.

These advisers will be subject to the same registration requirements, regulatory oversight, and other requirements that apply to other SEC-registered investment advisers.

Reporting Requirements for Hedge Fund and Other Investment Advisers


When investment advisers register with the Commission, they provide information in their registration form that is not only used for registration purposes, but that is used by the Commission in its regulatory program to support its mission to protect investors.

To enhance its ability to oversee investment advisers to private funds, the Commission is considering requiring advisers to provide additional information about the private funds they manage. The information obtained as a result of these amendments would assist the Commission in fulfilling its increased responsibility for private fund advisers arising from the Dodd-Frank Act.

The Rules

Under the proposed rules, advisers to private funds would have to provide:

  • Basic organizational and operational information about the funds they manage, such as information about the amount of assets held by the fund, the types of investors in the fund, and the adviser's services to the fund.
  • Identification of five categories of "gatekeepers" that perform critical roles for advisers and the private funds they manage (i.e., auditors, prime brokers, custodians, administrators and marketers).

These reporting requirements are designed to help identify practices that may harm investors, deter advisers' fraud, and facilitate earlier discovery of potential misconduct. And this information would provide for the first time a census of this important area of the asset management industry.

In addition, the Commission proposed other amendments to the adviser registration form to improve its regulatory program. These amendments would require all registered advisers to provide more information about their advisory business, including information about:

  • The types of clients they advise, their employees, and their advisory activities.
  • Their business practices that may present significant conflicts of interest (such as the use of affiliated brokers, soft dollar arrangements and compensation for client referrals).

The proposal also would require advisers to provide additional information about their non-advisory activities and their financial industry affiliations.

Reporting Requirements for Exempted Advisers


While many private fund advisers will be required to register, some of those advisers may not need to if they are able to rely on one of three new exemptions from registration under the Dodd-Frank Act, including exemptions for:

  • Advisers solely to venture capital funds.
  • Advisers solely to private funds with less than $150 million in assets under management in the U.S.
  • Certain foreign advisers without a place of business in the U.S.

The Commission can still impose certain reporting requirements upon advisers relying upon either of the first two of these exemptions ("exempt reporting advisers").

The Rules

Under proposed rules, exempt reporting advisers would nonetheless be required to file, and periodically update, reports with the Commission, using the same registration form as registered advisers. Rather than completing all of items on the form, exempt reporting advisers would fill out a limited subset of items, including:

  • Basic identifying information for the adviser and the identity of its owners and affiliates.
  • Information about the private funds the adviser manages and about other business activities that the adviser and its affiliates are engaged in that present conflicts of interest that may suggest significant risk to clients.
  • The disciplinary history of the adviser and its employees that may reflect on their integrity.

Exempt reporting advisers would file reports on the Commission's investment adviser electronic filing system (IARD), and these reports would be publicly available on the Commission's website.

Reallocation of Regulatory Responsibility


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 existing law, 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 adviser, which generally may not register with the Commission and will be subject to state registration, is defined as an 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 4,100 of the current 11,850 registered advisers will switch from registration with the Commission to registration with the states. These advisers will continue to be subject to the Advisers Act's general anti-fraud provisions.

The Rules

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

  • Reflect the higher threshold required for Commission registration.
  • Clarify when an adviser will be a mid-sized adviser.
  • Facilitate the transition of advisers between federal and state registration in accordance with the new requirements.


The Rule

The Commission also proposed to amend the investment adviser "pay-to-play" rule in response to changes made by the Dodd-Frank Act. The pay-to-play rule prohibits advisers from engaging in pay to play practices.

Under the proposed amendment, an adviser would be permitted to pay a registered municipal advisor, instead of a "regulated person," 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.

Comments on the proposal should be received by the Commission within 45 days after publication in the Federal Register.

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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 repealed 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 U.S.
  • Certain foreign advisers without a place of business in the U.S.

The Commission proposed rules that would implement these exemptions and define the various terms.

New Exemptions

Definition of Venture Capital Fund

The Dodd-Frank Act amended the Advisers Act to exempt advisers that only manage venture capital funds from registration under the Advisers Act, and the Commission was directed to define the term "venture capital fund." The Commission is proposing a definition of "venture capital fund" that is designed to effect Congress' intent in enacting this exemption. Under the proposed definition, a venture capital fund is a private fund that:

  • Represents itself to investors as being a venture capital fund.
  • Only invests in equity securities of private operating companies to provide primarily operating or business expansion capital (not to buy out other investors), U.S. Treasury securities with a remaining maturity of 60 days or less, or cash.
  • Is not leveraged and its portfolio companies may not borrow in connection with the fund's investment.
  • Offers to provide a significant degree of managerial assistance, or controls its portfolio companies.
  • Does not offer redemption rights to its investors.

Under a proposed grandfathering provision, existing funds that make venture capital investments would generally be deemed to meet the proposed definition, as long as they have represented themselves as venture capital funds. The Commission is proposing this approach because it could be difficult or impossible for advisers to conform existing funds, which generally have terms in excess of 10 years, to the new definition.

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

The Commission also is proposing an exemptive 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. Under the same approach the Commission has taken in the past in applying the Advisers Act to foreign advisers, the availability of the exemption would vary depending on whether an adviser is a U.S. or a foreign adviser.

In order to rely on the exemption, a U.S. adviser would have to meet the conditions of the exemption with respect to all of its private fund assets under management. A foreign adviser would have to meet the conditions with respect to its assets under management in the United States, but generally not with respect to its assets managed from abroad.

Definition of Foreign Private Advisers

The Dodd-Frank Act also amended the 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 Commission is proposing 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. The proposed rule incorporates definitions set forth in other Commission rules, all of which are likely to be familiar to foreign advisers active in the U.S. capital markets.

Comments on the proposal should be received by the Commission within 45 days after publication in the Federal Register.

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Modified: 11/19/2010