Rules Implementing Dodd-Frank Act Amendments to the Investment Advisers Act

A Small Entity Compliance Guide¹

Introduction

The Securities and Exchange Commission (“Commission”) adopted new rules and rule amendments on June 22, 2011 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). These rules and amendments:

• Implement the statutory requirement that certain advisers to hedge funds and other private funds register with the Commission.
• Require disclosure of additional information by investment advisers, particularly about the private funds they manage.
• Establish reporting requirements for certain advisers relying on new exemptions from Commission registration.
• Implement the statutory requirement that reallocates regulatory responsibility for advisers between the Commission and state securities authorities. 
• Revise the Commission’s pay-to-play rule.

Private Fund Advisers and Commission Registration

Title IV of the Dodd-Frank Act eliminated the private adviser exemption on which many advisers, including those to many hedge funds, private equity funds and venture capital funds, relied in order to avoid registering with the Commission under the Investment Advisers Act of 1940. Consequently, many previously unregistered advisers will be subject to the same registration requirements, regulatory oversight, and other requirements that apply to SEC-registered investment advisers.

To provide advisers relying on the private adviser exemption with a window to meet their new obligations, the Commission adopted transition provisions that require advisers relying on the exemption on July 20, 2011 to be registered with the Commission by March 30, 2012. Because initial applications for registration can take up to 45 days to be approved, these advisers should file a complete application, both Part 1 and a brochure(s) meeting the requirements of Part 2 of Form ADV, at least by February 14, 2012.

Form ADV Reporting Requirements for Investment Advisers

To enhance its oversight capabilities, the Commission amended Form ADV, the investment adviser registration form, to require additional information about the private funds advisers manage. Specifically, advisers filing Form ADV will have to provide:

• Basic organizational and operational information about each fund they manage . For example, advisers must indicate the type of private fund that it advises (e.g., hedge fund, private equity fund, or liquidity fund), general information about the size and ownership of the fund, general fund data, and the adviser's services to the fund.
• Gatekeeper identification . Advisers must also identify 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).

In addition, other amendments to the adviser registration form are intended to improve the Commission’s regulatory program and require all registered advisers to provide more information about their advisory business, including information about:

• Risk-assessment . The amended form requires expanded disclosure about types of clients they advise, their employees, and their advisory activities.
• Conflicts of interest . Advisers must also disclose additional information about certain 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 form also requires advisers to provide additional information about their non-advisory activities and their financial industry affiliations.

Reporting Requirements for Exempt Reporting 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. The Commission imposed reporting requirements upon advisers ("exempt reporting advisers") relying upon either of the 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.

Under the new rules, exempt reporting advisers are required to file, and periodically update, reports with the Commission, using Form ADV – the same form registered advisers are required to file. Rather than completing all of the items on the form, exempt reporting advisers fill out a limited subset of items, including, but not limited to:

• Adviser Identification . This includes basic identifying information for the adviser and the identity of its owners and affiliates.
• Private fund data and conflicts of interest (discussed above) . An exempt reporting adviser must provide 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.
• Disciplinary information . An exempt reporting adviser must also disclose disciplinary history (if any) of the adviser and its employees that may reflect on the integrity of the firm.

Exempt reporting advisers must file reports on the Commission's investment adviser electronic filing system (IARD), and these reports will be publicly available on the Commission's website. These advisers will be required to file their first reports in the first quarter of 2012.

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 prior law, advisers generally could not register with the Commission unless they managed at least $25 million for their clients.

The Dodd-Frank Act raised 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 is 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; and
• Would be subject to examination by that state, if required to register.

Generally, these advisers will switch from registration with the Commission to registration with the states, but will continue to be subject to the Advisers Act's general anti-fraud provisions. Mid-sized advisers that advise a registered investment company or a business development company, however, will be required to remain registered with the Commission.

The Commission adopted amendments to several rules and forms that reflect the higher threshold required for Commission registration, and also:

• Provide a buffer to prevent advisers from having to frequently switch between Commission and state registration . A mid-sized investment adviser must register with the Commission only if it has $110 million or more of assets under management, but once registered with the Commission, a mid-sized adviser need not withdraw its registration until it has less than $90 million of assets under management.
   
• Clarify when an adviser will be a mid-sized adviser . A mid-sized adviser “is not required to be registered” with a state if the adviser is exempt from registration or is excluded from the definition of investment adviser under the law of that state. A mid-sized adviser with its principal office and place of business in either New York or Wyoming is not “subject to examination.”
   
• Amend the requirements for certain advisers to register with the Commission . Advisers that do not have the required amount of assets under management register with the Commission if they meet the requirements of certain exemptions from the prohibition on Commission registration. The Commission amended three of the exemptions to reflect developments since their original adoption. The amendments:
   
• Eliminate the exemption for nationally recognized statistical rating organizations.
• Increase the required minimum value of plan assets for pension consultants from $50 million to $200 million.
• Decrease the number of states in which a multi-state adviser otherwise must register from 30 states to 15 states.
   
• Facilitate the transition of advisers between federal and state registration in accordance with the new requirements . All advisers registered with the Commission will have to declare whether they are permitted to remain registered in a Form ADV filing in the first quarter of 2012. Those advisers no longer eligible for Commission registration will have until June 28, 2012 to complete the switch to state registration.

Pay-to-Play

The Commission also amended the investment adviser "pay-to-play" rule in response to 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 adviser is 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 the Commission has determined 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 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 the Commission has determined is at least as stringent as the investment adviser pay-to-play rule.

Other Resources

The final adopting release and related rules can be found on the Commission's website at http://www.sec.gov/rules/final/2011/ia-3221.pdf. The proposing release can be found on the Commission's website at http://www.sec.gov/rules/proposed/2010/ia-3110.pdf. Answers to frequently asked questions regarding mid-sized advisers can be found on the Commission’s website at http://www.sec.gov/divisions/investment/midsizedadviserinfo.htm.

The text of the amended rules can be accessed through the "Laws and Rules" section of the Division of Investment Management page of the Commission's website at http://www.sec.gov/divisions/investment.shtml. Amended Form ADV can be accessed at: http://www.sec.gov/rules/final/2011/ia-3221-appd.pdf. Amended Form ADV instructions can be accessed at: http://www.sec.gov/rules/final/2011/ia-3221-appa.pdf and http://www.sec.gov/rules/final/2011/ia-3221-appb.pdf.

Contacting the Commission

The Commission's Division of Investment Management is happy to assist small investment advisers with questions regarding these new rules and amendments. The Division's Office of Investment Adviser Regulation answers questions submitted by e-mail and telephone. You can submit a question by e-mail to iarules@sec.gov and a staff member of the office will call you to discuss your question. In addition, you can contact the Office of Investment Adviser Regulation at (202) 551-6787. Questions on other investment management matters concerning small companies may be directed to the Division's Office of Chief Counsel by e-mail at IMOCC@sec.gov, or by telephone at (202) 551-6825.

Endnotes

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¹ This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a “small entity compliance guide” under section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.

http://www.sec.gov/rules/final/2011/ia-3221-secg.htm