Dodd-Frank provides several new exemptions from the investment adviser registration requirements at the federal level, such as exemptions for managers solely of venture capital funds (Venture Capital Exemption) and an exemption for advisers “solely to private funds” where the amount of AUM is less than $150 million (150 Exemption). Fund managers relying on the Venture Capital or 150 Exemptions need to file exempt adviser reports (EARs).
Exempt Adviser Reports
The SEC refers to managers that qualify for the Venture Capital or 150 Exemptions as exempt reporting advisers. Exempt reporting advisers need to file an EAR with the SEC. This report consists of specified portions of Form ADV. The EAR consists of the following items of Part 1A of Form ADV:
- 1 (Identifying Information)
- 2B (SEC Reporting by Exempt Reporting Advisers)
- 3 (Form of Organization)
- 6 (Other Business Activities)
- 7 (Financial Industry Affiliations and Private Fund Reporting)
- 10 (Control Persons)
- 11 (Disclosure Information)
In addition, exempt reporting advisers need to complete the corresponding sections of Schedules A, B, C, and D of Form ADV.
These exempt adviser reports are publicly available.
Joint Filings
In many cases, the general partner, or managing member, (GP) of a private fund delegates day-to-day management to a separate entity (Adviser). The SEC permits an Adviser that qualifies for the Venture Capital or 150 Exemptions to include the GP on the Adviser’s EAR if the GP:
- does not engage in activities that would cause the GP to be considered to be an investment adviser (other than supervising and hiring or firing the Adviser)
- is the general partner only for private funds managed by the Adviser, or a related person of the Adviser.
If the GP retains and exercises discretionary authority, then the Adviser can include the GP on the Adviser’s EAR if:
- the GP only acts as general partner for private funds managed by the Adviser
- the Adviser controls the GP
- the advisory activities of the GP are subject to the Investment Advisers Act
- the GP has no employees other than officers, directors, partners or employees of the Adviser, and
- the GP, its officers, directors, partners and employees are subject to the supervision and control of the Adviser
In these types of EAR filings, all information required for an exempt reporting adviser would be included for both the Adviser and the GP, or GPs.
These types of filings avoid the need to file a separate EAR for the GP.
Timing and Method of Filing
EARs are made on the IARD system, which is the electronic reporting system used by registered advisers. An exempt reporting adviser needs to set up an account with the IARD, and prepare the filing online. The filing is made online and there is a nominal filing fee.
The first EAR is required to be filed on or before March 30, 2012.
A manager needs to obtain an ID number (called a CRD number) and set up an account with the IARD in order to file this report. Because the first EAR is due on or before March 30, it would be a good idea to set up your IARD account immediately, if you have not done so already. You should get the FINRA Entitlement Package. This document contains instructions for setting up an IARD account as well as the forms that need to be sent in to FINRA.
Updating
The EAR is required to be updated on an annual basis within 90 days after fiscal year end. In this annual amendment, all items need to be updated.
In between annual updates, amendments need to be filed if there is a change in the information in Items 1, 3 or 11 or a material change in Item 10.
Consequences of Going Over $150 Million in AUM
The AUM calculation for the 150 Exemption is made on an annual basis. The AUM needs to be calculated based on asset value as of a date that is no more than 90 days before the filing of the report. If the manager reports more than $150 million in AUM on its next annual EAR update, then the manager has 90 days to register. This 90-day period is available if the manager has complied with its reporting obligations, but is not available if the manager is no longer in compliance with the 150 Exemption for a different reason, such as starting to advise a person or an entity that is not a private fund.
In other words, if as a result of an increase in the assets in a private fund managed a manager goes over the $150 million AUM limit after filing an exempt report, then the manager has until March 30 of the following year to file its next report, and once that report is filed, the manager has 90 days to register.
Compliance Issues
An exempt reporting adviser is subject to certain provisions of the Advisers Act, even though it is not required to register as an investment adviser. An exempt reporting adviser is required to comply with the “pay to play” restrictions and to have an internal policy restricting insider trading. The SEC has the power to require exempt reporting advisers to retain records, but the SEC has not taken action on this matter yet. Of course, exempt reporting advisers are also subject to the antifraud provisions.
An exempt reporting adviser should adopt an internal compliance policy that covers the required items, and possibly others.
Detailed Description of EAR
Item 1 contains 16 questions that deal with identifying data, such as location, business hours, website address and the contact person.
Item 2 is the place where the manager indicates that it is an exempt reporting adviser (2B).
Item 3 deals with the form of organization (corporation, partnership, limited liability company), fiscal year and jurisdiction of organization.
Items 6 and 7 of Part 1A require advisers, including exempt reporting advisers, to report those financial services the adviser or a related person is actively engaged in providing, from lists of financial services set forth in the items. Items 6 and 7A provide details regarding other business activities in which the adviser and its affiliates are engaged, which will permit the SEC to identify conflicts that the adviser may have with its clients that may suggest significant risks to those clients. These items also allow the SEC to identify affiliated financial service businesses.
Item 6A contains a list of 14 types of business activities. If the manager is actively engaged in one or more of those businesses, it needs to check all that apply.
Item 6B contains three additional questions that elicit information about any other businesses engaged in by the manager and whether the manager sells products or services other than providing investment advice to clients. In certain cases, the manager will need to provide additional information on Schedule D.
Item 7A contains a list of 16 categories and requires the manager to indicate if any “related persons” of the manager fit into one of the specified categories.
A related person is any advisory affiliate and any person under common control with the manager. Advisory affiliates include:
- all officers, partners or directors of the manager, or persons performing similar functions,
- persons directly or indirectly controlling the manager or controlled by the manager, and
- all employees of the manager, other than employees performing only clerical administrative or similar functions.
Section 7A of Schedule D requires the manager to provide certain identifying information for any type of related person listed in Item 7A as well as to provide more details about the relationship between the manager and the related person, including whether the related person is registered with a foreign financial regulatory authority, whether they share employees or the same physical location and, if the adviser is reporting a related person investment adviser, whether the related person is exempt from registration.
A manager need not complete Section 7A of Schedule D for any related person if (1) the manager has no business dealings with the related person in connection with advisory services it provides to its clients; (2) the manager does not conduct shared operations with the related person; (3) the manager does not refer clients or business to the related person, and the related person does not refer prospective clients or business to the manager; (4) the manager does not share supervised persons or premises with the related person; and (5) the manager has no reason to believe that its relationship with the related person otherwise creates a conflict of interest with its clients. However, a manager may not omit an affiliated manager with whom the manager shares information technology infrastructure, for example, because the managers would be considered to share operations.
An adviser must file a separate Section 7B(1) (Parts A and B) for each private fund it manages.
Part A of Section 7B(1) requires an adviser to provide the name of the fund and the state or country in which the fund is organized and to identify other persons involved in the management of the fund. Part A also requires the adviser to report whether the fund is part of a master-feeder arrangement or is a fund of funds and to provide information about the regulatory status of the fund, such as the Investment Company Act exemption on which the fund relies, whether the fund is subject to the jurisdiction of a foreign regulatory authority, and whether the fund relies on an exemption from registration under the Securities Act with respect to its securities. An adviser must also identify, within seven broad categories, the type of investment strategy the fund employs; report whether the fund invests in securities of registered investment companies; and provide the gross asset value of the fund. Finally, an adviser must provide limited information regarding investors in the fund, including (1) the minimum amount that investors are required to invest; (2) the approximate number of beneficial owners of the fund and the approximate percentage of the fund beneficially owned by the adviser and its related persons, funds of funds and non-United States persons; and (3) the extent to which clients of the adviser are solicited to invest, and have invested, in the fund.
Part B of Section 7B(1) also requires advisers to report information concerning five types of service providers that generally perform important roles as “gatekeepers” for private funds — auditors, prime brokers, custodians, administrators and marketers. An adviser must identify each of these service providers, report their locations and indicate which of them, if any, are related persons of the adviser. In addition, for certain types of service providers, an adviser would report information concerning the nature of the services provided. For instance, with respect to each prime broker, an adviser must indicate whether the prime broker has custody of fund assets.
Item 10 requires information about the persons who control the manager. This information is contained in Schedule A (direct owners and executive officers of the manager) and Schedule B (indirect owners of the manager) of the initial report. Changes are reported on Schedule C.
Item 11 requires advisers to disclose the disciplinary history of the adviser and its employees and to complete a separate schedule containing details of each disciplinary event.
State Law Provisions
Many states are considering changing their adviser provisions in response to Dodd-Frank.
The North American Securities Administrators Association (NASAA) has adopted a model rule for states to consider in response to Dodd-Frank. The model rule would provide an exemption for C7 funds and for C1 funds that are either venture capital funds or in which all investors are qualified clients, if additional disclosures are made. There is a grandfather clause for C1 funds that include investors that are not qualified clients under certain conditions. The exemption would not be available to affiliates of persons with a disqualifying regulatory history. The federal exempt adviser report would also need to be filed with the state.
Each state will make its own decision whether to amend its statute, and if so whether to use the NASAA model rule or some other provision.
Fund managers will need to monitor developments in their states, because changes in the applicable law could impact state registration and filing requirements.