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SEC Proposes Rules Regarding the Oversight of Investment Advisers


Written by Michael Wu

On Friday, November 19, 2010, the Securities and Exchange Commission (the “SEC”) issued a Proposed Rule amending the Investment Advisers Act of 1940, as amended, and a Proposed Rule implementing provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The purpose of the proposed rules is to strengthen the SEC’s oversight of investment advisers and fill key gaps in the regulatory landscape. The following is a summary of the key provisions of the proposed rules.

Increased Disclosure for Registered Advisers:  Under the proposed rules, advisers to private funds would have to provide the following information about the private funds they manage:

  • 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).

In addition, the proposed rules would require registered advisers to provide more information about their advisory businesses, 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 proposed rules also would require advisers to provide additional information about their non-advisory activities and their financial industry affiliations.

Increased Disclosure for Exempted Advisers:  The proposed rules would require exempt reporting advisers (i.e., advisers that are exempt because they only advise venture capital funds or advise private funds with less than $150 million in assets under management (“AUM”)) to file, and periodically update, reports with the SEC, 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.

As with registered advisers, exempt reporting advisers would file the reports on the SEC’s investment adviser electronic filing system (IARD), which means that such reports would be publicly available.

Pay-to-Play:  The proposed rules would amend the current 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 rules, an adviser could pay a registered municipal adviser, instead of a “regulated person,” to solicit government entities on its behalf if the municipal adviser 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.

Dodd-Frank Act Exemptions:  Under the Dodd-Frank Act, the following advisers would not need to register with the SEC: (i) advisers solely to venture capital funds; (ii) advisers solely to private funds with less than $150 million in AUM in the U.S. or (iii) certain foreign advisers without a place of business in the U.S.  The proposed rules provide further guidance regarding these exemptions.

Definition of Venture Capital Fund:  Under the proposed rules, 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 grandfathering provision, private funds that currently make venture capital investments and represent themselves as venture capital funds would generally be deemed to meet the proposed definition.

Definition of Private Fund Advisers with less than $150 million AUM in the U.S.:  Under the proposed rules, in order to rely on this exemption, a U.S. adviser would have to meet the conditions of the exemption with respect to all of its private fund AUM. A foreign adviser would have to meet the conditions of the exemption only with respect to its AUM in the U.S., but generally not with respect to its assets managed from abroad.

Definition of Foreign Private Advisers:  The proposed rules would 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 rules incorporate definitions set forth in other SEC rules, all of which are likely to be familiar to foreign advisers active in the U.S. capital markets.