SEC Proposes New Rules and Oversight of Investment Advisers

December 2, 2010

The Securities and Exchange Commission (the “Commission”) recently voted to propose new rules that would implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Commission’s proposed rules would require private fund advisers to register with the Commission, exempt certain private fund advisors from registering with the Commission, and reallocate regulatory responsibility of investment advisers.

Registration of Private Fund Advisers with Commission
Historically, advisers to private funds that had fewer than 15 clients were exempt from registering as an investment adviser with the Commission. Under the applicable law, each fund was counted as one client rather than counting the investors in the funds. Under Title IV of the Dodd-Frank Act, that exemption was eliminated. As such, such advisers to private funds will have to register with the Commission and be subject to additional regulations and oversight.

In addition to becoming subject to registration requirements with the Commission, the proposed rules would require additional information about the private funds that are managed. In particular, advisers would be required to provide additional organizational and operational information, such as the amount of assets held by the funds, the types of investors in the funds, and the services provided by the adviser to the fund. The proposed rules also include indentifying the administrators, auditors, brokers, custodians and marketers of the funds and would require advisers to provide more information about their business activities, including their advisory and non-advisory activities and business practices that pose conflicts of interest.

Exemption of Certain Private Funds from Registration Requirement
Under the Dodd-Frank Act and as expanded upon in the proposed rules, advisers could rely on three new exemptions from registering as an investment adviser with the Commission, namely (1) advisers solely to venture capital funds, (2) advisers solely to private funds with less than $150 million in assets under management in the United States, and (3) certain foreign advisers without a place of business in the United States.

As directed, the Commission is proposing to define “venture capital fund” for purposes of the exemption. Under the proposed rules, a venture capital fund would be defined as a private fund that (a) represents itself to investors as being a venture capital fund, (b) only invests in equity securities of private operating companies to provide primarily operating or business expansion capital, U.S. Treasury securities with maturities of 60 days or less, or cash, (c) is not leveraged and its portfolio companies may not borrow in connection with the private fund’s investment, (d) offers to provide a significant degree of managerial assistance or controls its portfolio companies, and (e) does not offer redemption rights to its investors. Under a proposed provision, existing funds would be grandfathered under the exemption so long as they have represented themselves as venture capital funds.

With respect to the exemption for advisers solely to private funds with less than $150 million in assets under management in the United States, the adviser would need to meet the threshold for all of its private fund assets under management.

Under the third exemption, the Dodd-Frank Act would exempt 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 and fewer than 15 U.S. clients and private fund investors.

Reallocation of Regulatory Responsibility of Investment Advisers
Historically, the regulatory responsibility for overseeing investment advisers has been divided between the Commission and the states. Advisers could not generally register with the Commission unless they managed at least $25 million for clients. Under the Dodd-Frank Act, a new category of advisers called “mid-sized advisers” was created. A mid-sized adviser may not generally register with the Commission but instead must be subject to state registration. A mid-sized adviser is defined as an adviser that manages between $25 million and $100 million for clients, is required to be registered in the state in which it maintains its principal office and place of business, and would be, if required to be registered, subject to examination by that state.

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For more information about "SEC Proposes New Rules and Oversight of Investment Advisers," contact Jonathan L. Schuster at jschuster@axley.com or 608.283.6769.