RIA Compliance Blog
On June 22, 2011, the Securities and Exchange Commission (SEC) adopted new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Among other things, the rules, as adopted, provided transitional provisions for investment advisers required to switch from SEC to state registration because they fail to meet the new requirement of $100 million in assets under management, require advisers to hedge funds and other private funds to register with the SEC, require reporting by certain exempt investment advisers, and make substantial changes to the Form ADV.
The final rule relating to transition differed somewhat from the rule originally proposed by the SEC. The final rule requires that any “mid-sized” registrant with the SEC (defined as any firm with between $25 million and $100 million under management) that is registered as of July 21, 2011 (Dodd-Frank’s effective date) must remain registered with the SEC through the transition. New applicants that meet the definition of mid-sized advisers and who seek to apply between January 1, 2011 and July 21, 2011 can apply either with the SEC or the state or states in which it must register.
Rule 203A-5 is amended to require all SEC registrants to file an amended Form ADV by March 30, 2012. Combined with the ADV amendments passed by the SEC, this will contain information sufficient to allow the SEC to identify what mid-sized advisers are no longer eligible for registration with the Commission. Any mid-sized adviser that is ineligible for failure to meet the assets under management test must withdraw its registration by June 28, 2012.
As anticipated, these transition rules constituted a significant departure from the transition rules initially proposed by the SEC, due to delays in programming the Investment Adviser Registration Depository (IARD) that are currently being experienced by the IARD Administrator/Contractor, the Financial Industry Regulatory Authority (FINRA). The SEC noted in its adopting release that the 180-day period for mid-sized advisers to file their amended ADV and then achieve registration comports with the current 180-day period required by rule for advisers switching from SEC to state registration.
In order to determine whether they meet the assets under management test, advisers must apply a slightly revised test for “assets under management.” Revisions to the instructions for Form ADV now will create two classes: “assets under management,” which corresponds to the traditional definition, and “regulatory assets under management,” which will include family and proprietary assets, assets managed by the adviser without compensation, and assets of foreign clients. These latter three categories of assets have traditionally been excluded by firms in calculation of their assets under management.
Certain other changes to the Form ADV instructions that are achieved by the new rules relate to advisers to private funds. Specifically, the ADV instructions now will require private fund assets to be calculated based on fair value rather than cost of the investment or some other value. Advisers must also include, in a determination of the assets under management, all uncalled capital contributed by the investment adviser to the fund. The new rules eliminate the buffer between $25 million and $30 million currently in existence, and substitutes therefore a new buffer applicable to firms reaching the $100 million threshold. Under the new rule, as adopted, firms must register when they reach $110 million in assets under management. To provide some flexibility due to fluctuation of asset values and market conditions, an adviser, once registered with the Commission, need not withdraw its registration until its assets under management fall below $90 million.
The new rule also makes modifications to the existing exemptions for registration. For example, the exemption that currently exists for pension consultants with $50 million or more in plan assets has been modified to exempt only those with greater than $200 million in plan assets. The consequence of this is that those currently with less than $200 million in plan assets may need to de-register with the SEC and register with one or more states.
Another exemption permits investment advisers required to register with fifteen or more states to register with the SEC and de-register with the states.
In order to assist the SEC in determining eligibility for registration under Dodd-Frank, any mid-size adviser that attempts to register with the SEC must affirmatively check a box on the ADV, as amended by the new rule, that provides the basis for its eligibility. More specifically, a mid-sized firm, in order to register with the Commission, must certify that it is either not required to be registered by the state in which it has its principal office or is not subject to examination by that state. Based upon a survey conducted by the SEC, the states of Minnesota, New York, and Wyoming do not currently conduct examinations of investment advisers, and thus advisers based in those states must register with the SEC under Dodd-Frank.
Although the transition rules permit mid-sized advisers a total of 180 days from the end of 2011 to withdraw their registration with the SEC and register with the states, private advisers previously exempt from registration under Section 203(b)(3) of the Advisers Act must register on or before March 30, 2012. Because initial applications for registration can take up to 45 days to be approved, the SEC recommended in its adopting release that advisers relying on that transition provision should file a complete application by not later than February 14, 2012.
The SEC also adopted a new rule to implement new sections 203(l) and 203(m) of the Advisers Act, specifically requiring advisers exempt from registration under those two subsections to file a Form ADV for informational purposes to provide the SEC with information it deems necessary to track industry developments in the private fund arena. The exempt advisers affected by this reporting rule are those who advised private funds with less than $150 million under management and those that advised solely one or more “venture capital funds.” The filers are referred to as “exempt reporting advisers,” and must submit their initial Form ADV within sixty days upon the date upon which they rely upon exemption from registration, i.e., by May 30, 2012. The information that should be contained in the informational report as part of the ADV includes an identification of the exemption on which it was relying to report, rather than register, with the Commission and to complete existing sections of Part IA of Form ADV (Identifying Information), Item 2.B (SEC Reporting by Exempt Reporting Advisers), Item 3 (Form of Organization), Item 6 (Other Business Activities), Item 7 (Financial Industry Affiliations and Private Fund Reporting), Item 10 (Control Persons), and Item 11 (Disclosure Information). Additionally, exempt reporting advisers must complete Schedules A, B, C and D.
The reports of the exempt reporting advisers will be made public and available on the Investment Adviser Public Disclosure (IAPD) website. Exempt reporting advisers must also file updating amendments within ninety days of the end of the advisers’ fiscal year or more frequently if required by specific new instructions to the Form ADV. When an adviser ceases to be an exempt reporting adviser, new Rule 204-4 requires that adviser to file an amendment to its Form ADV to indicate that it is filing a final report.
The SEC rule also implements a number of amendments to Form ADV that the Commission believes will improve its ability to oversee investment advisers. These amendments require additional information about three areas of advisers’ operations: first, additional information is required about private funds advised by the adviser; second, more detailed information about the types of clients advisers have, their employees, and their advisory activities is required, as well as conflicts of interests; and third, the Commission requires additional information about advisers’ non-advisory activity and other financial industry affiliations. As to the first category, private fund reporting, the new rules require an adviser to complete a separate Section 7.B of Schedule D for each private fund that it advises. This form requires an adviser to provide basic information regarding the organization, operation, and characteristics of each fund. It also requires information about five types of service providers that are commonly referred to as “gatekeepers” (administrators, prime brokers, custodians, auditors, and marketers). Specifically, an adviser must identify each such provider, report their location, and indicate which, if any, of them are related to the adviser.
An adviser must file a separate Section 7.B.(1) for each private fund it manages. The form also requires each adviser to a private fund to identify persons involved in the management of the fund, whether it is part of a master-feeder arrangement, whether it is a fund of funds, and what category, within seven broadly defined categories, best describes the fund’s investment strategy, among other things.
The SEC also refined definitions and instructions within the Form ADV, including Part IA, so that the questions typically require more specific responses than before, for example, an adviser must now identify the specific number of registered investment adviser representatives it has, rather than merely providing a range. There are a number of changes to the ADV instructions that fall into this category. The revisions to Form ADV will also require an adviser to identify the specific number of qualified custodians used.
This description of the new rules and rule amendments is not exhaustive, but is intended as a summary only. Any questions about the rules should be directed to Parker MacIntyre’s Regulatory Practice Group.