Today, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). The Act will have a significant impact on a broad range of financial products and services by increasing the oversight and regulation of the United States financial system. In addition to increased bank regulation and the creation of a consumer financial protection bureau, the Act will expand the regulatory oversight over private investment pools and private investment fund managers. The investment adviser provisions of the Act are sweeping, requiring both the registration of a large number of currently unregistered investment advisers, such as management companies and general partners of larger investment funds that were previously exempt from registration under the Investment Advisers Act of 1940 (as amended, the “Advisers Act”), and heightened recordkeeping and reporting by all investment advisers.
Generally, the Act will become effective on July 21, 2011 and, in particular, investment advisers that currently rely on an exemption from registration that is being eliminated by the Act will have until that date (one year from today) to register. Private fund management companies and general partners that manage $150 million or more in the aggregate should start planning now for registration and to comply with the other provisions of the Act. Please contact us if you have any questions or need assistance with registration or compliance under the Act.
The remainder of this Client Alert summarizes some of the provisions of the Act that apply to private investment fund managers.
Federal Registration of Investment Advisers
Elimination of the Most Commonly Used “Private Adviser”/“Under 15 Client” Exemption – Under former Section 203(b)(3) of the Advisers Act, an investment adviser was exempt from registration if it (i) had fewer than 15 clients during the preceding 12 months and (ii) neither held itself out generally to the public as an investment adviser nor advised any registered investment company or business development company. This was the most common exemption from registration, but it was eliminated by the Act. Other less used exemptions from registration under the Advisers Act also are being eliminated.
Venture Capital Fund Exemption – The Act provides that investment advisers that act as advisers solely to venture capital funds will not be subject to the registration requirements of the Advisers Act. The term “venture capital fund” is not defined in the Act; rather, the Act requires the SEC to issue final rules to define such term within one year of its enactment. While these investment advisers will not be required to register with the SEC, they will be subject to certain disclosure and reporting requirements, as described below.
Private Fund Adviser Exemption – The Act requires that the SEC provide an exemption from the registration requirements of the Advisers Act for an investment adviser that acts solely as an adviser to private funds and has assets under management in the U.S. of less than $150 million. While such investment advisers will not be required to register with the SEC, they will be subject to certain disclosure and reporting requirements, as set forth below.
Additional Exemptions – The Act provides additional exemptions for family offices (to be defined by the SEC), advisers to certain small business investment companies and certain foreign private advisers.
State Registration of Investment Advisers
While the Act requires many larger investment advisers to register with the SEC, it also eliminates the provisions of federal law that permitted smaller advisers to avoid registration under state law. As a result, many smaller advisers, including management companies and general partners of smaller funds that are not required (or permitted) to register with the SEC, will have to determine whether they must register under state investment adviser laws.
Disclosure and Reporting Requirements; Information Sharing
The Act imposes new disclosure and recordkeeping requirements on many investment advisers. Registered investment advisers will be required to maintain records and file reports with the SEC regarding the “private funds” that they advise, including (i) the amount of assets under management and use of leverage, (ii) counterparty credit risk exposure, (iii) trading and investment policies, (iv) fund valuation policies and practices, (v) types of assets held, (vi) side arrangements or letters, (vii) trading practices and (viii) other information that the SEC determines to be “necessary and appropriate.” The SEC may also conduct periodic inspections and examinations of investment adviser records. The Act directs the SEC to determine the recordkeeping and reporting requirements for advisers that may remain unregistered, and we will apprise you of those regulations when they are issued.
The SEC will be required to share the information it obtains from registered investment advisers to private funds with a new Financial Stability Oversight Council and Congress and must comply with requests for such information from other U.S. federal departments, agencies or self-regulatory organizations (SROs). However, all recipients of SEC information obtained under the Act will be subject to confidentiality requirements (although these are still being fleshed out).
“Accredited Investor” and “Qualified Client” Standards
“Accredited Investor” – Under the Act, the value of an individual’s primary residence will be excluded from the determination of that individual’s net worth (or joint net worth with the individual’s spouse) for purposes of determining whether the individual may be classified as an “accredited investor” (under the “net worth” test) in connection with an offering of securities pursuant to Regulation D of the Securities Act. Furthermore, the SEC is authorized to adjust the accreditation standards for an “accredited investor” once every 4 years, beginning 4 years after the enactment of the Act. These changes may make it more difficult for certain individual investors to satisfy the “accredited investor” test for the purposes of investing in funds.
“Qualified Client” – Investment advisers registered with the SEC are generally prohibited from charging performance fees based on an appreciation in the value of assets under management (that is, carried interest) absent an exemption. Under an existing exemption in the Advisers Act, a registered investment adviser may charge performance fees to “qualified clients,” which includes natural persons or companies with at least $750,000 under management or natural persons with a net worth of more than $1.5 million. Under the Act, the SEC is tasked with adjusting both asset tests, and any other “dollar amount test” which may be used in determining “qualified client” status, for inflation within 1 year of enactment and every 5 years thereafter.
Private fund managers are urged to revisit their current compliance and reporting procedures as soon as possible in order to ensure that they are well positioned to address any compliance issues that may be appropriate in advance of the deadlines imposed by the Act. If you have any questions about the status or details of the proposed Act, please contact:
Keith W. Kaplan, Esq.
Jon M. Katona, Esq.
This Client Alert has been prepared by Klehr Harrison Harvey Branzburg LLP (the “Firm”) for the general information of our clients and other interested persons. This Client Alert is not, and is not intended to be, comprehensive in nature. Due to the general nature of its content, this Client Alert is not and should not be regarded as legal advice or the opinion of the Firm, and you should not rely on any information in this Client Alert for any specific situation. Rather, you should consult with us or other legal counsel with respect to particular circumstances addressed in this Client Alert before taking any action. Receipt of this summary does not create an attorney-client relationship between you and the Firm.
 A “private fund” is an issuer that is exempt from registration as an “investment company” by virtue of section 3(c)(1) or 3(c)(7) of the Advisers Act.