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Paperwork Galore: SEC Proposes Rules Requiring Public Reporting by Exempt Investment Advisers

By | November 20, 2010

The SEC has proposed rules (Release No. IA-3110) requiring public reporting by exempt investment advisers.  The proposed reporting requirements for exempt investment advisers, which are not necessarily required under the Dodd-Frank Act, will impose substantial burdens on exempt investment advisers.  The Dodd-Frank Act neither specifies the types of information the SEC could require in reports by exempt investment advisers nor specifies the purpose for which the SEC would use the information but the regulation is nonetheless on the horizon.  And there is more regulation on the way for exempt investment advisers by way of record keeping and examination.  The first reports for exempt investment advisers will be due by August 20, 2011, so exempt investment advisers should begin to plan accordingly.

 The proposal will likely affect many exempt advisers to hedge funds, private equity funds and venture capital funds.  Open your check book, sharpen your pencils, and get ready to fill in detailed forms every year, if not more often.  Further information is set forth below.

 Overview

 The Dodd-Frank Act repealed the “private adviser exemption” contained in section 203(b)(3) of the Investment Advisers Act on which advisers to many hedge funds and other pooled investment vehicles had relied in order to avoid registration under the Act.  In eliminating this provision, Congress amended the Investment Advisers Act to create, or directed the SEC to adopt, other, in many ways narrower, exemptions for advisers to certain types of “private funds.”  Both section 203(l) of the Investment Advisers Act (which provides an exemption for an adviser that advises solely one or more “venture capital funds”) and section 203(m) of the Investment Advisers Act (which instructs the SEC to exempt any adviser that acts solely as an adviser to private funds and has assets under management in the United States of less than $150 million) provide that the SEC shall require such advisers to maintain such records, which the SEC has the authority to examine, and to submit reports “as the [SEC] determines necessary or appropriate in the public interest.”  The SEC refers to these advisers in the proposed rules as “exempt reporting advisers.”

 To implement sections 203(l) and 203(m) of the Investment Advisers Act, the SEC is proposing a new rule to require exempt reporting advisers to submit, and to periodically update, reports to the SEC by completing a subset of items on Form ADV.  The SEC is also proposing amendments to Form ADV to permit the form to serve as a reporting, as well as a registration, form and to specify the items exempt reporting advisers must complete.

 Reporting Required

The SEC is proposing a new rule, rule 204-4, to require exempt reporting advisers to file reports with the SEC electronically on Form ADV.  Rule 204-4 would require these advisers to submit their reports through the IARD using the same process as registered investment advisers.  Each Form ADV would be considered filed with the SEC upon acceptance by the IARD,  and advisers filing the form would be required to pay a filing fee.  Like IARD filings by registered advisers, the SEC would approve, by order, the amount of the filing fee charged by FINRA.  It is anticipate that filing fees would be the same as those for registered investment advisers, which currently range from $40 to $200, based on the amount of assets an adviser has under management.  The filing fees would be set at amounts that are designed to pay the reasonable costs associated with the filing and the maintenance of the IARD.

 The reports filed by exempt reporting advisers would be publicly available on the SEC website. The SEC believes because exempt reporting advisers may be required to register on Form ADV with one or more state securities authorities, use of the existing form and filing system would also permit exempt reporting advisers to satisfy both state and SEC requirements with a single electronic filing.

 Information in Reports

 In General. The SEC is proposing several amendments to Form ADV to facilitate filings by exempt reporting advisers.  First, the SEC would re-title the form to reflect its dual purpose as both the “Uniform Application for Investment Adviser Registration,” as well as the “Report by Exempt Reporting Advisers.” Second, the SEC is proposing to amend the cover page so that exempt reporting advisers would indicate the type of report they are filing.   Finally, the SEC is proposing to amend Item 2 of Part 1A, which requires advisers to indicate their eligibility for SEC registration, by adding a new subsection C that would require an exempt reporting adviser to identify the exemption(s) that it is relying on to report, rather than register, with the SEC.

 Form ADV is today designed to obtain information from registered advisers that provide a wide variety of types of advisory services, including providing advice to private funds.  Therefore, the information that the information the SEC proposes to collect from exempt reporting advisers is for the most part currently required by Form ADV.  The SEC will provide an instruction to these advisers to complete only certain items in the form, but it does not propose to change the content of the items for exempt reporting advisers.  As noted above, the SEC proposes to require exempt reporting advisers to complete a subset of Form ADV items, which would provide the SEC and the public with some basic information about the adviser and its business, but is not all of the information the SEC requires registered advisers to submit. The SEC proposes to require exempt reporting advisers to complete the following items in Part 1A of Form ADV: Items 1 (Identifying Information), 2.C. (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), and 11 (Disclosure Information).  In addition, exempt reporting advisers would have to complete corresponding sections of Schedules A, B, C, and D. The SEC would not require exempt reporting advisers to complete and file with the SEC other Items in Part 1A or prepare a client brochure (Part 2).

 Private Funds.  The SEC proposes to expand the information it requires advisers to provide  about the private funds they advise in response to Item 7.B., and Schedule D. Both registered and exempt reporting advisers would complete this Item.  This amendment would incorporate the new term “private fund,” defined in section 202(a)(29) of the Act, the primary effect of which would be to require advisers to report pooled investment vehicles regardless of whether they are organized as limited partnerships.  New Section 7.B.1. would expand on the identifying information currently required to be reported in order to provide the SEC with basic organizational, operational and investment characteristics of the fund; the amount of assets held by the fund; the nature of the investors in the fund; and the fund’s service providers.  The SEC proposes to add an instruction to the item to permit an adviser that seeks to preserve the anonymity of a private fund client by maintaining its identity in code in its records to identify the private fund in Schedule D using the same code.  Among other things, the SEC is also proposing several questions to help it better understand the private fund’s investment activities and other areas of potential investor protection concerns.   For example, the form would ask about the size of the fund, including both its gross and net assets.  The form would also ask the  adviser to identify within seven broad categories (which the applicable instruction would define) the type of investment strategy employed by the adviser, and to break down the assets and liabilities held by the fund by class and categorization in the fair value hierarchy established under U.S. generally accepted accounting principles.

 Gatekeeper Information.  The proposal would  require advisers to report information concerning five types of service providers that generally perform important roles as “gatekeepers” for private funds (i.e., auditors, prime brokers, custodians, administrators and marketers).  It would require that an adviser identify them, provide their location, and state whether they are related persons.  For each of these service providers, it would also require specific information that would clarify the services they provide and include certain identifying information such as registration status. This information includes the following for each service provider.  For the auditors, whether they are independent, registered with the Public Company Accounting Oversight Board and subject to its regular inspection, and whether audited statements are distributed to fund investors.   For the prime broker, whether it is SEC-registered and whether it acts as custodian for the private fund.  For the custodian, whether it is a related person of the adviser.  For the administrator, whether it prepares and sends to investors account statements and what percentage of the fund’s assets are valued by the administrator or another person that is not a related person of the adviser.  Finally, for marketers, whether they are related persons of the adviser, their SEC file number (if any), and the address of any website they use to market the fund.

 Updating Requirements

 The SEC is also proposing to amend rule 204-1 under the Investment Advisers Act, which requires advisers to update their Form ADV filings, to require exempt reporting advisers to file updating amendments to reports filed on Form ADV.  Proposed rule 204-1(a) would require an exempt reporting adviser, like a registered adviser, to amend its reports on Form ADV: (i) at least annually, within 90 days of the end of the adviser’s fiscal year; and (ii) more frequently, if required by the instructions to Form ADV.  Consequently, the SEC is proposing to amend General Instruction 4 to Form ADV to require an exempt reporting adviser to update Items 1 (Identification Information), 3 (Form of Organization), or 11 (Disciplinary Information) promptly if they become inaccurate in any way, and to update Item 10 (Control Persons) if it becomes materially inaccurate.  The SEC is proposing the same updating requirements with respect to these Items as are applicable to registered advisers because it believes it is equally important for exempt reporting advisers to report information on a timely basis. The SEC also believes it could create confusion to apply different updating standards within each item of the form depending on who completes the item.

 Transition

 The SEC proposal would require each exempt reporting adviser to file its initial report with the SEC on Form ADV no later than August 20, 2011, 30 days after the July 21, 2011 effective date of the Dodd-Frank Act.  The SEC’s  ability to effect this transition may be affected by its need to re-program IARD.  The SEC is working closely with FINRA, its IARD contractor, to make the needed modifications, but the programming may not be completed until after the SEC adopts the proposed rules. If IARD is unable to accept filings of amended Form ADV by that time, the SEC may delay the reporting deadline until the system can accept electronic filing of the revised form.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

Contact Steve Quinlivan for more information.