Wall Street

Board of Contributors: Dodd-Frank eliminates exemptions for many fund advisers

Posted on Thursday, January 13, 2011

New requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act will affect advisers to private investment funds such as private equity funds, hedge funds and other pooled investment vehicles with the costs and resources dedicated to compliance expected to disproportionately affect smaller managers.
The Securities and Exchange Commission is tasked with drafting the new rules for advisers under the Dodd-Frank legislation. Based on recent SEC releases proposing new adviser rules, the scope of registration requirements for these advisers will be expanded and their reporting and record-keeping responsibilities will significantly increase, even for advisers who are not required to register with the SEC.
Currently, under the Investment Advisers Act, almost all firms that manage private funds are considered to be "investment advisers." Until now, however, many of them have been exempt from SEC registration requirements due to what is ref erred to as the "private adviser exemption." These advisers were typically exempt because they managed fewer than 15 funds and did not promote themselves as investment advisers. Generally, the Investment Advisers Act is designed to permit the SEC to regulate larger investment advisers, while leaving the regulation of smaller advisers to the various states.
However, the Dodd-Frank Act rescinds the private adviser exemption. Most of the advisers who have relied upon the private adviser exemption will now be required to register either with the SEC or with state regulators because of the limited scope of the new exemptions from registration.
The new exemptions from registration proposed by the SEC under Dodd-Frank would apply to: advisers with assets under management in the United States of less than $150 million that solely advise unregistered funds; advisers to "venture capital funds;" advisers to small business investment companies, family off ices; and foreign private advisers. The SEC will define the terms "venture capital fund," "family office" and "foreign private adviser" during its rulemaking process.
Advisers to private funds, even if exempt from registration under the new legislation, must register with the securities regulator of the state or states in which they maintain a principal office or place of business if the adviser has between $25 million and $100 million in assets under management and the state regulates and examines private fund advisers. Advisers to private funds currently are and will continue to be required to register with the state in which they maintain a principal office or place of business if they have less than $25 million in assets under management.
For advisers to private funds that become subject to SEC registration requirements, their new compliance challenges will include appointment of a compliance officer and implementation of a compr ehensive compliance program, annual compliance reviews, adoption of new codes of ethics to address personal trading and insider trading, creating rules and oversight for conflicts of interest, implementing guidelines governing marketing materials and performance presentations, and handling periodic SEC examinations.
The Dodd-Frank Act provides the SEC with the authority to require advisers to private funds to maintain records, file reports and produce records upon request or examination. A registered adviser must maintain for each of its funds information regarding most of its business and operations, and Dodd-Frank adds new categories: the amount of assets under management, use of leverage, counterparty credit risk exposure, trading practices, valuation policies, types of assets held, side arrangements with certain investors, and such other information as the SEC and other regulators determine is "necessary and appropriate in the public interest and for the prote ction of investors or for the assessment of systemic risk."
Under the SEC's proposed rules, most of the "exempt" advisers would still be required to maintain certain records and file certain reports with the SEC even though they would be exempt from registration and most of the recordkeeping requirement. These exempt advisers must maintain and furnish to the SEC any annual or other reports that the SEC determines to be "necessary or appropriate in the public interest or for the protection of investors." These reports would need to include the adviser's corporate structure, business activities, control persons or owners, affiliations in the financial industry, and disciplinary history.
These more rigorous reporting and record-keeping requirements will create significant challenges for smaller managers, as these processes often cannot be implemented quickly and involve a significant time investment by advisers.
The new registration r equirements under the Dodd-Frank Act are scheduled to become effective July 21. Advisers to private funds will need to complete any required SEC registration prior to such date and also ensure all other requirements created by the new laws are met. The failure of an adviser to register can result in financial penalties and breach and/or voiding of existing contracts with funds or investors. Many advisers find that the process of preparing a compliance program and related SEC filings can take three to six months.
In response to the new requirements, advisers to private investment funds should consider the following steps: consult with legal counsel to determine the impact of the new registration requirements on the adviser (whether with the SEC or state regulatory bodies); regardless of registration requirements, evaluate existing record-keeping policies and implement new policies to meet heightened requirements; and retain additional personnel to assist with new compli ance requirements or designate specific reporting and oversight responsibilities among existing executives.
As the SEC rulemaking process continues and is finalized, fund advisers are tasked with monitoring the effects of the Dodd-Frank Act on their organization and, together with legal counsel, determining their ultimate responsibilities under the SEC's final rules.

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