Investment advisers who provide investment advice for compensation typically must register or claim an exemption from registration with either the Securities and Exchange Commission (the “SEC”) or state securities authorities (or both), depending on their operations and assets under management, as described in our article: Form ADV Compliance for Investment Advisers. An adviser that qualifies for an exemption from registration under the Investment Advisers Act of 1940 (the “Advisers Act”) or applicable state adviser registration rules is an exempt reporting adviser (“ERA”).
Each state has different exemption and registration requirements for investment advisers. A state’s jurisdiction over an investment adviser tends to apply when a certain amount of investment adviser clients are located in the state or when the investment adviser has an office in the state. Below is a brief overview of the SEC private fund and venture capital exemptions and the California ERA exemption, along with information on the ongoing Form ADV filing requirements for those ERAs. This overview is not comprehensive of all compliance requirements applicable to ERAs.
SEC Private Fund and Venture Capital ERAs
An investment adviser with regulatory assets under management (“RAUM”) under $150 million that advises only private funds may be exempt from SEC registration as a private fund ERA under Rule 203(m) of the Advisers Act. A “private fund” is an issuer of securities that would be an “investment company” but for the exceptions listed in sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940, as amended (the “ICA”).
An investment adviser that only advises venture capital funds may be exempt from SEC registration as a venture capital ERA under Advisers Act Rule 203(l). A “venture capital fund” is a private fund that: (a) holds no more than 20% of its capital commitments in non-qualifying investments (other than short-term holdings, qualifying investments generally consist of equity securities of qualifying portfolio companies that are acquired by the fund directly from the portfolio company); (b) does not borrow or otherwise incur leverage, other than limited short-term borrowing (excluding certain guarantees of qualifying portfolio company obligations by the fund); (c) does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances; (d) represents itself as pursuing a venture capital strategy; and (e) is not registered under the ICA and has not elected to be treated as a business development company.
ERAs should be aware that the SEC takes the view that advisers and their affiliates cannot circumvent the requirements under the Advisers Act by separately organizing if they are operationally integrated. For example, an investment adviser relying on the exemption from registration for private fund advisers under section 203(m) of the Advisers Act generally cannot be affiliated and operationally integrated with an adviser that relies on the venture capital fund exemption under section 203(l) of the Advisers Act. If the affiliates are operationally integrated, then each would fail to qualify for either of the SEC registration exemptions.
Other State ERAs
An adviser that is exempt from registration as an investment adviser with the SEC may also have to file as an ERA or register as an investment adviser in each state where it has an office. Although specific state requirements vary, generally, each adviser must determine whether it is subject to the filing requirements in a state in which the investment adviser holds itself out to the public as a place it regularly provides investment advisory services from or where it solicits, meets or otherwise communicates with clients.
California ERAs
California provides an exemption from state investment adviser registration for private fund advisers under section 260.204.9 of Title 10 of the California Code of Regulations. Under this exemption, an adviser is not required to register as an investment adviser with the California Department of Financial Protection and Innovation (“DFPI”) if it provides advice solely to one or more qualifying private funds (which is a fund that qualifies for exclusion from the definition of investment company under one or more of ICA sections 3(c)(1), 3(c)(5) and 3(c)(7)). To rely on this private fund adviser exemption in California, the adviser may not otherwise provide advisory services to separately managed accounts or registered investment companies. The private fund adviser exemption requires that advisers file a truncated Part 1A of Form ADV on the Investment Adviser Registration Depository (“IARD”) system, pay any required IARD system fees (including annual renewal fees) and comply with specific investor eligibility and disclosure requirements. Additionally, neither the adviser nor any of its advisory affiliates may have committed any disqualifying act (as defined under Rule 262 of Regulation A).
A private fund adviser relying on the California exemption that advises a “retail buyer fund” must meet certain additional requirements with respect to those retail buyer funds, as described in our article on the California Private Fund Adviser Exemption, including obtaining audited financial statements. A retail buyer fund is a private fund that is not a venture capital company and that is excluded from the definition of “investment company” under ICA section 3(c)(1) or 3(c)(5). To clarify, a fund that is excluded under ICA section 3(c)(7), with only qualified purchasers as investors, is not a retail buyer fund.
A private fund adviser that advises one or more qualifying private funds that are venture capital companies may qualify for the California private fund adviser exemption with respect to that fund without some of the additional investor protections that apply to retail buyer funds. Under the exemption, a “venture capital company” is a private fund that meets either of the following characteristics:
- On at least one occasion during the annual period commencing with its inception, and on at least one occasion during each annual period thereafter, at least 50% of the fund’s assets, valued at cost, are “venture capital investments” (i.e., an acquisition in an operating company and the fund, the adviser or an affiliate has obtained, contractually or through ownership of securities, management rights) or “derivative investments” (i.e., the acquisition of securities on exercise, obtained on conversion of an existing investment or obtained in connection with a public offering, merger or reorganization); or
- The fund is a “venture capital fund” as defined in Rule 203(l)-1 under the Advisers Act (described above).
If your firm relies on the California exemption from registration and its RAUM increases to over $25 million, the firm must generally also rely on an applicable SEC exemption from registration, as described above, and update its Form ADV accordingly.
Amendments to Form ADV
SEC and California ERAs are required to file annual updating amendments to Forms ADV, Part 1A, as well as file other-than-annual amendments promptly if (a) information in Items 1 (except Item 1.O. and Section 1.F. of Schedule D), 3 or 11 becomes inaccurate in any way, or (b) information in Item 10 becomes materially inaccurate.
ERAs are also required to pay any associated filing fees and any renewal fees when due, or risk losing status as an ERA. For example, California ERAs that fail to pay their renewal fees by December 31 of each year will have their status as an ERA revoked by the DFPI and a “Failure to Renew” registration status will appear on the SEC’s Investment Adviser Public Disclosure website. For more information on Form ADV filing requirements for ERAs, please see our article: Form ADV Compliance for Investment Advisers.
Switching to SEC or California Registration
If a California-based firm is relying on either SEC ERA exemption (for private fund ERAs or venture capital ERAs) or the California ERA exemption, it will lose that applicable exemption if it accepts any client that is not a private fund and must register with the SEC or the DFPI (depending on its RAUM) before accepting any such client.
In addition, if an adviser (a) advises any private fund that does not qualify as a venture capital fund, (b) reports on its Form ADV annual updating amendment that its RAUM has reached at least $150 million and (c) has complied with all reporting requirements applicable to an SEC private fund ERA, it must file an application to register as an investment adviser with the SEC and, if it has a California office, is likely required to make a notice filing in California within 90 days of filing its annual updating amendment that reported the RAUM above $150 million. If an adviser has not complied with all SEC private fund ERA reporting requirements, this 90-day transition period is not available.
If your firm is an SEC venture capital ERA, expects to advise a fund that does not qualify as a venture capital fund and does not qualify for the private fund exemption because your RAUM is $150 million or more, the SEC generally must approve your firm’s application for registration before the firm may advise any fund that does not qualify as a venture capital fund.
Please contact one of the Shartsis Friese attorneys in the Investment Funds & Advisers Group if you have any questions regarding your status as an ERA and any ongoing compliance requirements to maintain status as an ERA.
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