Final Foreign Private Adviser and Private Fund Adviser Rules Issued by the U.S. Securities and Exchange Commission.

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1 July 2011 Final Foreign Private Adviser and Private Fund Adviser Rules Issued by the U.S. Securities and Exchange Commission. Contents Implications for Non-U.S. Investment Advisers On June 22, 2011, the U.S. Securities and Exchange Commission (the SEC ) adopted final rules implementing, among other things, new exemptions from registration requirements under the U.S. Investment Advisers Act of 1940 (the Advisers Act ) for certain categories of investment advisers brought in under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd- Frank Act ). In particular, the rules (i) define venture capital fund as it relates to the new exemption for venture capital fund advisers; (ii) detail a new exemption for private fund advisers with less than $150 million in assets under management at a place of business in the United States (any such investment adviser, a Private Fund Adviser ); and (iii) clarify the application of the new exemption for foreign private advisers. The SEC release adopting these rules (the Exemption Rules Release ) is available here. On the same day, the SEC also adopted Advisers Act rules and rule amendments that, among other things, (i) clarify eligibility requirements for registration as an investment adviser under the Advisers Act for advisers with less than $100 million in assets under management; (ii) detail the reporting obligations established by Form ADV to expand the required disclosure by a reporting adviser, including registered investment advisers and exempt reporting advisers, as described below; and (iii) amend the SEC s pay to play rule. The SEC release adopting these rules (the Adopting Release ) is available here. Finally, the SEC also issued on June 22, 2011, a third release adopting rules defining family offices for the purposes of a new exemption for such entities. This release is available here. Private Adviser Exemption Repealed... 2 New Registration Exemptions Become Effective... 2 I. Foreign Private Adviser Exemption... 3 Definitions: Private Fund... 4 Definitions: Places of business... 4 Definitions: Counting Clients and Investors in Private Funds... 5 Definitions: Assets under Management... 6 II. The Private Fund Adviser Exemption... 6 Advisers that advise only private funds... 7 Private fund assets managed in the United States... 8 Reporting Obligations... 9 Next Steps This briefing summarizes the rules issued pursuant to the Exemption Rules Release that are most likely to affect our non-u.s. investment adviser clients and the associated interpretive guidance set forth in this Release and in the Adopting Release. We focus, in particular, on the tests for assessing whether or not Exchange Commission. 1

2 investment advisers with a principal office outside the U.S. may be required to register as an investment adviser pursuant to the Advisers Act in the wake of the Dodd-Frank Act. While the new rules are effective immediately, the required registration compliance date, as expected, has been postponed until March 30, Advisers filing initial applications for registration with the SEC are advised to file no later than February 14, 2012, since applications for registration can take up to 45 days to be approved. Please see our related briefing SEC Reporting Obligations Expanded for Registered and Exempt Reporting Advisers for a summary of the new reporting obligations applicable to (a) U.S. registered investment advisers, and (b) investment advisers that (although exempt from registration with the SEC as investment advisers) will still be required to make publicly available disclosure filings with the SEC. The revisions to the pay to play rule are addressed in a separate briefing, which is available here. Private Adviser Exemption Repealed As required by the Dodd-Frank Act, the private adviser exemption available under section 203(b)(3) of the Advisers Act has been repealed with effect from July 21, The private adviser exemption provided a registration exemption for advisers with fewer than 15 clients over a trailing 12-month period that did not hold themselves out to the public as investment advisers and that did not act as investment advisers to U.S. registered investment companies or business development companies. While anti-fraud and other provisions of the Advisers Act have applied to such private advisers, private advisers have not been subject to reporting or recordkeeping provisions under the Advisers Act or to routine examination by the SEC staff. The elimination of this popular exemption reflects the intention of the U.S. Congress to require advisers to private funds, including hedge funds, private equity funds and other types of privately offered pooled investment vehicles, to register with the SEC. The Dodd-Frank Act and the Advisers Act rules and SEC releases issued in response thereto materially change the registration and registration exemption regimes for private fund advisers under the Adviser Act, impose expanded reporting obligations on registered and unregistered investment advisers and promise to increase future recordkeeping obligations. New Registration Exemptions Become Effective At the same time as it repealed the private adviser exemption, the Dodd-Frank Act introduced three new Advisers Act registration exemptions, including exemptions for (i) non-u.s. advisers with less than $25 million in aggregate assets under management from U.S. clients and private fund investors and fewer than 15 of such clients and investors (the Foreign Private Adviser Exchange Commission. 2

3 exemption ) 1 ; (ii) advisers who act exclusively for private funds and have less than $150 million in assets under management in the United States (the Private Fund Adviser exemption ) 2 ; and (iii) advisers who act exclusively for qualifying venture capital funds (the VC Fund Adviser exemption ). These exemptions are effective immediately, although the principal compliance deadlines associated with the exemptions, as expected, have been postponed until March 30, As indicated above, this briefing focuses primarily on the new rules implementing the Foreign Private Adviser exemption and the Private Fund Adviser exemption as it applies to non-u.s. advisers. While the new rules have limited effect upon the non-u.s. investment activities of non-u.s. advisers, which have been deemed less likely to implicate U.S. regulatory interests than those of U.S. advisers 3, the new rules significantly expand the registration and reporting obligations applicable to non-u.s. investment advisers with U.S. clients or private fund investors including non-u.s. advisers who are able to rely upon the Private Fund Adviser exemption. Moreover, it is important to note that investment advisers, as defined in the Investment Advisers Act and the rules promulgated pursuant to the Act, include all persons that meet the definition of investment adviser as set forth in Section 202(a)(11) of the Act. Consequently, the new rules apply to persons that may be considered advisory affiliates of, or subadvisers to, persons more frequently considered to be investment advisers. 4 I. Foreign Private Adviser Exemption Section 203(b)(3) of the Advisers Act, as amended by the Dodd-Frank Act, provides an exemption from registration for certain foreign private advisers. New section 202(a)(30) of the Advisers Act defines foreign private adviser as an investment adviser that does not hold itself out to the public in the United States as an investment adviser or act as an investment adviser to an investment company or a business development company registered with the SEC in accordance with the U.S. Investment Company Act of 1940, as amended (the Investment Company Act ) and which has: > no place of business in the United States; See section 403 of the Dodd-Frank Act, which eliminates the private adviser exemption and adds a new exemption for foreign private advisers, and section 403 of the Dodd-Frank Act, which defines the term foreign private adviser. See section 408 of the Dodd-Frank Act, which adds new section 203(m) to the Advisers Act. This section sets forth the framework for the Foreign Private Adviser exemption; the application of the exemption is addressed by the newly issued rule 202(a)(30) which is set forth and discussed in the Exemption Rules Release. This is consistent with the SEC s approach expressed in the SEC No-Action Letter ABA Subcommittee on Private Investment Companies (publicly avail. Aug. 10, 2006), that the substantive provisions of the Advisers Act do not apply to non-u.s. advisers with respect to their dealings with non-u.s. clients. See Exemption Rules Release part II (D): Subadvisory Relationships and Advisory Affiliates pages The treatment of subadvisers and other advisory affiliates under the Advisers Act and the newly issued registration and reporting rules is facts and circumstances dependent. Integration analyses can be complex and are beyond the scope of this briefing. Please contact a member of Linklaters Investment Management Group if you would like more information regarding those issues. Exchange Commission. 3

4 > fewer than 15 clients and investors in the United States in private funds advised by the investment adviser; and > less than $25 million in assets under management attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser. New rule 202(a)(30)-1 and the interpretive guidance set forth in the Exemption Rules Release and discussed below clarify the application of this new exemption and define a number of terms included in the statutory definition of foreign private adviser. It should be noted that the Foreign Private Adviser exemption is very narrow. As discussed in more detail below, the requirement to look-through private funds and count their investors (and their invested capital) towards the restrictions on having fewer than 15 U.S. clients and U.S. investors in private funds advised by an adviser, and less than $25 million under management from such clients and investors, is likely to materially limit the availability of this exemption to private fund advisers with material amounts of U.S. capital under management. In addition, the inclusion of offices in which marketing and other client relations activities are conducted in the definition of place of business will prevent the many non-u.s. advisers that have client relations operations in the United States from relying on this exemption. Consequently, we regard the Foreign Private Adviser exemption as providing a de minimus safe harbor for non-u.s. investment advisers that do not conduct business in the U.S. or source capital from U.S. clients or investors. Definitions: Private Fund Private funds are defined in the new Advisers Act rules as investment vehicles that rely on any of the exceptions from the registration requirements of the Investment Company Act set forth in section 3 thereof, including, without limitation, sections 3(c)(1) and 3(c)(7), in order to avoid registering with the SEC under that Act. 5 This broad definition captures hedge funds, private equity funds and many other types of pooled investment vehicles privately offered in the United States. Definitions: Places of business A place of business includes (i) an office where the investment adviser regularly provides investment advisory services, solicits, meets with, or otherwise 5 See rule 203(m)-1(d)(4): an investment adviser may treat as a private fund an issuer that qualifies for an exclusion from the definition of an investment company, as defined in section 3 of the Investment Company Act in addition to those provided by section 3(c)(1) or 3(c)(7) provided that the investment adviser treats the issuer as a private fund under the Act and the rules thereunder for all purposes. Section 3(c)(1) of the Investment Company Act excludes from the definition of investment company any issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than 100 persons and which does not publicly offer its securities; section 3(c)(7) excludes from this definition any issuer whose outstanding securities are owned by qualified purchasers and which does not publicly offer its securities. Exchange Commission. 4

5 communicates with clients, and (ii) any other location that it holds out to the general public as a place where those activities take place 6. Accordingly, an office from which an adviser conducts marketing activities would constitute a place of business for these purposes. If an adviser has any place of business in the U.S., that adviser is not eligible for the Foreign Private Adviser exemption. Definitions: Counting Clients and Investors in Private Funds In order to rely on the Foreign Private Adviser exemption, (a) the number of an adviser s clients (including discretionary and non-discretionary clients) that are U.S. persons (as such term is defined in U.S. Securities Act of 1933 (the Securities Act ) rule 902, better known as part of Regulation S 7 ) plus (b) the number of investors in the United States in private funds (including U.S. and non-u.s. funds) advised by the adviser, may not exceed 14. The definition of client for the above purposes is included in new rule 202(a)(30)-1 and generally tracks the approach taken when counting clients under the repealed private adviser exemption. Under rule 202(a)(30)-1, an adviser generally may treat as a single client corporations, partnerships, limited liability companies and other entities or contractual arrangements that are generally regarded as single entities under U.S. law. The new rule does not, however, carry over provisions from the repealed private adviser exemption that permit an adviser to disregard clients to whom it provides investment advisory services without compensation. A non-u.s. adviser would, therefore, have to count typical friends and family accounts and investment vehicles that do not pay management fees or performance compensation as clients for these purposes. The definition of an investor in a private fund for the purposes of the Foreign Private Adviser exemption is also included in new rule 202(a)(30)-1. It includes any person who would be included in determining whether the outstanding securities of a private fund relying on section 3(c)(1) are beneficially owned by 100 or fewer persons or the outstanding securities of a private fund relying on section 3(c)(7) are owned exclusively by qualified purchasers. 8 This approach requires, among other things, a look-through to the securityholders of a private fund s institutional investors in certain circumstances, including, for example, where they are formed for the purpose of investing in the private fund (e.g., Advisers Act Rule defines a place of business as any office at which, or a location held out to the general public as a location at which, the adviser regularly provides advisory services, solicits, meets with, or otherwise communicates with clients. Rule 203(m)-1(d)(8) provides that a United States person means any person that is a U.S. person as defined in rule 902 under Regulation S, except that any discretionary account or similar account that is held for the benefit of a United States person by a dealer or other professional fiduciary is a United States person if the dealer or professional fiduciary is a related person of the investment adviser relying on rule 203(m)-1 and is not organized, incorporated or (if an individual) resident in the United States. Rule 202(a)(30)-1 also requires all holders of debt securities, including short-term paper (i.e., notes), issued by a private fund to be counted as investors. These debt holders, which, as a practical matter, include certain providers of short term financing to a fund, are explicitly excluded from the determination of the number of beneficial owners of funds seeking to rely upon the Investment Company Act registration exception afforded by section 3(c)(1) of that Act. Exchange Commission. 5

6 feeder funds). The underlying owners of these investors would have to be treated as if they invested directly in the private fund. The rule also requires a lookthrough to counterparties to derivative instruments, such as total return swaps, that have the effect of passing on the risk/reward of an investment in a private fund to a third party. It should be noted, however, that, in a break from the release issued by the SEC in November 2010 that included the proposed form of rule 203(a)(30)-1, the final version of the new rule specifically excludes knowledgeable employees (e.g., portfolio managers) from the category of private fund investors. 9 Definitions: Assets under Management As noted above, in order to qualify for the Foreign Private Adviser exemption, an adviser must have less than $25 million in aggregate assets under management from (i) U.S. clients and (ii) investors in the U.S. in private funds advised by the adviser. The Exemption Rules Release clarifies that assets under management for these purposes means regulatory assets under management. Regulatory assets under management is a new measurement introduced by the Adopting Release 10. Regulatory assets under management include the sum of the gross market value (or, if such market value is not readily available, the fair value ) of all managed accounts (including those of fund clients), proprietary capital, nonfee paying capital and committed but uncontributed capital under the management of an adviser. 11 The requirement to include proprietary and non-fee paying third party capital under management in determining compliance with the $25 million in assets under management test further restricts the usefulness of this exemption as a practical matter. II. The Private Fund Adviser Exemption The Private Fund Adviser exemption is likely to provide a more meaningful Advisers Act registration exemption for many non-u.s. investment advisers than the Foreign Private Adviser exemption. Investment advisers relying upon this exemption, however, will be subject to significant ongoing U.S. reporting and other obligations, as discussed in more detail below. New section 203(m) of the Advisers Act, as introduced by the Dodd-Frank Act, provides an exemption from registration for any investment adviser having its principal place of business outside the United States that meets the following criteria: (i) all of its clients that are U.S. persons are private funds (i.e., funds that, as noted, are exempt from registration under the Investment Company Act pursuant to one of the exceptions set forth in section 3 of the Investment Company Act); (ii) the regulatory assets 9 See rule 202(a)(30)-1. This approach is consistent with the exclusions of knowledgeable employees from beneficial ownership determinations pursuant to section 3(c)(1) and the ownership qualification criteria applicable to investors in funds seeking to rely upon section 3(c)(7) of the Investment Company Act. 10 For a more detailed discussion of calculation of regulatory assets under management, see our related briefing SEC Reporting Obligations Expanded for Registered and Exempt Reporting Advisers here. 11 See Form ADV: Instructions for Part 1A, instr. 5.b. Exchange Commission. 6

7 under management by the adviser from a place of business in the U.S. are less than $150 million; and (iii) the adviser does not hold itself out to the public in the U.S. as an investment adviser. If the adviser fails any of these tests, the Private Fund Adviser exemption will not be available to it. If it fails the test set out in (ii) above, the adviser will need to register with the SEC; if it fails the test set out in (i), other exemptions and registration requirements must be assessed. The adviser may qualify for the Foreign Private Adviser exemption, or it may be required to register as an investment adviser with the SEC or with one or more U.S. State regulatory authorities. 12 In the Exemption Rules Release, the SEC indicates that in certain limited circumstances subadvisers to advisers to Private Fund Advisers may also be able to rely upon the Private Fund Adviser exemption. 13 Advisers that advise only private funds Rule 203(m)-1 requires that an adviser seeking to rely upon the Private Fund Adviser exemption act only on behalf of clients that are private funds. 14 Private funds for these purposes has the same meaning as described above in relation to the Foreign Private Advisers exemption (i.e., privately offered investment vehicles that rely on an exception from registration afforded by section 3 of the Investment Company Act in order to avoid registering with the SEC under that Act). Accordingly, advisers to other types of clients, for example, advisers that also manage institutional client capital through separately managed accounts, will not be able to rely on this exemption. 15 While rule 203(m)-1 requires a U.S. investment adviser to take into account all of its clients when determining whether it meets the only advises private funds test, an adviser with its principal office and place of business outside the United States is not required to take into account its non-u.s. clients in determining if it complies with this restriction unless assets of these clients are managed from a place of business in the United States. 16 Accordingly, a non-u.s. adviser with no place of business in the United States and whose only U.S. clients are private funds will meet this test. By contrast, however, while the existence of a single 12 The treatment of small and mid-size advisers and the interaction between U.S. Federal and State regulatory regimes is beyond the scope of this briefing. If you have questions with regard to such topics, please contact a member of the Linklaters Investment Management Group. 13 See Exemption Rules Release II(D), Subadvisory Relationships and Advisory Affiliates, pages As noted, the SEC has indicated that subadvisers may nonetheless fall within the scope of this requirement if the subadviser s services to advisory affiliates relate only to private fund clients of such affiliates and certain other conditions are met. See Exemption Rules Release part II(D). 15 It is important to note that the Exemption Rule Release raises questions about the treatment of managed accounts that are structured as private funds established for a single investor. While the SEC does not state definitively in the Release that such single investor private funds may not be treated as private fund clients for the purposes of the Private Fund Adviser exemption, it does indicate that the status of such single investor private funds will be subject to a facts and circumstances analysis and suggests that advisers ability to treat such single investor funds as private funds may be limited in the future. 16 Non-U.S. clients include, with some limited exceptions, clients that are not U.S. Persons under Regulation S of the U.S. Securities Act of 1933 (the Securities Act ). See also rule 203(m)-1(b)(1). Exchange Commission. 7

8 non-private fund U.S. client will eliminate the availability of the exemption, the fact that the adviser may have a variety of different clients outside the United States need not be taken into account. Similarly, the fact that a non-u.s. private fund or other non-u.s. investment vehicle advised by the adviser has U.S. investors is not required to be taken into account. Non-U.S. advisers that have a place of business in the U.S., however, require closer scrutiny. The Private Fund Adviser exemption will not be available to a non-u.s. adviser with a place of business in the United States where (a) $150 million or more of assets are managed from that place of business, or (b) the assets (regardless of amount) of any client that is not a private fund are managed from that place of business. Private fund assets managed in the United States As indicated, once an adviser has a place of business in the United States, it becomes necessary to ascertain whether that adviser has assets under management at that place of business and if so, how much. The SEC clarifies in the Exemption Rules Release that the determination of whether assets are under management at a place of business is based upon an assessment of whether continuous and regular supervisory or management services in respect such assets are conducted at that place of business. 17 This requires a facts and circumstances analysis. The Exemption Rules Release suggests, however, that not all services that relate to the management of assets will constitute the management of such assets for the purposes of this test. In particular, the SEC states in the Release that it would not view providing research or conducting due diligence from a U.S. place of business to constitute the conduct of continuous and regular supervisory or management services at such place of business if a person outside of the United States makes independent investment decisions and implements those decisions. 18 Once an investment adviser has determined that it has assets under management from a U.S. place of business for the purposes of the Private Fund Advisers exemption, it must determine whether it has $150 million or more of such assets. The Exemption Rules Release clarifies that the adviser should take into account all of the regulatory assets under management from such place of business in accordance with the guidance provided in Form ADV and as discussed above under Definitions: Assets under Management above in relation to the Foreign Private Adviser exemption. Accordingly, all assets under 17 Continuous and regular supervisory or management services is described in the instructions to Form ADV as discretionary authority or ongoing responsibility to select or make recommendations, based upon the needs of the client, as to specific investments the account may purchase. 18 See also Form ADV: Instructions for Part 1A, instr. 5.b(3)(b) (an adviser provides continuous and regular supervisory or management services with respect to an account if it has ongoing responsibility to select or make recommendations, based upon the needs of the client, as to specific securities or other investments the account may purchase or sell and, if such recommendations are accepted by the client, [it is] responsible for arranging or effecting the purchase or sale). Exchange Commission. 8

9 management at a U.S. place of business must be included in this calculation. These regulatory assets under management include the sum of the gross market value (or, if such market value is not readily available, the fair value ) of all managed accounts (including those of fund clients), proprietary capital, non-fee paying capital and committed but uncontributed capital under the management of an adviser from such place of business. Compliance with this test must be determined at the conclusion of each fiscal year of the adviser. An adviser will have 90 days after it exceeds the $150 million threshold, and, therefore ceases to comply with the Private Fund Adviser exemption, to register with the SEC. 19 Since regulatory assets under management must be calculated within 90 days of the end of the adviser s fiscal year, the rule effectively requires registration within no more than 180 days of the end of the preceding calendar year. Any such registration application, however, would need to be filed at least 45 days prior to such applicable registration deadline in order to ensure that registration becomes effective prior to the registration deadline. Reporting Obligations As noted above, the SEC has also adopted a number of revisions to SEC Form ADV, including revisions that will require investment advisers to disclose a significant amount of information regarding the private funds managed by such advisers. 20 While previously only investment advisers who were registered with the SEC were required to file a Form ADV with SEC, under the new rules investment advisers seeking to rely on the Private Fund Adviser exemption will be required to complete a sub-set of the information required by Form ADV and file this abbreviated Form ADV with the SEC. Mandatory disclosure includes information regarding business activities and financial industry affiliations, control persons, disciplinary history and private funds advised by the exempt advisers. This information will be publicly available and must be kept up to date on an ongoing basis. Finally, the SEC has indicated that non-u.s. advisers relying on the Private Fund Adviser exemption will be subject to recordkeeping requirements, to be proposed at a later date, and may be subject to examination by SEC staff. It is not clear at this point what an SEC examination of an exempt adviser would involve and the SEC has not yet indicated the timing of such recordkeeping rules. For additional information regarding these expanded reporting obligations, please see our briefing SEC Reporting Obligations 19 Rule 203(m)-1. It should be noted that this three-month transition period is only available to the adviser if it has complied with reporting requirements applicable to it as an adviser relying on the Private Fund Adviser exemption (see Reporting obligations below). 20 Form ADV Part 1A currently serves as a registration statement for advisers seeking to register with the SEC under the Advisers Act. It is filed electronically through an automated web-based system (the Investment Adviser Registration Depository) and, once filed, is publicly available through the SEC website. Exchange Commission. 9

10 Contacts Expanded for Registered and Exempt Reporting Advisers which is available here. Next Steps The new Advisers Act rules are effective immediately. However, investment advisers currently relying upon the private adviser exemption that will now be required to register with the SEC or required to submit Form ADV as an exempt reporting adviser will have until March 30, 2012 to comply with the new rules. Investment advisers filing initial applications to register with the SEC as investment advisers are advised to file no later than February 14, 2012, since applications for registration can take up to 45 days to be approved. For further information please contact: Scott Bowie Partner, Global Head of IMG Lorna Bowen Partner Stephen Culhane Partner This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2011 Linklaters in the U.S. provides leading global financial organizations and corporations with legal advice on a wide range of domestic and cross-border deals and cases. Our offices are located at 1345 Avenue of the Americas, New York, New York Linklaters LLP is a multinational limited liability partnership registered in England and Wales with registered number OC The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on Please refer to for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com Avenue of the Americas New York, NY Telephone Facsimile Exchange Commission. 10