On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted rules under the Investment Advisers Act of 1940 (the “Advisers Act”) to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) and exemptions from the registration requirements of the Advisers Act for advisers to certain privately offered investment funds. In addition, the SEC adopted amendments to Part 1A of Form ADV, expanding the disclosure requirements applicable to advisers to private funds and reflecting an ADV filing obligation (which is limited to certain items on Form ADV Part 1A) for advisers relying on the private fund adviser exemption or venture capital adviser exemption. The SEC also announced the extension of the deadline for registration until March 30, 2012 for advisers relying on the exemption provided for in Section 203(b)(3) of the Advisers Act on July 20, 2011 (the “Private Adviser Exemption”).

The adopted rules and Form ADV amendments:

• implement an exemption from SEC registration for any U.S. or non-U.S. adviser that acts solely as an adviser to private funds and manages private fund assets of less than $150 million;
• clarify certain terms used in the foreign private adviser exemption;
• define “venture capital fund” for purposes of the venture capital adviser exemption;
• amend Form ADV Part 1A to reflect several significant changes, including changes requiring additional information about private funds managed by an adviser and providing a uniform method for calculating an adviser’s regulatory assets under management;
• impose a Form ADV Part 1A filing obligation on advisers relying on the private fund adviser exemption or venture capital adviser exemption (collectively, “exempt reporting advisers”) to require completion of a limited subset of items;
• clarify the transition process for “mid-sized advisers” from SEC registration to state registration;
• provide a “grandfathering provision” for advisers that are currently relying on the Private Adviser Exemption with respect to certain performance-related records; and
• define a “family office” for the purpose of excluding it from the definition of investment adviser.

I. Exemptions from SEC Registration

(A) Private Fund Adviser Exemption

U.S. Private Fund Advisers

An adviser with its principal office and place of business in the U.S. (a “U.S. adviser”) is exempt from SEC registration if the adviser: (i) acts solely as an investment adviser to one or more “qualifying private funds”¹; and (ii) manages private fund assets² of less than $150 million. An adviser who advises managed accounts is precluded from relying on this exemption. Advisers must calculate the value of private fund assets in accordance with the instructions for calculating regulatory assets under management, which are discussed below.

Several commenters on the proposed rules requested that the SEC clarify whether an adviser that manages a single-investor fund could rely on the private fund adviser exemption. The SEC adopting release stated that an analysis of the particular facts and circumstances would be required to determine whether a single-investor fund could constitute a “qualifying private fund”. An investment adviser that establishes a single-investor fund to avoid registration with the SEC cannot rely on the private fund adviser exemption.

The SEC adopting release also noted that an adviser relying on the private fund adviser exemption cannot rely on that exemption and another exemption simultaneously because an adviser may rely on the private fund adviser exemption only if it acts solely as an adviser to private funds.

Non-U.S. Private Fund Advisers

An adviser that has its principal office and place of business outside of the U.S. (a “non-U.S. adviser”) may rely on the private fund adviser exemption if: (i) the adviser has no client that is a U.S. Person (as defined in Regulation S under the Securities Act of 1933 (“Regulation S”)) except for one or more “qualifying private funds” and (ii) all assets managed by the adviser from a place of business in the U.S. are solely attributable to private fund assets, the total value of which is less than $150 million.

A non-U.S. adviser will only need to count private fund assets it manages from a place of business in the U.S. toward the $150 million asset threshold. Therefore, a non-U.S. adviser that does not manage assets from a place of business in the U.S. will not need to register with the SEC, regardless of the amount of assets in qualifying private funds.³

General

An adviser relying on the private fund adviser exemption must annually assess its regulatory assets under management to determine its continued eligibility to rely on the exemption. An adviser that is no longer eligible to rely upon the private fund adviser exemption due to an increase in its assets under management must register with the SEC within 180 days after the end of its fiscal year. No transition period is available to an adviser relying on the private fund adviser exemption that seeks to advise a managed account; an adviser relying on the private fund adviser exemption must register with the SEC prior to advising any client that is not a private fund.

(B) Foreign Private Adviser Exemption

Dodd-Frank amended the Advisers Act to include a new exemption from registration for a foreign private adviser, which is defined in a new Section 202(a)(30) of the Advisers Act as an adviser that: (i) has no place of business in the U.S.; (ii) has, in total, fewer than 15 clients in the U.S. and investors in the U.S. in private funds advised by it; (iii) has less than $25 million in aggregate in assets under management attributable to such clients and investors; and (iv) does not hold itself out generally to the public in the U.S. as an investment adviser. The SEC adopted rules clarifying the meaning of certain terms included in the definition of a foreign private adviser.

Counting Clients and Defining Investors

The SEC has preserved the general methods of counting a non-U.S. adviser’s clients by including certain safe harbor provisions from current Rule 203(b)(3)-1. For example, a natural person and his/her minor children or a natural person and his/her spouse who shares his/her principal residence will continue to be counted as a single client. If an adviser counts an investor in a private fund under the investor “look through”, then the adviser does not also need to count the private fund as a client under certain circumstances. Additionally, “knowledgeable employees” will not be counted as investors.

In the United States

The phrase “in the United States” is used a number of times in the context of the “foreign private adviser” exemption. The terms “U.S. Person” and “United States” are defined by incorporating their definitions under Regulation S.

Place of Business

The phrase “place of business” is defined as any office where the investment adviser regularly provides advisory services, solicits, meets with, or otherwise communicates with clients, and any location held out to the public as a place where the adviser conducts any such activities. A place of business does not include an office where an adviser solely performs administrative services and back-office activities if those activities are not intrinsic to providing investment advisory services and do not involve communicating with clients.

Assets under Management

The value of the investment adviser’s “assets under management” must be determined in accordance with the newly adopted “regulatory assets under management” calculation (which is described below in more detail).

(C) Venture Capital Adviser Exemption

For purposes of the venture capital adviser exemption, a venture capital fund means a private fund that: (i) holds no more than 20% of the fund’s capital commitments in non-qualifying investments⁴ (other than short-term holdings); (ii) does not borrow or otherwise incur leverage (other than short term borrowing); (iii) does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances; (iv) represents itself as pursuing a venture capital strategy to investors and prospective investors and (v) is not registered under the Investment Company Act of 1940 and has not elected to be treated as a business development company.

The SEC also adopted a “grandfathering provision” in the definition of a venture capital fund for any private fund that: (i) represented to investors and potential investors at the time the fund offered its securities that it pursues a venture capital strategy; (ii) has sold securities to one or more investors prior to December 31, 2010 and (iii) does not sell any securities to, including accepting any additional capital commitments from, any person after July 21, 2011.

II. Proposals Implementing Amendments to the Advisers Act

(A) Amendments to Form ADV Part 1A

The SEC adopted a number of amendments to Form ADV Part 1A, including most significantly, amendments requiring additional information about private funds advised by the adviser and amendments revising the method for calculating assets under management.

Information Regarding Private Funds

Registered investment advisers and exempt reporting advisers (as described in Section II.B below) will be required to provide detailed information about the “private funds” that they advise. Item 7 of Form ADV Part 1A now requires an adviser to complete Section 7.B of Schedule D for each “private fund” that the adviser (but not a related person) advises.

Both registered investment advisers and exempt reporting advisers must provide information regarding the basic organizational, operational and investment characteristics of each private fund, including the fund’s gross asset value, information about its beneficial owners, the name of its general partner or directors, required minimum investment amounts, and identification of certain of its service providers (i.e., prime broker, custodian, administrator, auditor and marketer (if any)).

Determination of Assets under Management

For purposes of Form ADV Part 1A and determining whether an adviser can rely on the private fund adviser exemption, an investment adviser is required to calculate its assets under management in accordance with the definition of “regulatory assets under management”. An adviser’s regulatory assets under management must (i) be calculated on a gross basis and (ii) include family and proprietary assets, assets managed without receipt of compensation and the amount of any uncalled capital commitments.

(B) Limited Form ADV Reporting Imposed on Private Fund Advisers and Venture Capital Advisers as Exempt Reporting Advisers

The SEC adopted Rule 204-4 and is requiring “exempt reporting advisers” to complete a limited subset of items on Form ADV Part 1A using the same publicly available website used to access the Form ADV of an investment adviser registered with the SEC.

Exempt reporting advisers will be required to complete seven items on Form ADV Part 1A: Item 1-Identifying Information, Item 2.B.-SEC Reporting by Exempt Reporting Advisers, Item 3-Form of Organization, Item 6-Other Business Activities, Item 7-Financial Industry Affiliations and Private Fund Reporting, Item 10-Control Persons, and Item 11-Disclosure Information.

The SEC noted that, contrary to what had been suggested in the adopting release, it does not intend to subject exempt reporting advisers to routine examinations. The adopting release indicated, however, that the SEC staff will conduct examinations when there are indications of wrongdoing.

(C) Mid-sized Advisers and Transition between State and SEC Registration

Mid-Sized Advisers

A “mid-sized adviser” is prohibited from registering with the SEC if the adviser: (i) is “required to be registered” as an investment adviser in the state in which it maintains its principal office and place of business; (ii) if registered, the adviser would be “subject to examination” and (iii) has assets under management between $25 million and $100 million.

The Form ADV instructions provide that an adviser is not “required to be registered” with the state securities authority of the state if it is exempt from registration with that state or is excluded from the definition of investment adviser in that state. The SEC contacted each state’s securities authority to determine which states do not subject advisers registered with the state to examination. Based on those responses, investment advisers with their principal place of business in New York, Wyoming and Minnesota with assets under management between $25 million and $100 million will be required to register with the SEC unless another exemption from registration or exclusion from the definition of investment adviser is applicable.

The SEC established a registration buffer to address the issue of asset fluctuation. An adviser must register with the SEC (unless another exemption from registration or exclusion from the definition of investment adviser is applicable) if it has assets under management in excess of $110 million, and an adviser is not required to withdraw its registration with the SEC until it has less than $90 million in assets under management (as reported on its most recent annual amendment).

Transition between State and SEC Registration

Each investment adviser registered with the SEC on January 1, 2012 must file an amendment to its Form ADV no later than March 30, 2012 to report its regulatory assets under management in order to establish its eligibility to remain registered with the SEC. An adviser no longer eligible for registration with the SEC will have until June 28, 2012 to withdraw its SEC registration. Mid-sized advisers that are registered with the SEC as of July 21, 2011 must remain registered with the SEC until January 1, 2012 (unless an exemption from registration is available to such adviser).

Mid-sized advisers applying for registration prior to July 21, 2011 may chose to register with either the SEC or the appropriate state securities authority. Mid-sized advisers applying for registration after July 21, 2011 are prohibited from registering with the SEC, and must register with the appropriate state securities authority.

(D) Grandfathering Provision for Performance Information

The SEC adopted amendments to Rule 204-2 under the Advisers Act to update the “grandfathering provision” for advisers that are currently exempt from registration under the Private Adviser Exemption but will be required to register with the SEC as a result of the Dodd-Frank amendments to the Advisers Act. These advisers do not need to keep certain performance-related records to the extent they pertain to the performance of a private fund or account they advised for the period prior to such adviser’s registration, provided, however, that if an adviser preserved performance-related records even though it was not required to do so, it must continue to preserve them.

(E) Pay to Play Amendments

The SEC also adopted amendments to Rule 206(4)-5, the “Pay to Play” Rule. The three main changes are that: (i) the SEC clarified that the rule will apply to both exempt reporting advisers and foreign private advisers; (ii) municipal advisors were added to the category of registered entities excepted from the prohibition on paying third parties to solicit government entities and (iii) the SEC is extending the date by which advisers must comply with the ban on third-party solicitation from September 13, 2011 to June 13, 2012.

III. Family Offices

On June 22, 2011, the SEC also adopted a rule defining the term “family office” for purposes of excluding a family office from the definition of an investment adviser. A family office is defined as a company that: (i) has no clients other than “family clients” (which includes certain employees of a family office); (ii) is wholly owned by “family clients” and controlled by family members and (iii) does not hold itself out to the public as investment adviser. A family office is not considered an exempt reporting adviser and therefore is not required to complete and file a limited subset of items on Form ADV Part 1A with the SEC. We will be sending out a separate, more detailed memorandum regarding family offices shortly.

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If you have any questions with respect to the foregoing, please contact your primary attorney in the Investment Management Group at Seward & Kissel LLP. We will also be distributing various more detailed memoranda regarding some of these topics during the next several months.

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¹ “Qualifying Private Fund” means any private fund that is not registered under Section 8 of the Investment Company Act and has not elected to be treated as a business development company under the Investment Company Act. 3(c)(1) and 3(c)(7) funds are qualifying private funds.

² “Private fund assets” mean the investment adviser’s assets under management attributable to qualifying private funds.

³ A non-U.S. adviser with a place of business in the U.S. from which certain advisory and support services are provided to the non-U.S. adviser and its clients will need to consider whether those services constitute continuous and regular supervisory or management services for purposes of determining eligibility for this exemption.

⁴ “Qualifying investments” generally consist of any equity security issued by a “qualifying portfolio company” that is directly acquired by a qualifying fund and certain equity securities exchanged directly for the directly acquired securities. A “qualifying portfolio company” is defined as any company that: (i) is not a reporting or foreign traded company and does not have a control relationship with a reporting or foreign traded company; (ii) does not incur leverage in connection with the investment by the private fund and distribute the proceeds of any such borrowing to the private fund in exchange for the private fund investment; and (iii) is not itself a fund.