§ 5.02 Investment Adviser Registration

• Jurisdiction: United States
• Publication year: 2022

§ 5.02 Investment Adviser Registration

Historically, many hedge fund managers relied on a "private adviser exemption" from SEC registration, pursuant to former Section 203(b)(3) of the Advisers Act which provided that investment advisers with fewer than fifteen clients did not have to register with the SEC.⁵⁷ Dodd-Frank⁵⁸ repealed Section 203(b)(3), and as a result many hedge fund managers are registered as investment advisers with the SEC. Dodd-Frank also introduced a limited set of exemptions from SEC registration and re-drew the lines between SEC and state registration for smaller hedge fund managers.

Hedge fund managers that register with the SEC as investment advisers are subject to all of the provisions of the Advisers Act⁵⁹ and are required to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder by the manager or its supervised persons.⁶⁰

[1]—SEC Registration Thresholds

Under Dodd-Frank, there are two categories of advisers that are eligible for registration with the SEC: (1) larger advisers, which are advisers with regulatory assets under management ("Regulatory AUM")⁶¹ of $100 million or more; and (2) mid-sized advisers, which are advisers with Regulatory AUM between $25 million and $100 million and that: (1) are not required to be registered in the state in which they maintain their principal office and place of business; (2) are not subject to examination as investment advisers by such state; (3) are required to register in fifteen or more states; or (4) are advisers to registered investment companies or business development companies.⁶² Larger advisers and mid-sized advisers that rely on exemptions in the state in which they have their principal place of business are required to register with the SEC unless an exemption from registration is available.⁶³

[2]—Exemptions

Dodd-Frank's elimination of Section 203(b)(3) resulted in many hedge fund managers being required to register as investment advisers with the SEC; however, Dodd-Frank also created three limited exemptions from SEC registration:⁶⁴

• Private Fund Adviser Exemption. An adviser is exempt from registration if it acts solely as an adviser to private funds and manages Regulatory AUM of less than $150 million (if the adviser's principal place of business is in the United States) or manages Regulatory AUM of less than $150 million from a place of business in the United States (if the adviser's principal place of business is not in the United States).⁶⁵
• Venture Capital Fund Exemption. An adviser is exempt from registration if it manages only venture capital funds (as defined by the SEC).⁶⁶

• Foreign Private Adviser Exemption. An adviser is exempt from registration if it is a foreign private adviser with de minimis U.S. investors, clients and assets.⁶⁷

An adviser relying on the Private Fund Adviser Exemption or the Venture Capital Fund Exemption is referred to as an "Exempt Reporting Adviser" and is subject to SEC examination and must comply with certain recordkeeping and reporting requirements discussed herein. Advisers that rely on the Foreign Private Adviser Exemption are not subject to SEC examination or reporting requirements.⁶⁸

[a]—Private Fund Adviser Exemption

[i]—Exemption for Investment Advisers with Less than $150 Million Regulatory AUM in the United States

An investment adviser with its principal office and place of business⁶⁹ in the United States (a "U.S. Adviser") is exempt from registration if it: (1) acts solely as an investment adviser to one or more "qualifying private funds";⁷⁰ and (2) manages private fund assets⁷¹ of less than $150 million.⁷² An investment adviser with its principal office and place of business outside of the United States (a "Non-U.S. Adviser") is exempt from registration if: (1) it has no client that is a United States person except for one or more qualifying private funds; and (2) all assets it manages at a place of business in the United States are solely attributable to private fund assets, the total value of which is less than $150 million.⁷³ Notably, reliance on the Private Fund Adviser Exemption is not based on the number of clients advised by the investment adviser and there is no limit on the amount of private fund assets from U.S. investors managed from a principal office and place of business outside the United States.

[ii]—Advising Solely Private Funds

As set forth above, the Private Fund Adviser Exemption requires that investment advisers relying on the exemption solely advise "qualifying private funds."⁷⁴ In the adopting release for the Private Fund Adviser Exemption,⁷⁵ the SEC noted that there may be a single-investor fund, or may be a private fund depending on the facts and circumstances, but only provided two narrowly defined examples. The examples cited as being appropriate are when (i) a fund seeks to raise capital from multiple investors but only has a single, initial investor for a period of time or (ii) a fund has only one investor left as a result of redemptions. The SEC also stated that an adviser generally should not consider a single-investor fund to be a pooled investment vehicle if that entity in fact operates as a means for the adviser to provide individualized investment advice directly to the investor in the fund.⁷⁶ The SEC declined to provide comfort that single-investor funds, formed at the request of an investor, would qualify as a private fund for purposes of the Private Fund Adviser Exemption.

[iii]—Determination of Regulatory AUM in the United States

For the purpose of determining an investment adviser's Regulatory AUM under the Private Fund Adviser Exemption, U.S. Advisers and Non-U.S. Advisers are treated differently from each other because the non-U.S. activities of Non-U.S. Advisers are less likely to implicate U.S. regulatory interests.⁷⁷ While a U.S. Adviser is presumed to manage all of its assets from within the United States, and generally must count private fund assets in non-U.S. countries in determining its Regulatory AUM in the United States, a Non-U.S. Adviser is required only to count the assets managed at a place of business in the United States. Assets are considered to be "managed" if an adviser provides "continuous and regular supervisory or management services"⁷⁸ with respect to such assets. The SEC has recognized that this is an inherently factual determination, but has indicated that it would not "view providing research or conducting due diligence to be 'continuous and regular supervisory or management services' at a U.S. place of business if a person outside of the United States makes independent investment decisions and implements those decisions."⁷⁹

The determination of the location at which the management services are provided (i.e., whether or not assets are managed at a place of business in the United States) is also inherently factual. Factors to consider include: (1) the terms of the relevant advisory agreement (e.g., an advisory contract specifies that certain services be provided from a place of business in the United States); (2) the form of compensation (e.g., specific U.S. personnel are compensated for the service); and (3) management practices (e.g., U.S. office personnel perform a portion of the service).

The SEC's doctrine of "operational integration" provides that investment advisers integrated with other advisers (including affiliated advisers based outside the United States) are treated as one adviser.⁸⁰ Therefore, investment advisers with offices in both the United States and outside the United States should assess whether these offices are operationally integrated when making a determination of the amount of private fund assets managed from a place of business in the United States, as well as whether such advisers are able to utilize the exemption from registration. An affiliated advisory entity may, in certain circumstances, be treated independently for purposes of determining whether it meets an exemption from registration. The SEC staff has provided guidance as to whether two advisory businesses are required to be integrated for registration purposes.⁸¹

[iv]—Frequency of Calculation of Private Fund Assets

Investment advisers must calculate private fund assets annually.⁸² If an adviser previously relied on the Private Fund Adviser Exemption but may no longer do so because it now has private fund assets of $150 million or more, the adviser has up to ninety days after filing its annual updating amendment to Form ADV to apply for SEC registration (unless it qualifies for another exemption).⁸³ During this time, the adviser may continue doing business as a private fund adviser; however, note that this transitional relief is only available to advisers that complied with all SEC reporting requirements applicable to an exempt reporting adviser.⁸⁴

[b]—Exemption for Advisers to Venture Capital Funds

The Venture Capital Fund Exemption exempts from registration any investment adviser that acts solely as an adviser to venture capital funds.⁸⁵ A hedge fund manager that launches a venture capital fund will not be eligible for this exemption. Pursuant to Rule 203(l)-1, a private fund will only be considered a venture capital fund if all of the following criteria are met:

(1) the fund represents itself as pursuing a venture capital strategy to investors and potential investors;

(2) the historical cost (or fair value) of the fund's non-qualifying investments (other than short-term holdings)⁸⁶ may not exceed 20% of the fund's capital commitments;

(3) the fund does not utilize leverage except for limited short-term borrowing;

(4) the fund provides investors with no liquidity rights, except in extraordinary circumstances; and

(5) the fund has not registered under, or elected to be treated as a business development company pursuant to, the Investment Company Act.

[c]—Foreign Private Adviser Exemption

The Foreign Private Adviser Exemption is...