The U.S. Investment Advisers Act of 1940 (the "Advisers Act"), as amended by the Dodd-Frank Act, not only required registration of thousands of investment advisers, but also implemented a new category for a narrow class of advisory firms: the Exempt Reporting Adviser.1
Exempt Reporting Advisers ("ERAs") are investment advisers that are not required to register as an adviser with the U.S. Securities Exchange Commission ("SEC") or state regulators, but must still pay fees and report public information via the IARD/FINRA system. Federally, the two exemptions that advisers can use to claim ERA status are (i) the Private Fund Adviser Exemption or (ii) the Venture Capital Fund Adviser Exemption.
Private fund adviser exemption
U.S.-based advisers that only manage solely private funds and have less than $150 million in regulatory assets under management (“AUM”) will generally be exempt from SEC registration. Non-U.S. advisers must ensure that the sole U.S. clients of the adviser are private funds; only assets managed from the U.S. are counted toward the $150 million limit.
Venture capital adviser exemption
Generally, an adviser advising solely venture capital funds2 can qualify for the federal venture capital adviser exemption. Unlike the private fund adviser exemption, the level of AUM is not an issue precluding use of the venture capital adviser exemption.
An investment adviser relying on either exemption, it must complete its ERA filing within 60 days of claiming the exemption. The applicable date for this will typically be date on which the firm commences the advisory relationship with its first fund. If either exemption will become inapplicable because the adviser will be taking on separately managed accounts (SMAs), in addition to the current funds, then the investment adviser must promptly register with the appropriate regulator (SEC or state) prior to taking on its first SMA.
State vs. SEC ERA Registration
Large Advisers (firms with $100+ million in regulatory AUM) will register with the SEC unless an exemption is available. This means that advisers with between $100 million and $150 million AUM solely attributable to private funds (as described above) are exempt under the Private fund adviser exemption, while advisers with over $150 million AUM must register with the SEC. It's important to note that the venture capital adviser exemption is not based on AUM.
However, the analysis for Mid-Sized Advisers (firms with between $25 million and $100 million in regulatory AUM) is more complicated. As a general rule, Mid-Sized Advisers must register with the relevant state regulatory authority, rather than the SEC. Specifically, a Mid-Sized Adviser would register with the SEC only if the firm is not:
- subject to examination as an adviser by the state where it maintains its principal office and place of business (e.g. New York – see http://www.riainabox.com/sec-investment-advisor-registration-requirements); or
- required to be registered as an adviser with the state securities authority in the state where it maintains its principal office and place of business.
This second scenario for Mid-Sized Advisers is more complex than the first, requiring the adviser to consult the home state investment adviser laws to determine if it is required to register as an investment adviser or file as an ERA in that state. Many states, such as California, Texas, and Virginia, have regulations providing for exemptions from registration for advisers to certain types of private funds providing the grounds for, effectively, an ERA registration at the state level. State rules vary considerably, and you should consult with counsel as to your particular circumstances.
If the adviser does not need to register with or file as an ERA with the state regulator, then the adviser will look to the SEC to determine registration requirements (meaning it must either register with the SEC or fall within the Private Fund Adviser or Venture Capital Fund Adviser exemptions). If an adviser in this situation can avail itself of an exemption, then it can file as an ERA and avoid registration with the SEC (and of course the state(s)).
Requirements for Federal ERAs
At the federal level, ERAs, like registered investment adviser (RIA) firms, are required to file annual updating amendments to Form ADV (within 90 days of the firm’s fiscal year end and more frequently in certain circumstances based on material developments in accordance with the Form ADV instructions. ERA’s with a non-resident general partner or managing agent would also have to submit a Form ADV-NR, filed via a paper form separate from the Form ADV filing submitted via the IARD/FINRA system. However, an ERA need not prepare a Form ADV Part 2A firm brochure and need only complete select items and schedules in Form ADV Part 1A.3 Additionally, states may require notice filings and fees for ERAs depending on the firm’s nexus with that state.
ERAs, since they are now subject to Section 204 of the Advisers Act, must implement written policies and procedures reasonably designed to prevent the misuse of material non-public information (MNPI). Additionally, compliance requirements that apply to all advisers regardless of registration status would apply to federally-filed ERAs. This includes, inter alia, the SEC’s “pay to play” provisions and the USA PATRIOT Act’s anti-fraud requirements. ERAs are not required to adopt a policies & procedures / compliance manual; however, doing so as a “best practice” can be beneficial. All advisory firms should note that once a compliance manual or other internal procedures are implemented, those procedures should be followed regardless of whether or not their adoption was strictly required in the first place. Furthermore, the SEC does not perform routine compliance examinations of ERAs. While the SEC does have the authority to inspect an ERA’s books & records, such inspection would typically be triggered by some independent indication of wrongdoing on the part of the firm.
Note: The information contained herein is an overview regarding certain exempt reporting adviser considerations. It is not intended to be a comprehensive analysis or apply to any one investment adviser’s particular situation. RIA in a Box LLC is not a law firm, investment advisory firm, or a CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities.
1ERAs are investment advisers that generally rely on either the Private Fund Adviser Exemption (Advisers Act Section 203(m)) or the Venture Capital Fund Adviser Exemption (Advisers Act Section 203(l)). See www.sec.gov/rules/final/2011/ia-3222.pdf.
2Rule 203(l)-1 of the Advisers Act defines a “venture capital fund” generally as any private fund that: (1) represents to investors that it pursues a venture capital strategy; (2) immediately after the acquisition of any asset, other than qualifying investments or short-term holdings (as defined in the rule), holds no more than 20% of the amount of the fund’s aggregate capital contributions and uncalled committed capital in assets (other than short-term holdings) that are not qualifying investments, valued at cost or fair value, consistently applied by the fund; (3) does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage in excess of 15% of the private fund’s aggregate capital contributions and uncalled committed capital, and any such borrowing, indebtedness, guarantee or leverage is for a nonrenewable term of no longer than 120 calendar days, except that any guarantee by the private fund of a qualifying portfolio company’s obligations up to the amount of the value of the private fund’s investment in the qualifying portfolio company is not subject to the 120 calendar day limit; (4) only issues securities the terms of which do not provide a holder with any right, except in extraordinary circumstances, to withdraw; and (5) is not registered under section 8 of the Investment Company Act and has not elected to be treated as a business development company pursuant to section 54 of the Investment Company Act.
Lexington Compliance and RIA in a Box LLC are not law firms, investment advisory firms, or CPA firms. Lexington Compliance and RIA in a Box LLC do not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.