The Dodd-Frank Act (“Dodd-Frank”) not only mandated the registration of countless investment advisers, but also introduced a new classification of advisory firm – the Exempt Reporting Adviser – that is exempt from registration under the Investment Advisers Act of 1940 (the “Advisers Act”). Exempt Reporting Advisers (“ERAs“) are investment advisers that are not required to register as an adviser with the SEC or state regulators, due to their status as an advisor to either: (i) private funds and having less than $150 million of assets under management; or (ii) qualifying venture capital funds.
Types of Exemptions:
Private Fund Adviser:
Dodd-Frank exempts from registration advisers with their principal office and place of business in the United States that:
- act solely as an investment adviser to one or more “qualifying private funds”; and,
- have assets under management attributable of less than $150 million.
The term “qualifying private funds” under the private fund adviser exemption includes private funds that rely on any of the exemptions under Section 3 of the Investment Company Act of 1940 (the “Investment Company Act”), including:
- Section 3(c)(1) – private fund may not be beneficially owned by more than 100 shareholders;
- Section 3(c)(5)(C) – private fund engaged in “purchasing or otherwise acquiring mortgages and other liens on and interests in real estate;” and,
- Section 3(c)(7) – private fund may only be owned by “qualified purchasers.”
Advisers relying on this exemption are required to calculate annually the amount of private fund assets they have under management and report these amounts in the adviser’s annual amendments to its Form ADV. Advisers reporting $150 million or more of private fund assets under management no longer qualify for the private fund adviser exemption and must register under the Advisers Act unless they qualify for another exemption from registration.
Venture Capital Adviser:
The venture capital fund adviser exemption is generally available to investment advisers that solely advise venture capital funds.
To qualify as a venture capital fund for purposes of the exemption from registration, a private fund must:
- represent itself to its investors and prospective investors as pursuing a venture capital strategy;
- hold no more than 20% of the fund’s capital commitments in non-qualifying investments (other than short-term holdings);
- not borrow or otherwise incur leverage (other than limited short-term borrowing) in excess of 15% of the venture capital fund’s capital contributions and uncalled committed capital, with non-renewable terms of no longer than 120 calendar days (excluding certain guarantees of qualifying portfolio obligations by the fund);
- not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances, such as withdrawal or excuse rights for legal or regulatory requirements; and
- not be registered under the Investment Company Act and not have elected to be treated as a business development company.
Unlike the private fund adviser exemption, the level of assets under management is not an issue precluding use of the venture capital adviser exemption.
“Qualifying investments” are defined as:
- any equity security issued by a “qualifying portfolio company” that is directly acquired by the private fund from the company (“directly acquired equity”);
- any equity security issued by a qualifying portfolio company in exchange for directly acquired equity issued by the same qualifying portfolio company; or,
- any equity security issued by a company of which a qualifying portfolio company is a majority-owned subsidiary, or a predecessor, and that is acquired by the fund in exchange for directly acquired equity described above.
A “qualifying portfolio company” is defined as any company that:
- at the time of any investment by the private fund, is not a reporting or foreign traded company and does not control, is not controlled by or is not under common control with, a reporting or foreign traded company;
- does not borrow or issue debt obligations in connection with the private fund’s investment in the company and then distribute to the private fund the proceeds of such borrowing or issuance in exchange for the private fund’s investment; and,
- is not itself a private fund or other pooled investment vehicle (i.e., is an operating company.)