On June 30, 2010, the House of Representatives passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Bill”), which contains The Private Fund Investment Advisers Registration Act of 2010 (the “Act”). The Dodd-Frank Bill is subject to approval by the Senate before it can be presented to President Obama for his signature. The Senate is expected to vote on the Dodd-Frank Bill after Congress returns from its July 4th recess.

This memorandum provides a brief overview of the Act. While some of the most significant provisions of the Act relate to changes in the registration requirements for investment advisers that are currently not required to be registered with the SEC, other provisions of the Act such as the reporting requirements and the adjustment of the accredited investor standard will have a broader impact.

The provisions summarized in this memorandum will generally become effective one year from the date of enactment of the Dodd-Frank Bill. However, the amendment to the accredited investor net worth standard to exclude the value of a natural person’s primary residence will become effective immediately upon the enactment of the Dodd-Frank Bill.

Elimination of the Private Adviser Exemption from Registration

The Act eliminates the current private adviser exemption from SEC registration for investment advisers with fewer than 15 clients (the “Private Adviser Exemption”). Therefore, an investment adviser that previously relied upon the Private Adviser Exemption will be required to register with the SEC, unless the adviser is able to rely upon one of the exemptions from registration or exclusions from the definition of investment adviser included in the Act, further described below, or otherwise provided in the Investment Advisers Act of 1940 (the “Advisers Act”).

Assets Under Management Threshold for SEC Registration

An investment adviser with assets under management of over $25 million will be required to register with the SEC, unless it is a “Mid-Sized Investment Adviser” or can rely on another exemption or exclusion. A “Mid-Sized Investment Adviser” is an investment adviser with assets under management between $25 million and $100 million (or such higher amount as the SEC may, by rule, deem appropriate) that is: (i) required to be registered in the state in which it maintains its principal office and place of business; and (ii) if registered, would be subject to examination by such state. Accordingly, an investment adviser with assets under management of $100 million or more will be required to register with the SEC regardless of state registration, unless another exemption or exclusion applies.

Consistent with current law, an investment adviser with assets under management of less than $25 million is not permitted to register with the SEC, but may be required to register in the state where it maintains its principal office and place of business.

Additional Exemptions and Exclusions from SEC Registration

• Private Fund Adviser Exemption: The Act directs the SEC to provide for an exemption from registration for an investment adviser that: (i) advises only “private funds”¹; and (ii) has assets under management in the U.S. of less than $150 million.
• Foreign Private Adviser Exemption: The Act provides a limited exemption from registration for a “foreign private adviser”, which is defined as an investment 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 that it advises; (iii) has less than $25 million (or such higher amount to be determined by the SEC) in assets under management attributable to clients in the U.S. and investors in the U.S. in private funds that it advises; and (iv) does not hold itself out to the public in the U.S. as an investment adviser, or advise an investment company registered under the Investment Company Act of 1940, as amended (the “Investment Company Act”) or a business development company.
• Venture Capital Fund Adviser Exemption: The Act provides an exemption from registration for an investment adviser that serves as an adviser solely to one or more “venture capital funds” (such term to be defined by the SEC), however, such advisers will be required to maintain records and provide reports to the SEC that are deemed necessary or appropriate in the public interest.²
• Family Office Exception: The Act excludes from the definition of investment adviser any “family office” (such term to be defined by the SEC).
• Registered Commodity Trading Adviser: The Act provides an exemption from registration for an adviser that: (i) is registered as a commodity trading adviser with the CFTC; and (ii) advises a private fund, provided that the adviser’s business is not predominantly the provision of securities-related advice.

Adjustment of Accredited Investor Standard for Natural Persons

Effective immediately upon the enactment of the Dodd-Frank Bill, the accredited investor net worth standard for natural persons will be amended to exclude the value of the person’s primary residence. Accordingly, the net worth test for an accredited investor will be $1 million, excluding the value of the natural person’s primary residence. The adjustment of the accredited investor standard is applicable to all private placements made under Regulation D of the Securities Act of 1933. This amendment will be particularly relevant for private funds that rely on Section 3(c)(1) of the Investment Company Act since potential investors (or existing investors making additional contributions) may not be able to satisfy the new threshold. The Act also directs the SEC to review and adjust (if appropriate) the accredited investor standard at least once every four years (with the first adjustment (if any) to be made four years from the date of enactment of the Dodd-Frank Bill).³

Reporting and Recordkeeping Requirements

The Act provides that the SEC may require a registered investment adviser to maintain certain records and file reports regarding the private funds that it advises as the SEC deems necessary and appropriate in the public interest and for the protection of investors and the assessment of systemic risk by the Financial Stability Oversight Council (the “Council”). The Act also directs the SEC to issue rules requiring registered and unregistered advisers to private funds to file certain reports containing information that the SEC deems necessary and appropriate in the public interest and for the protection of investors and the assessment of systemic risk by the Council.

Both registered and unregistered investment advisers will be required to maintain certain records and reports, including, for each private fund advised, a description of:

• assets under management and leverage;
• counterparty credit risk exposure;
• trading and investment positions;
• valuation policies and practices;
• types of assets held;
• side arrangements or side letters;
• trading practices; and
• other information that the SEC deems necessary and appropriate in the public interest and for the protection of investors and the assessment of systemic risk.

The records and reports provided to the SEC will be expressly exempt from public disclosure in response to a request under the Freedom of Information Act (“FOIA”), although the SEC will be authorized to share such information with the Council and other government agencies. However, those agencies will also be required to maintain the confidentiality of the information and will not be required to produce the information in response to a FOIA request.

Definition of “Client”

The Act provides that the SEC may issue rules and regulations defining certain terms under the Advisers Act. However, for purposes of certain of the anti-fraud provisions of the Advisers Act, the SEC cannot define the term “client” to include an investor in a private fund managed by an investment adviser, provided that the adviser has entered into an investment advisory contract with such private fund.⁴

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We will be distributing a more detailed memorandum providing an overview of the provisions of the Dodd-Frank Bill that are most relevant to our clients shortly after the enactment of the Dodd-Frank Bill. We will also be distributing additional memoranda in the near future addressing certain other provisions of the Dodd-Frank Bill.
If you have any questions with respect to the foregoing, please contact your primary attorney in the Investment Management Group at Seward & Kissel LLP.

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¹ Private Fund” means an issuer that relies upon the exclusion from the definition of investment company provided for in Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940.

² The Act does not contain a similar exemption from registration for investment advisers to private equity funds.

³ The Act also directs the SEC to adjust the “qualified client” standard set forth in Rule 205-3 under the Advisers Act for inflation no later than one year following the enactment of the Dodd-Frank Bill and every five years thereafter.

⁴ Many U.S. private funds may not have separate investment advisory agreements in place with the investment adviser because such agreements may be embedded in the limited partnership or limited liability company agreements. It is recommended that private fund managers review the advisory arrangements in place with all of their private funds and enter into investment advisory agreements, if necessary.