The long reach of Dodd-Frank is about to extend to private investment funds. As of July 21, 2011, a private investment fund can no longer rely upon the private advisor exemption previously found in Section 203(b)(3) of the Advisers Act. The section generally exempted advisors from registration if it had fewer than 15 clients in the preceding 12 months and did not hold itself out to the public as an investment advisor. In its place, the Dodd-Frank Act has provided an exclusion from the definition of investment advisor for family offices (see “SEC Adopts Family Office Rule,” Investment Advisor, October 2011), and exemptions for advisors to private funds with less than $150 million in AUM and advisors to venture capital funds. This is the very section that most private fund advisors generally relied upon to remain exempt from investment advisor registration.
We have advised our private fund clients that under Dodd-Frank, a general partner or managing member of a private investment fund must register as an investment advisor unless the general partner or managing member: (1) is already a registered investment advisor; or (2) has aggregate assets under management in private funds of less than $150 million. On June 22, the Securities and Exchange Commission extended the registration deadline for those advisors who will no longer be able to rely on the private advisor exemption to March 30, 2012.
The Dodd-Frank Act implicates all large funds and puts medium-sized ones in a position where they may want to watch their growth. The 3(c)(1) and 3(c)(7) exemptions from registration under the Investment Company Act of 1940 have been rescinded. Thus, absent other exemptions, all fund issuers must be registered investment advisors. An exemption has been added, however, such that if the fund has assets under management below $150 million, then the fund issuer is exempt from the registration requirement. The statute is clear that the issuer, generally the general partner or managing member, must be the registered investment advisor. Once the fund crosses the $150 million threshold, the issuer cannot remain unregistered and simply enter into an advisory agreement or sub-advisory agreement with an existing registered investment advisor. The issuer itself must be a registered investment advisor regardless of any sub-advisor relationships it may have. Thus, fund managers of smaller funds now will have to weigh the benefits of growth against registration.
Previously, section 3(c)(1) of the Investment Company Act of 1940 created an exemption if the fund had fewer than 100 participants and section 3(c)(7) created a different exemption if the fund only sold to qualified purchasers. Section 402(a)(29) of Dodd-Frank redefines the fund manager and section 403, in its very title, eliminates the private advisor exemption in sections 3(c)(1) and 3(c)(7). Section 408 created a new exemption from registration solely for funds with assets under management of less than $150 million.
Funds that are currently relying on the private advisor exemption should note that the final rule treats U.S. advisors differently from non-U.S. advisors. Under the final rule, all private fund assets of a U.S. advisor are considered assets under management in the United States, even if the advisor has offices outside the country. Non-U.S. advisors need to count only assets they manage at offices in the United States toward the $150 million asset limit under the exemption.
As a result of the Dodd-Frank Act, private funds must calculate AUM every quarter. This means that the advisor’s AUM can fluctuate under the $150 million threshold at most for three months before the advisor must register with the SEC. Please note: Even if a private fund advisor is not subject to SEC registration, he or she may still be required to register under state law. Please consult with your legal counsel.