The North American Securities Administrators Association (NASAA) has published for public comment a revised version of the organization's proposed model rule that would exempt investment advisers to certain types of private funds from state registration. The deadline for submission of comments is July 13, 2011.
NASAA’s proposed rule was originally published on December 10, 2010 in response to new provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) governing the regulation of investment advisers to private funds. NASAA designed its model rule to follow certain provisions in the Dodd-Frank Act, as implemented by the SEC, which require that advisers to certain private funds who previously relied on an exemption from federal registration pursuant to Section 203(b)(3) of the Investment Advisers Act will now be subject to registration while others, including advisers to venture capital funds, will be exempt from registration but required to submit reports to the SEC. As established by the Dodd-Frank Act, a private fund is defined as an issuer that would be an investment company under Section 3 of the Investment Company Act of 1940 but for an exception provided from that definition by either Section 3(c)(1) or 3(c)(7). The Dodd-Frank Act delegates to the SEC the task of promulgating a rule defining “venture capital fund.”
As originally proposed, NASAA's model rule provided an exemption from state registration for advisers who solely advise private funds structured in compliance with Section 3(c)(7). Public comments submitted by persons who represent advisers and funds, however, argued that the exemption should not be limited to these funds but should include both advisers to venture capital funds and Section 3(c)(1) funds.
After evaluating the comments, the NASAA drafting group revised the proposal to expand the scope of the rule to cover investment advisers to venture capital funds and, in specific circumstances, investment advisers to Section 3(c)(1) funds. Although representatives from the private fund industry advocated for the inclusion of all 3(c)(1) funds, the drafting group expressed concern that the level of investor protection was not sufficient given the standards imposed for investing in such funds. Nevertheless, there may be legitimate reasons for including certain 3(c)(1) funds within the exemption, the drafting group stated, noting the assertion contained in several comment letters that 3(c)(1) funds make significant contributors to the capital formation efforts of small companies at the local level and are important to economic development.
Accordingly, the drafting group revised the proposal to include a provision that will exempt advisers to 3(c)(1) funds, but only if those funds are made up of investors who satisfy the “qualified client” standard contained in Rule 205-3(d)1 under the Investment Advisers Act of 1940. Further, the rule requires that the value of the investor’s primary residence be excluded in calculating an investor’s net worth for purposes of determining whether the investor is a qualified client.
Other revisions to the initial proposal include:
- Additional Disclosures. To qualify for the exemption, advisers to Section 3(c)(1) funds must provide, on an annual basis, audited financial statements to investors. The advisers would also be required to provide investors, in writing, with additional disclosures, including the fact that the fund, rather than the individual beneficial owners, is the client of the adviser. The disclosures must also include a description of all services, if any, to be provided to individual beneficial owners and of all duties owed, if any, by the adviser to the beneficial owners, as well as any other material information affecting the rights or responsibilities of the beneficial owners.
- Transition Provision. Advisers who become ineligible for the exemption will have 90 days to comply with applicable laws governing registration or notice filing.
- Optional Grandfathering Provision. The proposal includes a new provision that would grandfather into the exemption advisers to Section 3(c)(1) funds with existing investors who would not qualify for the heightened “qualified client” standard. If a state does not currently require registration for these advisers it may, at its discretion, include this optional provision to facilitate a continuing exemption for those advisers to funds that were in existence prior to the adoption of the model rule.
NASAA noted that the SEC has yet to adopt final rules regarding the registration and reporting requirements for advisers to private funds. The SEC has indicated, however, that it will adopt final rules in advance of the July 21 anniversary date of the passage of the Dodd-Frank Act. If necessary, NASAA may make further revisions to the model rule based on the final rules adopted by the SEC.
Comments should be submitted electronically to firstname.lastname@example.org and copied to Joseph Brady, NASAA Deputy General Counsel at email@example.com. Written comments may also be mailed to the attention of Joseph Brady at NASAA's corporate office in Washington, D.C.