Advisers Act

Securities and Exchange Commission Adopts Final Rule That Provides New Exemptions From Investment Adviser Registration for Advisers to Small Business Investment Companies

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On January 5, 2018, the SEC adopted amendments to Rule 203(l)-1 under the Investment Advisers Act of 1940 (the “Advisers Act“) that defines a “venture capital fund” and Rule 203(m)-1 under the Advisers Act that implements the private fund adviser exemption under the Advisers Act. These amendments were adopted to reflect changes made by title LXXIV, sections 74001 and 74002 of the Fixing America’s Surface Transportation Act of 2015 (the “FAST Act“). That legislation amended sections 203(l) and 203(m) of the Advisers Act. The amendments are effective on March 12, 2018.

In particular, Title LXXIV, section 74001 of the FAST Act amended the exemption from investment adviser registration for any adviser solely to one or more “venture capital funds” in Advisers Act section 203(l) by deeming “small business investment companies” to be “venture capital funds” for purposes of the exemption. Accordingly, the SEC amended the definition of a “venture capital fund” in Rule 203(l)-1 to include “small business investment companies.”

Title LXXIV, section 74002 of the FAST Act amended the exemption from investment adviser registration for any adviser solely to “private funds” with less than $150 million in assets under management in Advisers Act section 203(m) by excluding the assets of “small business investment companies” when calculating “private fund assets” towards the registration threshold of $150 million. Accordingly, the SEC amended the definition of “assets under management” in Rule 203(m) to exclude the assets of “small business investment companies.”

SEC Issues No-Action Letter Regarding Relief from Registration under Advisers Act for Adviser to Affiliated Foundation

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On December 8, 2016, the Chief Counsel’s Office of the Division of Investment Management of the Securities and Exchange Commission (“Commission“) provided “no‑action letter” assurance to CenturyLink Investment Management Company, an investment adviser registered as such under the Investment Advisers Act of 1940 (“Adviser“), that it would not recommend enforcement action to the Commission if it were to withdraw its registration. Adviser is an indirect wholly owned subsidiary of CenturyLink, Inc., a telecommunications firm (“Parent“), that was established, and has been operated, for the sole purpose of providing investment advisory services to (i) the employee benefit plans sponsored by the Parent (the “Plans“), which were established solely for the benefit of current and previous employees of the Parent, its predecessors and affiliates, and comprise retirement and health and welfare employee benefit plans, including both qualified and nonqualified plans governed by the Employee Retirement Income Security Act of 1974 (“ERISA“); and (ii) the CenturyLink – Clarke M. Williams Foundation (the “Foundation“), a charitable foundation organized as a Colorado nonprofit corporation by a predecessor company of the Parent for charitable and educational purposes.

The response of the staff is consistent with other no-action letters issued to wholly owned subsidiaries of a parent that satisfy comparable conditions, except with respect to the Foundation. The significance of this letter is that it extends the application of these principles to advisory services provided to a charitable foundation under the circumstances presented.

In providing its response, the staff stated that its position is based particularly on representations that:

  • Adviser is an indirect wholly owned subsidiary of the Parent and has been established, and has been operated, for the sole purpose of providing investment advisory services to the Plans and the Foundation;
  • Adviser does not hold itself out to the public as an investment adviser, provides investment advice only to the Plans and the Foundation, and will not in the future provide investment advisory services to any third party;
  • The Plans are established solely for the benefit of current and previous employees of the Parent, its predecessors and affiliates, and comprise employee benefit plans governed by ERISA;
  • The Foundation is a charitable foundation organized as a Colorado nonprofit corporation by the Parent for charitable and educational purposes, and its beneficiaries are charitable and educational organizations; the Parent is the sole voting member of the Foundation, has rights with respect to the management of the Foundation and, since 2012, is its sole contributor;
  • The only amounts received by the Parent in connection with the Plans are reimbursements that are subject to the restrictions imposed by ERISA;
  • The only amounts received in connection with Adviser’s advisory services to the Foundation are reimbursements to the Parent from the Foundation for Adviser’s expenses associated with such advisory services; and
  • Neither the Plans nor the Foundation is required to register as an investment company under the Investment Company Act of 1940.

New Jersey Appellate Court Clarifies Definition of Compensation under Advisers Act

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On August 12, 2016, the United States Court of Appeals for the Third Circuit affirmed the decision of the District Court of New Jersey and held in United States v. Everett C. Miller that the defendant was an “investment adviser” within the meaning of the Investment Advisers Act of 1940 (the “Advisers Act”), notwithstanding defendant’s arguments that he did receive “compensation” and was not engaged “in the business” of acting as an investment adviser.

The Advisers Act does not explicitly define “compensation” or what constitutes being engaged “in the business.”  Consequently, the Court of Appeals based its decision on a 1987 Release issued by the Staff of the Securities and Exchange Commission (Investment Advisers Release No. 1092) which states, in part: “The Staff considers a person to be ‘in the business’ of providing advice if the person . . . holds himself out as an investment adviser or as one who provides investment advice.” In reaching its decision that the defendant provided advice for “compensation,” the Court recognized that the Advisers Act also does not define “compensation.”  The Court again cited the SEC Release which defines compensation as “any economic benefit, whether in the form of an advisory fee or some other fee relating to the total services, rendered, commissions, or some combination of the foregoing . . .” and concluded that: “It is not necessary that an investor pay a discrete fee specifically earmarked as payment for investment advice.”  Opinion.

SEC Issues Order Increasing the Net Worth Test Under Rule 205-3 Under the Investment Advisers Act of 1940 to $2.1 Million

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Section 205(a)(1) of the Investment Advisers Act of 1940 (the “Advisers Act”) generally prohibits an investment adviser from entering into, extending, renewing, or performing any investment advisory contract that provides for compensation to the adviser based on a share of capital gains on, or capital appreciation of, the funds of the client. Rule 205-3 under the Advisers Ac exempts an investment adviser from this prohibition in certain circumstances when the client is a “qualified client.”  The definition of “qualified client” includes an assets under management standard set as $1,00,000 and a net worth test that set at (in the case of a natural person, with assets held jointly with a spouse), more than $2,000,000.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) amended Section 205(e) of the Advisers Act to provide that, by July 21, 2011 and every five years thereafter, the SEC shall adjust for inflation the dollar amount thresholds included in rules issued under Section 205(e), rounded to the nearest $100,000.  Rule 205-3 now states that the SEC will issue an order on or about May 1, 2016, and approximately every five years thereafter, adjusting for inflation the dollar amount thresholds of the rule’s assets-under-management and net worth tests based on the Personal Consumption Expenditures Chain-Type Price Index (published by the United States Department of Commerce).  Based upon this requirement, no change in the assets under management test is required, but the dollar amount of the net worth test would increase to $2,100,000.

Accordingly, on June 14, the SEC issued an Order, effective as of August 15, 2016, that:

  1. for purposes of Rule 205-3(d)(1)(i) under the Advisers Act, a “qualified client” means a natural person who, or a company that, immediately after entering the contract has at least $1,000,000 under the management of the investment adviser; and
  2. for purposes of Rule 205-3(d)(1)(ii)(A) under the Advisers Act, a “qualified client” means a natural person who, or a company that, the investment adviser entering into the contract (and any person acting on his behalf) reasonably believes, immediately prior to entering into the contract, has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $2,100,000.

SEC’s Division of Investment Management Issues Letter Regarding Independent Verification Required by Rule 206(4)-2 Under the Advisers Act

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On April 25, 2016, the Staff of the Division of Investment Management of the Securities and Exchange Commission issued a no-action letter that provides that it would not recommend enforcement action to the Commission under Section 206(4) of, and Rule 206(4)-2 under, the Investment Advisers Act of 1940 if an investment adviser does not obtain a surprise examination by an independent public accountant (as is generally required) where it acts as a sub-adviser in an investment advisory program for which a “related person” “qualified custodian” is the primary adviser (or an affiliate of the primary adviser), and the primary adviser is responsible for complying with Rule 206(4)-2.  A “related person” of another generally is a person who is directly or indirectly controlling or controlled by the other person or under common control with such person.  A “qualified custodian” is a bank, a registered broker-dealer, a registered futures commission merchant and certain foreign financial institutions.”

The Staff’s position was based, in particular, on the following:

  1. the sole basis for the sub-adviser having custody is its affiliation with the qualified custodian and the primary adviser;
  2. the primary adviser will comply with Rule 206(4)-2 (including by having client funds and securities in the investment advisory program verified by a surprise examination conducted by an independent public accountant registered with the Public Company Accounting Oversight Board (“PCAOB”) pursuant to an agreement entered into by the primary adviser);
  3. the sub-adviser does not: (i) hold client funds or securities itself; (ii) have authority to obtain possession of clients’ funds or securities; or (iii) have authority to deduct fees from clients’ accounts; and
  4. the sub-adviser will continue to be required to obtain from the primary adviser or qualified custodian annually a written internal control report prepared by an independent public accountant registered with and subject to regular inspection by the PCAOB as required by Rule 206(4)-2(a)(6).

Final Rules Affecting Private Fund Advisers Adopted Under the Dodd-Frank Act

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On June 22, 2011, the Securities and Exchange Commission (the “SEC”) adopted final rules and rule amendments implementing the provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) through the issuance of two Releases. Release IA-3222 (the “Exemptions Release”) defines terms and addresses certain issues with respect to the new exemptions from registration provided to investment advisers. Release IA-3221 (the “Implementing Release” and, together with the Exemptions Release, the “Releases”) implements companion amendments to the Investment Advisers Act of 1940 (the “Advisers Act”).

The exemption provided by Section 203(b)(3) of the Advisers Act (the “Private Adviser Exemption”), on which many advisers to “Private Funds” have relied, was repealed by the Dodd-Frank Act, effective July 21, 2011. As anticipated, the SEC granted relief to such advisers by providing, pursuant to new subsection (e) of Rule 203-1, that such an adviser is “exempt from registration with the [SEC] as an investment adviser until March 30, 2012,” provided that such adviser satisfies conditions which closely follow the requirements of the Private Adviser Exemption. This Alert provides an overview of how the new exemptions will be interpreted under the Exemptions Release and implemented under the Implementing Release.

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SEC Final Rules for Private Fund Adviser Registration

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On June 22, the SEC adopted final rules and rule amendments under the Investment Advisers Act of 1940 implementing provisions of Title IV of the Dodd-Frank Act. As anticipated, the SEC announced that it will extend the deadline for advisers that had been relying upon the “private adviser exemption” under Section 203(b)(3) of the Advisers Act to register with the SEC until March 30, 2012. (The private adviser exemption was rescinded by the Dodd-Frank Act, effective July 21.) We will provide an analysis of the final rules adopted and other actions taken upon reviewing them in their final form. SEC Release. Implementing Release Final Rules. Exemptions Release Final Rules.

SEC Open Meeting to Consider Adoption of New Rules for Private Fund Advisers

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On June 9, the SEC announced an Open Meeting scheduled for June 22 at 10:00 a.m. to consider the adoption of: (i) rules and rule amendments under the Investment Advisers Act of 1940 (Advisers Act) designed to give effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration of investment advisers with the SEC, require advisers to hedge funds and other private funds, including private equity funds, to register with the SEC, and address reporting by certain investment advisers that are exempt from registration; and (ii) rules that would implement new exemptions from the registration requirements of the Advisers Act for advisers to “venture capital funds” and advisers with less than $150 million in private fund assets under management in the United States. The SEC also will consider whether to adopt a rule defining “family offices” that will be excluded from the definition of an investment adviser under the Advisers Act. We will provide an analysis of the final rules adopted and other actions taken after publication. SEC Sunshine Act Meeting Notice.

SEC Study on Investment Advisers and Broker-Dealers

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On January 21, the SEC submitted to Congress a study on investment advisers and broker-dealers, as required under Section 913 of the Dodd-Frank Act. The SEC recommended that it adopt and implement a uniform fiduciary standard of conduct for investment advisers and broker-dealers, no less stringent than the standards applied to investment advisers under the Advisers Act, when those financial professionals provide personalized investment advice about securities to retail investors. SEC Release. SEC Staff Study.