On June 15, 2012, the Maryland Securities Commissioner issued an order adopting the NASAA model rule exemption for investment advisers to private funds.

Like the model rule, the new order issued by the Maryland Securities Commissioner, provides for an exemption from registration for “private fund advisers”, which is any investment adviser who provides advice solely to one or more private funds (i.e. a 3(c)(1) fund or a 3(c)(7) fund).   A private fund adviser must not be subject to disqualification from prior bad acts such as fraud or other securities law violations.  The private fund adviser must also make the same Form ADV filings as an exempt reporting adviser would.

Any private fund adviser that advises one or more 3(c)(1) funds (other than venture capital funds, as defined under federal regulations) must also comply with additional restrictions.  All investors in these funds must be “qualified clients.” [1]  The fund manager must also disclose in writing all services that are provided to individual owners (if any), all duties owed to individual owners (if any), and any other material information affecting the rights or responsibilities of owners.  Finally, the fund manager must provide audited financial statements to each investor.

Fund managers registered with the SEC will be required to make applicable notice filings to the Maryland Securities Commissioner even if they would otherwise qualify for the private fund adviser exemption.

The new rule also provides grandfathering provisions for fund managers of 3(c)(1) funds that existed before June 15, 2012 but cease accepting non-qualified clients after the date, as long as the fund manager does comply with the disclosure and audit requirements of the new exemption.

This order continues the trend of an increasing number of states adopting the NASAA model rule, or something substantially similar.  So far California, Indiana, Maine, Virginia, Massachusetts, Michigan, Wisconsin, Missouri, Rhode Island (proposed but not yet adopted), and Maryland have adopted some form of the NASAA model rule.

Footnotes

[1] A “qualified client” is defined as an individual or company that has at least $1 Million under the management with the investment adviser or has a net worth (together with assets held jointly with a spouse) of more than $2 Million, not counting an individual’s primary residence.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

On April 26, 2012, the Missouri Commissioner of Securities proposed revised regulations exempting certain private fund managers from investment adviser registration with the State of Missouri.

Background

Prior to the repeal of the federal 15-client exemption, Missouri had an exemption for fund managers who were exempt under the old federal 15-client exemption and who managed investments solely for private funds with at least $5 million under management.  After the repeal of the federal 15-client exemption, fund managers have relied on a No-Action Determination by the Missouri Commissioner of Securities dated July 20, 2011, which allowed private fund managers in Missouri to continue to rely on Missouri’s old exemption, until the earlier of June 28, 2012 or the promulgation of a new exemption, notwithstanding the repeal of the federal 15-client exemption.  Now, it appears that the Missouri Commissioner of Securities is ready to adopt that new exemption.

The New Proposed Regulations

The new proposed regulations are based upon the NASAA model rule exemption for investment advisers to private funds.    They provide for an exemption from registration for “private fund advisers.” A private fund adviser is any investment adviser who provides advice solely to one or more private funds (i.e. a 3(c)(1) fund or a 3(c)(7) fund).[1]   A private fund adviser must not be subject to disqualification from prior bad acts such as fraud or other securities law violations.  The private fund adviser must also make the same Form ADV filings as an exempt reporting adviser would.

Any private fund adviser that advises one or more 3(c)(1) funds (other than venture capital funds, as defined under federal regulations) must also comply with additional restrictions.  All investors in these funds must be (i) an accredited investor, as defined in Regulation D  or (ii) a qualified client, as defined in federal regulations. [2]  However, the exemption does not allow private fund managers that advise a 3(c)(1) fund to accept accredited investors who are individuals that qualify solely by the income test.[3]    The inclusion of certain categories of accredited investors within 3(c)(1) funds is a significant departure from the model NASAA rule, which requires that all investors in a 3(c)(1) fund at least be a qualified client (at least for the fund manager to be exempt from registration).  The fund manager must also disclose in writing all services that are provided to individual owners (if any), all duties owed to individual owners (if any), and any other material information affecting the rights or responsibilities of owners.  Finally, the fund manager must provide financial statements to each investor.  This is also a departure from the NASAA model rule, which requires that such financial statements be audited.

The new rule also provides grandfathering provisions for fund managers of 3(c)(1) funds that existed before the effective date of the new regulations but cease accepting, after the effective date, accredited investors that are individuals that meet the income test but don’t meet the net worth test, as long as the fund manager does comply with the disclosure and audit requirements of the new exemption.

The Commissioner of Securities did not state in their announcement when they expect the new exemption to take effect, but we can expect that to occur on or prior to June 28, 2012.

Footnotes

[1] A 3(c)(1) fund is a fund which has not more than 100 investors.  A 3(c)(7) fund is a fund which is limited to qualified purchasers, which are defined roughly as a person with at least $5 Million in investment assets or a company with at least $25 Million in investment assets.

[2] A “qualified client” is defined as an individual or company that has at least $1 Million under the management with the investment adviser or has a net worth (together with assets held jointly with a spouse, but not including the value of the individual’s primary residence) of more than $2 Million.

[3] Rule 501 of Regulation D allows an investor to qualify as an accredited investor if such investor has income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

On February 14, 2012, the Virginia Division of Securities and Retail Franchising proposed revised regulations exempting certain private fund managers from investment adviser registration with the Commonwealth of Virginia.

Background

Prior to the repeal of the federal 15 client exemption, Virginia had an exemption for fund managers that met the federal 15 client exemption and who advised only “corporation[s], general partnership[s], limited partnership[s], limited liability compan[ies], trust[s] or other legal organization[s]” with assets of $5 million or more.  This of course means that this exemption, left untouched, would no longer be available because of the repeal of the federal 15 client exemption. Pursuant to a Statement of Policy Regarding Regulation of Certain Investment Advisors Managing Private Equity and Venture Capital Funds (“Private Advisors”) dated July 19, 2011, the Virginia Division of Securities & Retail Franchising extended this exemption to advisers who previously were exempt from registration under the federal 15 client exemption, until such time as a more permanent approach could be adopted.  Now, the Division has proposed new regulations for comment, which have a target effective date of May 1, 2012.

The New Proposed Regulations

The new proposed regulations are based upon the NASAA model rule exemption for investment advisers to private funds.    They provide for an exemption from registration for “private fund advisers.” A private fund adviser is any investment adviser who provides advice solely to one or more private funds (i.e. a 3(c)(1) fund or a 3(c)(7) fund).[1]   A private fund adviser must not be subject to disqualification from prior bad acts such as fraud or other securities law violations.  The private fund adviser must also make the same Form ADV filings as an exempt reporting adviser would.  In addition, the private fund adviser must pay a filing fee to the Virginia State Corporation Commission.

Any private fund adviser that advises one or more 3(c)(1) funds (other than venture capital funds, as defined under federal regulations) must also comply with additional restrictions.  All investors in these funds must be “qualified clients.” [2]  If the adviser is relying on the net worth requirement to qualify an individual investor as a qualified client, then the value of an investor’s primary residence must be subtracted from his or her net worth.  The fund manager must also disclose in writing all services that are provided to individual owners (if any), all duties owed to individual owners (if any), and any other material information affecting the rights or responsibilities of owners.  Finally, the fund manager must provide audited financial statements to each investor.

Fund managers registered with the SEC will be required to make applicable notice filings to the Virginia State Corporation Commission even if they would otherwise qualify for the private fund adviser exemption.

The new rule also provides grandfathering provisions for fund managers of 3(c)(1) funds that existed before the effective date of the new regulations (May 1, 2012) but cease accepting non-qualified clients after the date, as long as the fund manager does comply with the disclosure and audit requirements of the new exemption.

Interested parties may submit comments by April 12, 2012.

Footnotes

[1] A 3(c)(1) fund is a fund which has under 100 investors.  A 3(c)(7) fund is a fund which is limited to qualified purchasers, which are defined roughly as a person with at least $5 Million in investment assets or a company with at least $25 Million in investment assets.

[2] A “qualified client” is defined as an individual or company that has at least $1 Million under the management with the investment adviser or has a net worth (together with assets held jointly with a spouse) of more than $2 Million.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

On December 15, 2011, the California Department of Corporations proposed revised regulations exempting certain private fund managers from investment adviser registration with the state of California.

Background

Previously, under Cal. Code Regs. tit. 10, § 260.204.9, private fund managers in California were exempt from investment adviser registration if they met the federal 15 client exemption, and they had assets under management of $25 million or more or they provided investment advice solely to “venture capital companies.”  On June 13, 2011, the California Department of Corporations amended this rule to remove the reference to the federal 15 client exemption.  Under this change, a private fund manager is exempt if it “(1) does not hold itself out generally to the public as an investment adviser, (2) during the course of the preceding twelve months has had fewer than 15 clients, (3) does not act as an investment adviser to any investment company registered under… the Investment Company Act of 1940…, and (4) either (i) has assets under management… of not less than $25,000,000 or (ii) provides investment advice to only venture capital companies…”[1]

However, the June 13, 2011 rule was temporary and the exemption automatically expired on January 21, 2012.  The California Department of Corporations stated that it intended to “study how best to regulate advisers to alternative investment vehicles, while balancing the regulatory burden on such advisers, with any corresponding investor protections issues.”   Now it appears that the California regulators have acted.

The New Rule

The new December 15, 2011 rule did two things.  First, it extended the temporary June 13, 2011 rule described above until June 28, 2012.  Second, it proposes for comment, a new private fund adviser exemption based on the NASAA model rule.

The new proposed regulations provide for an exemption from registration for “private fund advisers.” A private fund adviser is any investment adviser who provides advice solely to one or more private funds (i.e. a 3(c)(1) fund or a 3(c)(7) fund).[2]   A private fund adviser must not be subject to disqualification from prior bad acts such as fraud or other securities law violations.  The private fund adviser must also make the same Form ADV filings as an exempt reporting adviser would.  In addition, the private fund adviser must pay a filing fee to the California Department of Corporations.

Any private fund adviser that advises a 3(c)(1) fund (other than venture capital funds, using the California definition not the Federal one) must also comply with additional restrictions.  All investors in these funds must be accredited investors.  The fund manager must also disclose in writing all services that are provided to individual owners (if any), all duties owed to individual owners (if any), and any other material information affecting the rights or responsibilities of owners.  The fund manager must provide audited financial statements to each investor.  Finally, the fund manager must comply with California rules on incentive allocations, which essentially means that all investors will also need to be “qualified clients”[3] in addition to being accredited investors.

Fund managers registered with the SEC will be required to make applicable notice filings to the California Department of Corporations even if they would otherwise qualify for the private fund adviser exemption.

The new rule also provides grandfathering provisions for fund managers of 3(c)(1) funds that existed before the effective date of the new regulations but cease accepting non-accredited investors after the date, as long as the fund manager does comply with the disclosure and audit requirements of the new exemption.  There is a technical problem here: the grandfathering provision makes no mention to the “qualified client” requirement, so it is unclear how it would apply to funds that are owned exclusively by accredited investors but not by qualified clients (a very common situation).

One other issue I have with the rule is that it uses the old California definition of “venture capital company” to determine whether a fund is a venture capital fund, rather than the new Federal definition, as many states are using in their exemptions.  Funds that meet one definition may not meet another.  It seems counterproductive to make venture capital fund managers have to deal with two conflicting standards.

Interested parties may submit comments until 5:00pm, February 20, 2012.  I suspect that some of these technical issues may get resolved prior to the rule being finalized.

Footnotes

[1] California has its own definition of “venture capital company,” not to be confused with the federal definition of “venture capital fund.”  Under California law, an entity is a “venture capital company” if, on at least one occasion during the annual period commencing with the date of its initial capitalization, and on at least one occasion during each annual period thereafter, at least fifty percent (50%) of its assets (other than short-term investments pending long-term commitment of distribution to investors), valued at cost, are “venture capital investments” or investments derived therefrom.  A “venture capital investment” is an acquisition of securities in an “operating company” as to which the investment adviser, the entity advised by the investment adviser, or an affiliated person of either has or obtains management rights.  An “operating company” means an entity that is primarily engaged, directly or through a majority owned subsidiary or subsidiaries, in the production or sale (including any research or development) of a product or service.

[2]  A 3(c)(1) fund is a fund which has not more than 100 investors.  A 3(c)(7) fund is a fund which is limited to qualified purchasers, which are defined roughly as a person with at least $5 Million in investment assets or a company with at least $25 Million in investment assets.

[3] A “qualified client” is defined as an individual or company that has at least $1 Million under the management with the investment adviser or has a net worth (together with assets held jointly with a spouse, but not including the value of the individual’s primary residence) of more than $2 Million.

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© 2012 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.