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Investment Management Legal & Regulatory Update - January 2011

January 17, 2011

SEC Proposes New Rules and Rule Amendments to the Investment Advisers Act

The SEC issued two separate releases in November 2010 proposing new rules and rule amendments relating to investment adviser registration under the Advisers Act to give effect to provisions of the Dodd-Frank Act.

Eligibility for Registration with the SEC and Transition to State Registration for Mid-Sized Advisers. The Advisers Act requires investment advisers to register with the SEC unless the adviser is exempt from registration or prohibited from registering with the SEC under Section 203A. Section 203A prohibits investment advisers from registering with the SEC unless the adviser has at least $25 million in assets under management. The Dodd-Frank Act effectively raised this threshold to $100 million in assets under management. To implement the new threshold, the proposed rules create a new category of "mid-sized advisers," or advisers that manage between $25 million and $100 million in assets, and prohibits such mid-sized advisers from registering with the SEC unless:

  • the adviser is not required to be registered as an investment adviser with the securities commissioner of the state in which it maintains its principal office and place of business; or
  • if registered with the state, the adviser would not be subject to examination as an investment adviser by that state's securities commissioner.

In such cases, a mid-sized adviser would be required to register with the SEC unless otherwise exempt under the Advisers Act. In addition, a mid-sized adviser otherwise prohibited from registering with the SEC will be permitted to do so if the mid-sized adviser would be required to register with 15 or more states. All advisers that manage over $100 million in assets will be required to register with the SEC. The Dodd-Frank Act amendments take effect on July 21, 2011.

The SEC estimates that approximately 4,100 SEC-registered advisers will be required to withdraw their federal registrations and register with one or more state securities authorities due to the new threshold for federal registration. To facilitate the transition from federal to state registration, the SEC has proposed Rule 203A-5 under the Advisers Act, which would provide for a two-step transition process. First, all advisers registered with the SEC on July 21, 2011 would be required to file an amendment to Form ADV within 30 days (i.e., no later than August 20, 2011) that reports the market value of assets under management and the adviser's basis for continuing its federal registration, if applicable, as determined within 30 days prior to the filing. This initial step would provide the information necessary for the SEC and state regulators to identify those advisers that must transition to state registration or, alternatively, identify the basis upon which an adviser remains eligible for federal registration. Next, all SEC-registered advisers no longer eligible for federal registration would be required to withdraw from SEC registration within 60 days after the Form ADV amendment filing (i.e., no later than October 19, 2011).

Calculating Assets Under Management. In order to determine whether an adviser meets the $100 million threshold for federal registration, the proposal will continue to require the calculation of "assets under management" to consist of "securities portfolios" with respect to which the adviser provides "continuous and regular supervisory or management services" as reported on the adviser's Form ADV. This calculation would be referred to as the adviser's "regulatory assets under management." The proposal would amend the instructions to Form ADV to require the calculation of regulatory assets under management to include:

  • proprietary assets;
  • assets managed for no compensation; and
  • assets of foreign clients.

Currently, an adviser may (but is not required to) exclude such assets when calculating its assets under management. Advisers to private funds would be required to include in their regulatory assets under management:

  • the fair value of any private fund regardless of the nature of the assets held by the fund; and
  • the amount of any uncalled capital commitments made to the fund.

Switching Between State and SEC Registration. The SEC proposed to amend Rule 203A-1 under the Advisers Act to eliminate the $5 million "buffer" that permits advisers that manage between $25 million and $30 million in assets to remain registered with the state, and did not propose a similar "buffer" at the $100 million threshold. However, in order to address the concern that an adviser with assets under management approaching $100 million will frequently have to switch between state and federal registration, the SEC proposed to retain the provision in Rule 203A-1 that:

  • permits an adviser to rely on the calculation of assets under management reported annually in its annual updating amendment (and therefore avoid the need to change registration based on fluctuations during the year); and
  • provides an adviser that files an annual updating amendment with assets under the federal threshold a 180-day grace period from the adviser's fiscal year end to switch to state registration (unless it then meets the threshold for SEC registration).

Exemptions from the Prohibition on SEC Registration. The SEC proposed to amend the following exemptions from the prohibition on SEC registration set forth in Rule 203A-2 under the Advisers Act to reflect developments since their adoption:

  • NRSROs. The proposed rule would eliminate entirely the exemption for nationally recognized statistical rating organizations (NRSROs) as defined in the Exchange Act.
  • Pension Consultants. The proposed rule would increase the minimum value of plan assets from $50 million to $200 million.
  • Multi-State Advisers. The proposed rule would permit all advisers required to register with 15 or more states to register with the SEC.

Exempt Reporting Advisers. The Dodd-Frank Act repeals the "private adviser exemption" contained in Section 203(b)(3) of the Advisers Act, effective July 21, 2011, and directs the SEC to create exemptions for advisers to certain types of "private funds," including advisers to "venture capital funds" and advisers to private funds with less than $150 million in assets under management in the U.S. These exemptions are discussed in greater detail below. The Dodd-Frank Act requires these advisers, while exempt from registration, to maintain records, which the SEC has the authority to examine, and to submit reports as the SEC may require. Accordingly, the SEC has proposed new Rule 204-4 under the Advisers Act to require these "exempt reporting advisers" to electronically file reports (which will be publicly available)on Form ADV through the IARD system and to pay a filing fee. The SEC has also proposed to amend Form ADV in order to:

  • re-title the form to reflect its dual purpose;
  • amend the cover page to provide for the filing of a report; and
  • add a subsection where exempt reporting advisers would identify their applicable exemption.

The general instructions to Form ADV would also be amended to specify the disclosure items and schedules that must be completed in reports filed by exempt reporting advisers.

The SEC also proposed to amend Rule 204-1 under the Advisers Act to require an exempt reporting adviser to amend its report on Form ADV at least annually and to file amending reports to update specific disclosure items that become inaccurate. The proposal requires each adviser that will qualify as an "exempt reporting adviser" to file its initial report on Form ADV no later than August 20, 2011.

Form ADV Amendments. The proposed rules include amendments to Form ADV that would require an adviser to disclose the following additional information about its operations:

  • Item 1. Contact information for its chief compliance officer and whether it had "total assets" over $1 billion on its balance sheet for its most recent fiscal year. Both registered and exempt reporting advisers would complete this item.
  • Item 5. Expanded information about its advisory business, including data about its clients, its employees, and its advisory activities. Only registered advisers would complete this item.
  • Items 6 and 7. Additional information about its non- advisory activities and financial industry affiliations.
    Both registered and exempt reporting advisers would
    complete this item.
  • Item 7.B. New information on the "private funds" it advises, including basic organization information, operational and investment characteristics of the private funds, the amount of assets held by the funds, the
    nature of the investors in the funds and the funds'
    service providers. Both registered and exempt reporting
    advisers would complete this item.
  • Item 8. More information about its business practices that might present significant conflicts of interest, such as the use of affiliated brokers, soft dollar arrangements and compensation for client referrals. Only registered advisers would complete this item.
  • Item 9. More information about its custodial practices, including the total number of persons that act as qualified custodians for its clients. Only registered advisers would complete this item.
  • Item 11. More information with respect to disciplinary events. Both registered and exempt reporting advisers would complete this item.

Amendments to "Pay to Play" Rule. The SEC proposed to amend its recently adopted "pay to play" rule, Rule 206(4)-5 under the Advisers Act, to:

  • expand the scope of the rule to apply to exempt reporting advisers and foreign private advisers (discussed below);
  • permit an adviser to pay any "regulated municipal adviser" (a person registered under Section 15B of the Exchange Act and subject to the "pay to play" rules of the Municipal Securities Rulemaking Board) to solicit government entities on its behalf; and
  • clarify that the definition of "covered associate" includes a legal entity, not just a natural person, that is a general partner or managing member of an adviser.

Exemptions for "Exempt Reporting Advisers" and Foreign Private Advisers

The Dodd-Frank Act directed the SEC to create new exemptions for advisers to "venture capital funds" and advisers to private funds with less than $150 million in assets under management in the U.S., collectively referred to as "exempt reporting advisers." The Dodd-Frank Act also created an exemption for "foreign private advisers." These three exemptions are not mandatory. Therefore, any adviser that qualifies for any of these exemptions could choose to register with the SEC, subject to the prohibitions of Section 203A of the Advisers Act discussed above.

Venture Capital Funds. New Section 203(l) of the Advisers Act provides that an adviser that solely advises venture capital funds is exempt from registration under the Advisers Act. The SEC has proposed to define "venture capital fund" for purposes of the exemption as a private fund that:

  • invests in equity securities of "qualifying portfolio companies" and cash and cash equivalents and U.S. Treasuries with remaining maturities of 60 days or less;
  • directly, or through its advisers, offers or provides significant managerial assistance to, or controls, the qualifying portfolio company;
  • does not borrow or otherwise incur leverage (other than limited short-term borrowing);
  • does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances;
  • represents itself as a venture capital fund to investors; and
  • is not registered under the Investment Company Act and has not elected to be treated as a business development company.

"Qualifying portfolio companies" are companies that:

  • are not publicly traded;
  • do not incur leverage in connection with the investment by the venture capital fund;
  • use the capital provided by the venture capital fund for operating or business expansion purposes rather than
  • to buy out other investors; and
  • are operating companies (i.e., are not funds).

At least 80% of each qualified portfolio company's equity securities owned by the venture capital fund must be acquired directly from the qualifying portfolio company. The proposed rule also includes a grandfathering provision, which would include within the definition of "venture capital fund" private funds that represented to investors and potential investors at the time the fund offered its securities that it was a venture capital fund, sold securities prior to December 31, 2010 and does not sell any securities to, and does not accept additional capital commitments from, any person after July 21, 2011.

Private Fund Advisers with Less than $150 Million in Assets Under Management. New Section 203(m) of the Advisers Act directs the SEC to exempt from registration any adviser providing services solely to private funds and that has less than $150 million in assets under management in the U.S. Proposed new Rule 203(m)-1 provides that a U.S. adviser must aggregate the value of all assets of private funds it manages in the U.S. to determine if the adviser remains below the $150 million threshold. Advisers would be required to determine the amount of their private fund assets quarterly, based on the fair value of the assets at the end of the quarter. A non-U.S. adviser would only need to count private fund assets it manages from a place of business in the U.S. toward the $150 million threshold.

Under the proposed rule, an adviser has one calendar quarter to register as an adviser with the SEC, or otherwise come into compliance, after it exceeds $150 million in private fund assets. This grace period would only be available to advisers that are in compliance with all applicable SEC reporting requirements.

Foreign Private Advisers. The Dodd-Frank Act replaces the current private adviser exemption with a new exemption for a "foreign private adviser." A "foreign private adviser" is an adviser that:

  • has no place of business in the U.S.;
  • has, in total, fewer than 15 "clients" in the U.S. and "investors" in the U.S. in private funds advised by the adviser;
  • has less than $25 million in aggregate assets under management from such clients and investors; and
  • does not hold itself out generally to the public in the U.S. as an investment adviser.

The proposed rule would include a safe harbor for counting clients similar to the current private adviser exemption, including the provision that permits counting a corporation, partnership, limited liability company and other entities as a single client. The proposed rule would also define the term "investor" as any person who would be included in determining:

  • the number of beneficial owners of a private fund under Section 3(c)(1) of the Investment Company Act; or
  • the "qualified purchasers" under Section 3(c)(7) of the Investment Company Act.

Sources: SEC Proposed Rule, Release No. IA-3110 (available November 19, 2010); SEC Proposed Rule, Release No. IA-3111 (available November 19, 2010).
Comments due by January 24, 2011.

SEC Proposes Rule Defining "Family Office" Exclusion Under the Dodd-Frank Act

The Dodd-Frank Act amended Section 202(a)(11) of the Advisers Act to exclude from the definition of "investment adviser" any "family office." The SEC has proposed a rule defining "family office" to include any company that:

  • does not have any investment advisory clients other than "family clients" of a single family;
  • is wholly owned and controlled by "family members"; and
  • does not hold itself out to the public as an adviser.

Definition of "Family Clients." A family office may only have "family clients," which would include the following:

  • family members;
  • certain key employees of the family office;
  • charities established and funded exclusively by family members or former family members;
  • trusts or estates existing for the sole benefit of family clients; and
  • entities wholly owned and controlled exclusively by, and operated for the sole benefit of, family clients (with certain exceptions) and, under certain circumstances, former family members and former employees.

"Family members" would include an individual and his or her spouse or spousal equivalent for whose benefit the family office was established and any of their subsequent spouses or spousal equivalents, their parents, their lineal descendants (including by adoption and stepchildren) and the spouses and spousal equivalents of those lineal descendents.

Ownership and Control. In order to qualify for the exemption, a family office must be wholly owned and controlled, either directly or indirectly, by family members. This requirement serves to distinguish between "family offices" and "family-run offices" that operate as a more typical commercial investment adviser advising other people and other families. This requirement also serves to ensure that any profits made by the family office only accrue to family members.

Holding Out. A family office relying on the proposed rule is prohibited from holding itself out to the public as an adviser.

Exemptive Orders. The proposed rule does not rescind SEC exemptive orders that have previously been issued to family offices. Accordingly, family offices may continue to operate in reliance on a previously issued exemptive order or rely on the proposed rule, provided the conditions are satisfied.

Source: SEC Proposed Rule, Release No. IA-3098 (available October 12, 2010).
Comment Period ended November 18, 2010.

Regulated Investment Company Modernization Act of 2010

The Regulated Investment Company Modernization Act of 2010 (the "RIC Act") was signed into law on December 22, 2010. The RIC Act modernizes the tax laws governing regulated investment companies ("RICs" or mutual funds) by mitigating onerous penalties, eliminating obsolete requirements and implementing practical and flexible provisions for the tax treatment of RICs. The final legislation generally reflects the version passed by the U.S. House of Representatives in September 2010 with one notable change - the provision that would have expanded the definition of "good income" to include income produced by commodities was omitted. The key provisions of the RIC Act are summarized below:

  • RIC Qualification Failures Easier to Cure. The RIC Act permits failures of the good income test to be corrected by paying a tax based on the amount of the failure. Previously, if a RIC failed the good income test by even one dollar, it became taxable as a corporation. RICs will still need to monitor compliance with the good income test, but the consequences of failure will no longer be so drastic. Similarly, the RIC Act provides an easy cure for de minimus failures of the RIC asset diversification test if a correction is timely made, while more significant, inadvertent failures can be corrected by payment of an excise tax.
  • Preferential Dividends Rule Repealed. The RIC Act repeals the preferential dividend rule for publicly offered RICs. Prior to the RIC Act, a "preferential dividend" was not a qualifying distribution for the annual distribution requirement applicable to RICs, which set a trap for RICs making simple administrative errors.
  • Liberalized Loss Carry-Forward. The RIC Act permits RICs to carry forward losses indefinitely, rather than the eight-year limitation applicable prior to the RIC Act.

Other Provisions: The RIC Act also contains other updates to the laws governing RICs, including elimination of the obsolete 60-day notice requirement for the tax characterization of distributions (replaced with Form 1099 reporting), revised provisions for fund-of-fund structures and minimized penalties for deficiency dividends.

Sources: Regulated Investment Company Modernization Act of 2010, H.R. 4337, 111th Cong. (2010); Mutual Fund Directors Forum, RIC Modernization Act Passed Congress (December 20, 2010) (available at:
Effective Date: The effective date for most changes contained in the RIC Act is for taxable years beginning after December 22, 2010.

SEC Extends Compliance Date for Delivery of Form ADV "Brochure Supplements"

The SEC has extended the compliance date for Part 2B of Form ADV, the "brochure supplement," and for certain rule provisions that relate to the delivery of brochure supplements. The SEC said that it is extending the compliance date for four months to provide investment advisers with additional time to design, test and implement systems and controls to satisfy their obligations to prepare and deliver brochure supplements. The SEC did not extend the compliance date for the filing and delivery of the brochure required by Part 2A of Form ADV.

Sources: SEC Final Rule, Release No. IA-3129 (available December 28, 2010); SEC Final Rule, Release No. IA-3060
(July 28, 2010).
Effective Date: October 12, 2010.
Compliance Dates:

  • All advisers registered with the SEC as of December 31, 2010, and having a fiscal year ending on December 31, 2010 through April 30, 2011, have until July 31, 2011 to begin delivering brochure supplements to new and prospective clients. These advisers have until September 30, 2011 to deliver brochure supplements to existing clients.
  • Advisers applying for registration with the SEC from January 1, 2011 through April 30, 2011 have until May 1, 2011 to begin delivering brochure supplements to new and prospective clients. These advisers have until July 1, 2011 to deliver brochure supplements to existing clients.
  • The compliance dates for delivering brochure supplements remain unchanged for SEC-registered advisers with fiscal years ending after April 30, 2011 and newly-registered advisers filing applications for registration after that date.

ICI Comments on Enhancing Adviser Examinations

Section 914 of the Dodd-Frank Act requires the SEC to review and analyze the need for enhanced examination and enforcement resources for advisers. The study must examine, among other things, the number and frequency of examinations of advisers by the SEC over the last five years, and the extent to which having Congress authorize the SEC to designate one or more self-regulatory organizations ("SROs") to augment the SEC's efforts in overseeing advisers would improve the frequency of adviser examinations.

The ICI has commented that the SEC should retain the exclusive authority to oversee advisers. The ICI noted a number of points
in support of its position, including, among others:

  • the SEC's 75-year history of overseeing the industry and the significant institutional knowledge, experience and continuity that would be lost from a transfer of oversight responsibilities;
  • the conflicts of interest inherent in selfregulation;
  • the costs associated with developing an adviser SRO;
  • the appropriateness of the SEC's "principles-based" approach to regulation over an SRO's "rules-based" model of oversight; and
  • the additional resources provided to the SEC by the Dodd-Frank Act, including additional funding.

The SEC must report the results of its study to Congress by January 17, 2011.

Source: Comment Letter of the Investment Company Institute Regarding the Study on Enhancing Investment Adviser Examinations under Section 914 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (dated October 25, 2010) (available at:

SEC Proposes Rules to Implement New Whistleblower Program

The Dodd-Frank Act added new Section 21F to the Exchange Act, which establishes a whistleblower program that directs the SEC to pay an award to whistleblowers who voluntarily provide the SEC with information about a violation of the federal securities laws that leads to the successful enforcement of a federal court or administrative action brought by the SEC resulting in monetary sanctions exceeding $1 million. The SEC has proposed Regulation 21F to implement the whistleblower program.

Amount of Awards. Section 21F and the proposed rules provide that awards under the program will range between 10% and 30% of the monetary sanctions imposed and collected by the SEC relating to the enforcement action. In determining the amount of an award, the SEC will consider a number of factors, including the degree of assistance and significance of the information provided by the whistleblower and whether the award otherwise enhances the SEC's ability to enforce the federal securities laws, protect investors and encourage the submission of high quality information. The SEC stated that it will consider higher percentage awards for whistleblowers who first report violations through their company's internal compliance program.

"Whistleblower" Definition. A whistleblower would be defined as an individual who, alone or jointly with others, provides information to the SEC relating to a potential violation of the securities laws. A whistleblower must be a natural person. A company or other entity is not eligible to receive a whistleblower award.

Whistleblower Protection. Section 21F and the proposed rules require the SEC, in most cases, to treat as confidential information that could reasonably be expected to reveal the identity of a whistleblower. Section 21F also includes anti-retaliation protections for whistleblowers.

Excluded Groups. Regulation 21F would generally exclude certain groups from eligibility to receive whistleblower awards, including people who have a pre-existing legal or contractual duty to report their information, independent public accountants who obtain information through an engagement required under the securities laws and people who learn about violations through a company's internal compliance program or who are in positions of responsibility for an entity.

Procedural Requirements. The proposed rules describe procedures for submitting information to the SEC and for making an award claim after an action is brought. The claim procedures provide whistleblowers an opportunity to present their case before the SEC makes a final award determination.

Sources: SEC Proposed Rule, Release No. 34-63237 (available November 3, 2010); SEC Proposes New Whistleblower Program Under Dodd-Frank, Release No. 2010-213 (November 3, 2010) (available at:
Comment Period ended December 17, 2010.

Registration of Municipal Advisors with the SEC and the MSRB

Section 975 of the Dodd-Frank Act amended Section 15B of the Exchange Act to require municipal advisors to register with the SEC by October 1, 2010. Specifically, Section 15B, as amended, makes it unlawful for a municipal advisor to:

  • provide advice to or on behalf of a municipal entity with respect to municipal financial products or the issuance of municipal securities; or
  • undertake a solicitation of a municipal entity, unless the municipal advisor is registered with the SEC.

The definition of "municipal advisor" includes financial advisors, third-party marketers, placement agents, solicitors and finders, subject to certain exemptions. The definition of "municipal advisor" excludes, among other things, a broker-dealer serving as an underwriter and any registered adviser or its associated persons who are providing investment advice (as opposed to municipal securities advice). The Dodd-Frank Act also expanded the jurisdiction of the Municipal Securities Rulemaking Board ("MSRB") to require registration of "municipal advisors" using the same definition.

Proposed SEC Registration. The SEC adopted interim final temporary Rule 15Ba2-6T in September 2010 in order to provide a method for municipal advisors to satisfy the registration requirement by completing new Form MA-T through the SEC's website. The SEC has proposed new Rules 15Ba1-1 through 15Ba1-7 under the Exchange Act, and related forms, to establish a permanent SEC-registration regime for municipal advisors.

Municipal Advisory Firm Registration. A municipal advisory firm, including a firm currently registered on Form MA-T, would be required to apply for registration by filing new Form MA electronically with the SEC. Form MA, which is modeled after Form ADV, would require the applicant to provide information describing itself and its business through a series of fill-in-the-blank, multiple choice and check-the-box questions. The form also requires disclosure with respect to the disciplinary history of the municipal advisor and its associated persons.

Amendments. The proposed rules would generally require a municipal advisor to file an amendment to Form MA annually within 90 days of the end of the applicant's fiscal year. Amendments would be required to be filed promptly if certain information became inaccurate.

Books and Records Requirement. Under the proposed rules, municipal advisors would also be subject to books and records maintenance requirements, which are based generally on the requirements applicable to broker-dealers and investment advisers, with appropriate revisions to reflect the activities of municipal advisors.

Registration with the MSRB. As noted above, the Dodd-Frank Act also expanded the jurisdiction of the MSRB to require the registration of municipal advisors. Before a municipal advisor may register with the MSRB, however, it must first register as a municipal advisor with the SEC. Applicants may continue to access and complete the temporary SEC registration Form MA-T on the SEC's website. Rule A-12 requires the payment of an initial fee of $100 in connection with a firm's first-time registration with the MSRB, and Rule A-14 requires the payment of an annual fee of $500 per firm. Rule G-40 provides for the submission of information regarding the municipal advisor and one or more contacts within the firm.

Instructions on how to register with the MSRB on behalf of a municipal advisor business are posted on the MSRB's website ( under "Municipal Advisor News." Any municipal advisor that has previously registered with the MSRB as a broker, dealer or municipal securities dealer must register separately with the MSRB as a municipal advisor by updating its existing MSRB account. Municipal advisors were required to complete the MSRB registration process by December 31, 2010 in order to engage in municipal advisory activities after that date.

Sources: SEC Proposed Rule, Release No. 34-63576 (available December 20, 2010); MSRB Notice 2010-47 (November 1, 2010); MSRB Notice 2010-49 (November 15, 2010); MSRB Notice 2010-50 (November 15, 2010); MSRB Notice 2010-55 (December 13, 2010).
Comments regarding proposed SEC registration rules due by February 22, 2011.
Effective date of MSRB Registration Requirement: December 31, 2010.

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