As I’ve written about previously here, the SEC has proposed new rules for implementing the Dodd-Frank Act in determining whether fund managers will be exempt from registration under the Adviser’s Act. When the Dodd-Frank Act’s changes to the Adviser’s Act become effective starting on July 21, 2011, a much greater percentage of fund managers will be required to register and become subject to the Adviser’s Act, unless they qualify for one of the new, more limited exemptions. This includes a greater percetage of foreign fund managers. Even if a fund manager qualifies for an exemption, in most instances it will still become subject to some limited ongoing reporting requirements, and may be subject to SEC inspections, even though not required to register (see below).
The proposed rules are available here.
In today’s post, I’m turning from the definition of venture capital funds to focus on foreign fund managers (located outside the US that raise money from US investors) and how they may qualify for exemption from registration under the Adviser’s Act.
Managers of existing foreign funds may avail themselves of the grandfather relief of the venture capital fund exemption (and not be subject to the confines of the new definition) if the foreign managed funds were marketed to investors as venture capital funds, held at least one closing prior to December 31, 2010, and held their final closing on or prior to July 21, 2011. These are the same rules as those applicable to US fund managers.
Foreign managers of funds that do not qualify for the grandfathering rules, including managers of any funds that have their first closing in 2011 or afterwards, will need to avail themselves of one or more of the new proposed exemptions.
There are three primary exemptions for foreign fund managers:
- Exemption for advisers of Venture Capital Funds
- Exemption for Foreign Private Advisers with less than $25M under management from US clients
- De Minimis Exemption for private fund advisors with less than $150M under management in the US
Venture Capital Fund Exemption
I’ve previously written about the exemption for “venture capital funds” here, including the grandfather provision. Foreign managers may avail themselves of this exemption to the same extent as domestic managers. Issues that are relevant for this exemption relating to the definition of a “venture capital funds”, will have equal applicability to foreign managers .
Foreign Adviser Exemption
Don’t let the name fool you, the current proposed Foreign Adviser Exemption will likely have limited application for most foreign fund managers. This exemption is significant, however, because it is the only exemption that excludes fund managers from being obligated to comply with the more limited reporting obligations required of other exempted fund managers (as discussed below).
Currently, the proposed exemption would only apply to advisers that:
(i) have no place of business in the US
(ii) have fewer than 15 clients (i.e., funds) organized in the US (even if some or all of its investors are residents of the US) and investors (i.e., limited partners) in the United States (meaning beneficial owners of the fund’s clients, without double counting);
(iii) have aggregate investments under management attributable to US clients and US investors of less than $25M (without double counting when looking through clients to investors); and
(iv) do not hold themselves out to the US public as an investment adviser.
There are also proposed anti-circumvention provisions to prevent planning around these types of restrictions, such as through the use of intermediary accounts. As proposed, this rule is very narrow. Most foreign managers that seek access investors in US capital markets will not qualify for this exemption due to the $25M cap. I expect commenters will request expansion of this exemption (at least increasing the dollar limitations).
The De-Minimis Exemption, which applies to managers of qualifying investment funds with less than $150 million of assets under management in the US, also should be available for foreign fund managers. The language of the exemption is confusing and may be interpreted to apply only to managers who maintain a principal foreign office and a secondary domestic office. I do not believe this interpretation to be what the SEC intended. In the coming months, I would expect this to be clarified so that an entirely foreign fund manager who does not use a US office to manage US investments should qualify for this rule since they are not managing any US money (and, thus, fall below the $150M threshold). We will be monitoring these developments closely.
Reporting Requirements of Exempt Fund Managers
As noted above, foreign fund managers relying on the venture capital fund exemption or the $150M de minimis exemption are nonetheless subject to some reporting requirements to the SEC, including:
- Basic identifying information for the adviser and the identity of its owners and affiliates.
- Information about the private funds the adviser manages and about other business activities that the adviser and its affiliates are engaged in that present conflicts of interest that may suggest significant risk to clients.
- The disciplinary history of the adviser and its employees that may reflect on their integrity.
Significantly, foreign fund managers that qualify for the Foreign Private Advisor exemption would not be subject to these reporting requirements – hence the significance of comments to increase the scope of the foreign fund manager exemption exemption for if foreign fund managers would qualify for one of the other exemptions.
I understand that the China Venture Capital Association is working to provide detailed comments on these proposed rules. Steve Yentzer and I are also compiling comments on behalf of our fund manager clients. Please contact us if you’d like to discuss our anticipated comments or have us incorporate your comments into the version that we provide to the SEC.
Comments are due to the SEC by January 24, 2011.