Vol. 76 Wednesday, No. 129 July 6, 2011

Part IV

Securities and Exchange Commission

17 CFR Part 275 Exemptions for Advisers to Funds, Private Fund Advisers With Less Than $150 Million in , and Foreign Private Advisers; Final Rule

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SECURITIES AND EXCHANGE 6. No Redemption Rights The primary purpose of Congress in COMMISSION 7. Represents Itself as Pursuing a Venture repealing section 203(b)(3) was to Capital Strategy require advisers to ‘‘private funds’’ to 17 CFR Part 275 8. Is a Private Fund register under the Advisers Act.6 Private 9. Application to Non-U.S. Advisers [Release No. IA–3222; File No. S7–37–10] 10. Grandfathering Provision funds include hedge funds, private B. Exemption for Investment Advisers equity funds and other types of pooled RIN 3235–AK81 Solely to Private Funds With Less Than investment vehicles that are excluded $150 Million in Assets Under from the definition of ‘‘investment Exemptions for Advisers to Venture Management company’’ under the Investment Capital Funds, Private Fund Advisers 1. Advises Solely Private Funds Company Act of 1940 7 (‘‘Investment With Less Than $150 Million in Assets 2. Private Fund Assets Company Act’’) by reason of section Under Management, and Foreign 3. Assets Managed in the United States 3(c)(1) or 3(c)(7) of such Act.8 Section Private Advisers 4. United States Person 3(c)(1) is available to a fund that does C. Foreign Private Advisers AGENCY: Securities and Exchange 1. Clients not publicly offer the securities it 9 Commission. 2. Private Fund Investor issues and has 100 or fewer beneficial 10 ACTION: Final rule. 3. In the United States owners of its outstanding securities. A 4. Place of Business fund relying on section 3(c)(7) cannot SUMMARY: The Securities and Exchange 5. Assets Under Management publicly offer the securities it issues 11 Commission (the ‘‘Commission’’) is D. Subadvisory Relationships and and generally must limit the owners of adopting rules to implement new Advisory Affiliates its outstanding securities to ‘‘qualified III. Certain Administrative Law Matters purchasers.’’ 12 exemptions from the registration IV. Paperwork Reduction Analysis requirements of the Investment Advisers V. Cost-Benefit Analysis 6 Act of 1940 for advisers to certain VI. Regulatory Flexibility Certification See S. Rep. No. 111–176, at 71–3 (2010) (‘‘S. privately offered investment funds; Rep. No. 111–176’’); H. Rep. No. 111–517, at 866 VII. Statutory Authority (2010) (‘‘H. Rep. No. 111–517’’). H. Rep. No. 111– these exemptions were enacted as part Text of Rules 517 contains the conference report accompanying of the Dodd-Frank Wall Street Reform the version of H.R. 4173 that was debated in I. Background and Consumer Protection Act (the conference. While the Senate voted to exempt ‘‘Dodd-Frank Act’’). As required by Title On July 21, 2010, President Obama fund advisers in addition to venture signed into law the Dodd-Frank Act,2 capital fund advisers from the requirement to IV of the Dodd-Frank Act—the Private register under the Advisers Act, the Dodd-Frank Act Fund Investment Advisers Registration which, among other things, repeals exempts only venture capital fund advisers. Act of 2010—the new rules define section 203(b)(3) of the Advisers Act.3 Compare Restoring American Financial Stability ‘‘venture capital fund’’ and provide an Section 203(b)(3) exempted any Act of 2010, S. 3217, 111th Cong. § 408 (2010) (as investment adviser from registration if passed by the Senate) with The Wall Street Reform exemption from registration for advisers and Consumer Protection Act of 2009, H.R. 4173, with less than $150 million in private the investment adviser (i) had fewer 111th Cong. (2009) (as passed by the House) (‘‘H.R. fund assets under management in the than 15 clients in the preceding 12 4173’’) and Dodd-Frank Act (2010), supra note 2. United States. The new rules also clarify months, (ii) did not hold itself out to the 7 15 U.S.C. 80a. the meaning of certain terms included public as an investment adviser and (iii) 8 Section 202(a)(29) of the Advisers Act defines did not act as an investment adviser to the term ‘‘private fund’’ as ‘‘an issuer that would in a new exemption from registration for be an investment company, as defined in section 3 ‘‘foreign private advisers.’’ a registered investment company or a of the Investment Company Act of 1940 (15 U.S.C. DATES: Effective Date: July 21, 2011. company that has elected to be a 80a–3), but for section 3(c)(1) or 3(c)(7) of that Act.’’ business development company (the 9 Interests in a private fund may be offered FOR FURTHER INFORMATION CONTACT: ‘‘private adviser exemption’’).4 Advisers pursuant to an exemption from registration under Brian McLaughlin Johnson, Tram N. the Securities Act of 1933 (15 U.S.C. 77) specifically exempt under section 203(b) Nguyen or David A. Vaughan, at (202) (‘‘Securities Act’’). Notwithstanding these are not subject to reporting or 551–6787 or [email protected], Division exemptions, the persons who market interests in a recordkeeping provisions under the private fund may be subject to the registration of Investment Management, U.S. Advisers Act, and are not subject to requirements of section 15(a) under the Securities Securities and Exchange Commission, Exchange Act of 1934 (‘‘Exchange Act’’) (15 U.S.C. examination by our staff.5 100 F Street, NE., Washington, DC 78o(a)). The Exchange Act generally defines a 20549–8549. ‘‘broker’’ as any person engaged in the business of 2 Dodd-Frank Wall Street Reform and Consumer effecting transactions in securities for the account SUPPLEMENTARY INFORMATION: The Protection Act, Public Law 111–203, 124 Stat. 1376 of others. Section 3(a)(4)(A) of the Exchange Act (15 Commission is adopting rules 203(l)–1, (2010). U.S.C. 78c(a)(4)(A)). See also Definition of Terms in 203(m)–1 and 202(a)(30)–1 (17 CFR 3 In this Release, when we refer to the ‘‘Advisers and Specific Exemptions for Banks, Savings Act,’’ we refer to the Advisers Act as in effect on Associations, and Savings Banks Under Sections 275.203(l)–1, 275.203(m)–1 and July 21, 2011. 3(a)(4) and 3(a)(5) of the Securities Exchange Act 275.202(a)(30)–1) under the Investment 4 15 U.S.C. 80b–3(b)(3) as in effect before July 21, of 1934, Exchange Act Release No. 44291 (May 11, Advisers Act of 1940 (15 U.S.C. 80b) 2011. 2001) [66 FR 27759 (May 18, 2001)], at n.124 (the ‘‘Advisers Act’’).1 5 Under section 204(a) of the Advisers Act, the (‘‘Solicitation is one of the most relevant factors in Commission has the authority to require an determining whether a person is effecting Table of Contents investment adviser to maintain records and provide transactions.’’); Political Contributions by Certain reports, as well as the authority to examine such Investment Advisers, Investment Advisers Act I. Background adviser’s records, unless the adviser is ‘‘specifically Release No. 3043 (July 1, 2010) [75 FR 41018 (July II. Discussion exempted’’ from the requirement to register 14, 2010)], n.326 (‘‘Pay to Play Release’’). A. Definition of Venture Capital Fund pursuant to section 203(b) of the Advisers Act. 10 See section 3(c)(1) of the Investment Company 1. Qualifying Investments Investment advisers that are exempt from Act (providing an exclusion from the definition of 2. Short-Term Holdings registration in reliance on other sections of the ‘‘investment company’’ for any ‘‘issuer whose Advisers Act (such as sections 203(l) or 203(m) outstanding securities (other than short-term paper) 3. Qualifying Portfolio Company are beneficially owned by not more than one 4. Management Involvement which we discuss below) are not ‘‘specifically exempted’’ from the requirement to register hundred persons and which is not making and does 5. Limitation on Leverage pursuant to section 203(b), and thus the not presently propose to make a public offering of Commission has authority under section 204(a) of its securities.’’). 1 Unless otherwise noted, all references to rules the Advisers Act to require those advisers to 11 See supra note 9. under the Advisers Act will be to Title 17, Part 275 maintain records and provide reports and has 12 See section 3(c)(7) of the Investment Company of the Code of Federal Regulations (17 CFR 275). authority to examine such advisers’ records. Act (providing an exclusion from the definition of

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Each private fund advised by an registration under the Advisers Act (the These new exemptions are not adviser has typically qualified as a ‘‘venture capital exemption’’) and mandatory.24 Thus, an adviser that single client for purposes of the private directs the Commission to define qualifies for any of the exemptions adviser exemption.13 As a result, ‘‘venture capital fund’’ within one year could choose to register (or remain investment advisers could advise up to of enactment.18 New section 203(m) of registered) with the Commission, 14 private funds, regardless of the total the Advisers Act directs the subject to section 203A of the Advisers number of investors investing in the Commission to provide an exemption Act, which generally prohibits most funds or the amount of assets of the from registration to any investment advisers from registering with the funds, without the need to register with adviser that solely advises private funds Commission if they do not have at least us.14 if the adviser has assets under $100 million in assets under In Title IV of the Dodd-Frank Act management in the United States of less management.25 (‘‘Title IV’’), Congress generally than $150 million (the ‘‘private fund On November 19, 2010, the extended Advisers Act registration to adviser exemption’’).19 In this Release, Commission proposed three rules that advisers to hedge funds and many other we will refer to advisers that rely on the would implement these exemptions.26 private funds by eliminating the private venture capital and private fund adviser First, we proposed rule 203(l)–1 to adviser exemption.15 In addition to exemptions as ‘‘exempt reporting define the term ‘‘venture capital fund’’ removing the broad exemption provided advisers’’ because sections 203(l) and for purposes of the venture capital by section 203(b)(3), Congress amended 203(m) provide that the Commission exemption. Second, we proposed rule the Advisers Act to create three more shall require such advisers to maintain 203(m)–1 to implement the private fund limited exemptions from registration such records and to submit such reports adviser exemption. Third, in order to under the Advisers Act.16 These ‘‘as the Commission determines clarify the application of the foreign amendments become effective on July necessary or appropriate in the public private adviser exemption, we proposed 21, 2011.17 New section 203(l) of the interest or for the protection of new rule 202(a)(30)–1 to define several Advisers Act provides that an investors.’’ 20 terms included in the statutory investment adviser that solely advises Section 203(b)(3) of the Advisers Act, definition of a foreign private adviser as venture capital funds is exempt from as amended by the Dodd-Frank Act, defined in section 202(a)(30) of the provides an exemption for certain Advisers Act.27 On the same day, we ‘‘investment company’’ for any ‘‘issuer, the foreign private advisers (the ‘‘foreign outstanding securities of which are owned private adviser exemption’’).21 The term holds itself out generally to the public in the United exclusively by persons who, at the time of ‘‘foreign private adviser’’ is defined in States as an investment adviser. Section acquisition of such securities, are qualified new section 202(a)(30) of the Advisers 202(a)(30)(D)(i). purchasers, and which is not making and does not 24 An adviser choosing to avail itself of an at that time propose to make a public offering of Act as an investment adviser that has no exemption under section 203(l), 203(m) or such securities.’’). The term ‘‘qualified purchaser’’ place of business in the United States, 203(b)(3), however, may be required to register as is defined in section 2(a)(51) of the Investment has fewer than 15 clients in the United an adviser with one or more state securities Company Act. States and investors in the United States authorities. See section 203A(b)(1) of the Advisers 13 See rule 203(b)(3)–1(a)(2) as in effect before Act (exempting from state regulatory requirements July 21, 2011. in private funds advised by the any adviser registered with the Commission or that 14 See Staff Report to the United States Securities adviser,22 and less than $25 million in is not registered because such person is excepted and Exchange Commission, Implications of the aggregate assets under management from the definition of an investment adviser under Growth of Hedge Funds, at 21 (2003), http:// from such clients and investors.23 section 202(a)(11)). See also infra note 488 www.sec.gov/news/studies/hedgefunds0903.pdf (discussing the application of section 222 of the (discussing section 203(b)(3) of the Advisers Act as Advisers Act). 18 in effect before July 21, 2011). Concern about this See section 407 of the Dodd-Frank Act 25 Section 203A(a)(1) of the Advisers Act lack of Commission oversight led us to adopt a rule (exempting advisers solely to ‘‘venture capital generally prohibits an investment adviser regulated in 2004 extending registration to hedge fund funds,’’ as defined by the Commission). by the state in which it maintains its principal advisers. See Registration Under the Advisers Act 19 See section 408 of the Dodd-Frank Act office and place of business from registering with of Certain Hedge Fund Advisers, Investment (directing the Commission to exempt private fund the Commission unless it has at least $25 million Advisers Act Release No. 2333 (Dec. 2, 2004) [69 advisers with less than $150 million in aggregate of assets under management. Section 203A(b) FR 72054 (Dec. 10, 2004)] (‘‘Hedge Fund Adviser assets under management in the United States). preempts certain state laws regulating advisers that Registration Release’’). This rule was vacated by a 20 See sections 407 and 408 of the Dodd-Frank are registered with the Commission. Section 410 of Federal court in 2006. Goldstein v. Securities and Act. the Dodd-Frank Act amended section 203A(a) to Exchange Commission, 451 F.3d 873 (D.C. Cir. 21 Advisers specifically exempt under section also prohibit generally an investment adviser from 2006) (‘‘Goldstein’’). 203(b) are not subject to reporting or recordkeeping registering with the Commission if the adviser has 15 Section 403 of the Dodd-Frank Act amended provisions under the Advisers Act, and are not assets under management between $25 million and section 203(b)(3) of the Advisers Act by repealing subject to examination by our staff. See supra note $100 million and the adviser is required to be the prior private adviser exemption and inserting a 5. registered with, and if registered, would be subject ‘‘foreign private adviser exemption.’’ See infra 22 Subparagraph (B) of section 202(a)(30) refers to to examination by, the state security authority Section II.C. Unlike our 2004 rule, which sought to the number of ‘‘clients and investors in the United where it maintains its principal office and place of apply only to advisers of ‘‘hedge funds,’’ the Dodd- States in private funds,’’ while subparagraph (C) business. See section 203A(a)(2) of the Advisers Frank Act requires that, unless another exemption refers to the assets of ‘‘clients in the United States Act. In each of subparagraphs (1) and (2) of section applies, all advisers previously eligible for the and investors in the United States in private funds’’ 203A(a), additional conditions also may apply. See private adviser exemption register with us (emphasis added). We interpret these provisions Implementing Adopting Release, infra note 32, at regardless of the type of private funds or other consistently so that only clients in the United States section II.A. clients the adviser has. and investors in the United States should be 26 Exemptions for Advisers to Venture Capital 16 Title IV also created exemptions and exclusions included for purposes of determining eligibility for Funds, Private Fund Advisers with Less than $150 in addition to the three discussed at length in this the exemption under subparagraph (B). Million in Assets under Management, and Foreign Release. See, e.g., sections 403 and 409 of the Dodd- 23 The exemption is not available to an adviser Private Advisers, Investment Advisers Act Release Frank Act (exempting advisers to licensed small that ‘‘acts as—(I) an investment adviser to any No. 3111 (Nov. 19, 2010) [75 FR 77190 (Dec. 10, business investment companies from registration investment company registered under the 2010)] (‘‘Proposing Release’’). under the Advisers Act and excluding family offices [Investment Company Act]; or (II) a company that 27 Proposed rule 202(a)(30)–1 included from the definition of ‘‘investment adviser’’ under has elected to be a business development company definitions for the following terms: (i) ‘‘Client;’’ (ii) the Advisers Act). We are adopting a rule defining pursuant to section 54 of [that Act], and has not ‘‘investor;’’ (iii) ‘‘in the United States;’’ (iv) ‘‘place ‘‘’’ in a separate release (Family Offices, withdrawn its election.’’ Section 202(a)(30)(D)(ii). of business;’’ and (v) ‘‘assets under management.’’ Investment Advisers Act Release No. 3220 (June 22, We interpret subparagraph (II) to mean that the See discussion in section II.C of the Proposing 2011)). exemption is not available to an adviser that Release, supra note 26. We proposed rule 17 Section 419 of the Dodd-Frank Act (specifying advises a business development company. This 202(a)(30)–1, in part, pursuant to section 211(a) of the effective date for Title IV). exemption also is not available to an adviser that Continued

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also proposed rules to implement other Act, some of which also concern certain regarding the potential for systemic amendments made to the Advisers Act advisers that qualify for the exemptions risk.37 by the Dodd-Frank Act, which included discussed in this Release.32 We received over 70 comment letters reporting requirements for exempt on the proposed venture capital fund reporting advisers.28 A. Definition of Venture Capital Fund definition, most of which were from We received over 115 comment letters venture capital advisers or related We are adopting new rule 203(l)–1 to in response to our proposals to industry groups.38 A number of implement the new exemptions.29 Most define ‘‘venture capital fund’’ for commenters supported the of these letters were from venture purposes of the new exemption for Commission’s efforts to define a venture capital advisers, other types of private investment advisers that advise solely capital fund,39 citing the ‘‘thoughtful’’ fund advisers, and industry associations venture capital funds.33 In summary, the approach taken and the quality of the or law firms on behalf of private fund rule defines a venture capital fund as a proposed rule.40 Commenters and foreign investment advisers.30 We private fund that: (i) Holds no more than representing investors and investor also received several letters from 20 percent of the fund’s capital groups and others generally supported investors and investor groups.31 commitments in non-qualifying the rule as proposed,41 one of which Although commenters generally investments (other than short-term stated that the proposed definition supported the various proposed rules, holdings) (‘‘qualifying investments’’ ‘‘succeeds in clearly defining those many suggested modifications designed generally consist of equity securities of private funds that will be exempt.’’42 to expand the breadth of the exemptions ‘‘qualifying portfolio companies’’ that Some of these commenters expressed or to clarify the scope of one or more are directly acquired by the fund, which support for a definition that is no elements of the proposed rules. we discuss below); (ii) does not borrow broader than necessary in order to Commenters also sought interpretative or otherwise incur leverage, other than ensure that only advisers to ‘‘venture guidance on certain aspects of the scope limited short-term borrowing (excluding capital funds, and not other types of of each of the rule proposals and related certain guarantees of qualifying private funds, are able to avoid the new 43 issues. portfolio company obligations by the mandatory registration requirements.’’ Generally, however, our proposal II. Discussion fund); (iii) does not offer its investors prompted vigorous debate among redemption or other similar liquidity Today, the Commission is adopting commenters on the scope of the rules to implement the three new rights except in extraordinary definition. For example, a number of exemptions from registration under the circumstances; (iv) represents itself as commenters wanted us to take a Advisers Act. In response to comments, pursuing a venture capital strategy to its different approach from the proposal we have made several modifications to investors and prospective investors; and and supported two alternatives. Two the proposals. In a separate companion (v) is not registered under the commenters urged us to rely on the release (the ‘‘Implementing Adopting Investment Company Act and has not California definition of ‘‘venture capital Release’’) we are adopting rules to elected to be treated as a business implement other amendments made to development company (‘‘BDC’’).34 37 See, e.g., Proposing Release, supra note 26, the Advisers Act by the Dodd-Frank Consistent with the proposal, rule discussion at section II.A. and text accompanying 203(l)–1 also ‘‘grandfathers’’ any pre- nn.43, 60, 61, 82, 99, 136. 38 The National Venture Capital Association the Advisers Act, which Congress amended to existing fund as a venture capital fund explicitly provide us with the authority to define submitted a comment letter, dated January 13, 2011 technical, trade, and other terms used in the if it satisfies certain criteria under the (‘‘NVCA Letter’’) on behalf of its members, and 27 Advisers Act. See section 406 of the Dodd-Frank grandfathering provision.35 An adviser other commenters expressed their support for the Act. is eligible to rely on the venture capital comments raised in the NVCA Letter. 28 Rules Implementing Amendments to the 39 See BIO Letter; Comment Letter of Charles Investment Advisers Act of 1940, Investment exemption only if it solely advises River Ventures (Jan. 21, 2011) (‘‘Charles River Advisers Act Release No. 3110 (Nov. 19, 2010) [75 venture capital funds that meet all of the Letter’’); NVCA Letter. FR 77052 (Dec. 10, 2010)] (‘‘Implementing elements of the definition or funds that 40 See, e.g., Comment Letter of Abbott Capital Proposing Release’’). have been grandfathered. Management, LLC (Jan. 24, 2011) (‘‘Abbott Capital 29 The comment letters on the Proposing Release Letter’’); Comment Letter of DLA Piper LLP (Jan. 24, (File No. S7–37–10) are available at: http:// The proposed rule defined the term 2011) (‘‘DLA Piper VC Letter’’); Comment Letter of www.sec.gov/comments/s7-37-10/s73710.shtml. We venture capital fund in accordance with InterWest General Partners (Jan. 21, 2011) also considered comments submitted in response to (‘‘InterWest Letter’’); NVCA Letter; Comment Letter the Implementing Proposing Release that were what we believed Congress understood of Oak Investment Partners (Jan. 24, 2011) (‘‘Oak germane to the rules adopted in this Release. venture capital funds to be, as reflected Investment Letter’’); Comment Letter of Pine Brook 30 See, e.g., Comment Letter of Biotechnical in the legislative materials, including Road Advisors, LP (Jan. 24, 2011) (‘‘Pine Brook Letter’’). Industry Organization (Jan. 24, 2011) (‘‘BIO Letter’’); the testimony Congress received.36 As Comment Letter of Coalition of Private Investment 41 See AFR Letter; AFL–CIO Letter; EVCA Letter; Companies (Jan. 28, 2011) (‘‘CPIC Letter’’); we discussed in the Proposing Release, Comment Letter of U.S. Senator Carl Levin (Jan. 25, Comment Letter of European Private Equity and the proposed definition of venture 2011) (‘‘Sen. Levin Letter’’). Venture Capital Association (Jan. 24, 2011 (‘‘EVCA capital fund was designed to distinguish 42 AFL–CIO Letter. 43 Letter’’); Comment Letter of O’Melveny & Myers venture capital funds from other types Sen. Levin Letter. Although they did not object LLP (Jan. 25, 2011) (‘‘O’Melveny Letter’’); Comment to the approach taken by the proposed rule, several Letter of Norwest Venture Partners (Jan. 24, 2011) of private funds, such as hedge funds commenters cautioned us against defining venture (‘‘Norwest Letter’’). and private equity funds, and to address capital fund more broadly than necessary to 31 See, e.g., Comment Letter of the American concerns expressed by Congress preclude advisers to other types of private funds Federation of Labor and Congress of Industrial from qualifying under the venture capital Organizations (Jan. 24, 2011) (‘‘AFL–CIO Letter’’); exemption. See AFR Letter; CalPERS Letter; Sen. Comment Letter of Americans for Financial Reform 32 Rules Implementing Amendments to the Levin Letter (‘‘a variety of advisers or funds are (Jan. 24, 2011) (‘‘AFR Letter’’); Comment Letter of Investment Advisers Act of 1940, Investment likely to try to seek refuge from the registration The California Public Employees Retirement Advisers Act Release No. 3221 (June 22, 2011). requirement by urging an overbroad interpretation System (Feb. 10, 2011) (‘‘CalPERS Letter’’). See also, 33 Rule 203(l)–1. of the term ‘venture capital fund’ * * * It is e.g., Comment Letter of Adams Street Partners (Jan. important for the Commission to define the term 34 Rule 203(l)–1(a). 24, 2011); Comment Letter of Private Equity narrowly to ensure that only venture capital funds, Investors, Inc. (Jan. 21, 2011) (‘‘PEI Funds Letter’’) 35 Rule 203(l)–1(b). and not other types of private funds, are able to (letters from advisers of funds that invest in other 36 See Proposing Release, supra note 26, at n.38 avoid the new mandatory registration venture capital and private equity funds). and accompanying and following text. requirement.’’).

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operating company.’’44 These imposes a single standardized metric them by broadening the definition and commenters did not, however, address such as net income, the number of modifying the proposed criteria. our concern, discussed in the Proposing employees, or another single factor test Commenters wanted advisers seeking Release, that the California definition could ignore the complexities of doing to be eligible for the venture capital includes many types of private equity business in different industries or exemption to have greater flexibility to and other private funds, and thus regions. This could have the potential operate and invest in portfolio incorporation of this definition would result that even a low threshold for a companies and to accommodate existing not appear consistent with our size metric could inadvertently restrict (and potentially evolving) business understanding of the intended scope of venture capital funds from funding practices that may vary from what section 203(l).45 Our concern was otherwise promising young small commenters characterized as typical acknowledged in a letter we received companies.50 For these reasons, we are venture capital fund practice.56 Some from the current Commissioner for the not persuaded that the tests for a argued that a limited basket for such California Department of Corporations, ‘‘small’’ company suggested by atypical investing activity could stating that ‘‘we understand the commenters address these concerns. facilitate job creation and capital [Commission] cannot adopt verbatim Unlike the commenters who formation.57 They were also concerned the California definition of [venture suggested these alternative approaches, that the multiple detailed criteria of the capital fund]. Congressional directives most commenters representing venture proposed rule could result in require the [Commission] to exclude capital advisers and related groups ‘‘inadvertent’’ violations of the criteria private equity funds, or any fund that accepted the approach of the proposed under the rule.58 Some expressed pivots its investment strategy on the use rule, and many of them acknowledged concern that a Commission rule of debt or leverage, from the definition that the proposed definition would defining a venture capital fund by of [venture capital fund].’’46 For these generally encompass most venture reference to investing activity would reasons and the other reasons cited in capital investing activity that typically have the result of reducing an adviser’s the Proposing Release, we are not occurs.51 Several, however, also investment discretion.59 modifying the proposal to rely on the expressed the concern that a venture We are sensitive to commenters’ California definition.47 capital fund may, on occasion, deviate concerns that the definition not operate Several other commenters favored from its typical investing pattern with to foreclose investment funds from defining a venture capital fund by the result that the fund could not satisfy investment opportunities that would reference to investments in ‘‘small’’ all of the definitional criteria under the benefit investors but would not change businesses or companies, although they proposed rule with respect to each the character of a venture capital fund.60 disagreed on the factors that would investment all of the time.52 Others On the other hand, we are troubled that deem a business or company to be explained that an investment fund that the cumulative effect of revising the rule ‘‘small.’’48 As discussed in the seeks to satisfy the definition of a to reflect all of the modifications Proposing Release, we considered venture capital fund (a ‘‘qualifying supported by commenters could permit defining a qualifying fund as a fund that fund’’) would desire flexibility to invest reliance on the exemption by advisers to invests in small companies, but noted small amounts of fund capital in other types of private funds and thus the lack of consensus for defining such investments that would not meet the a term.49 We also expressed the concern criteria under the proposed rule, such as 56 See, e.g., NVCA Letter; Comment Letter of Bessemer Venture Partners (Jan. 24, 2011) in the Proposing Release that defining a 53 shares of other venture capital funds, (‘‘Bessemer Letter’’); Oak Investment Letter. See ‘‘small’’ company in a manner that non-convertible debt,54 or publicly also supra note 51. traded securities.55 Both groups of 57 See, e.g., NVCA Letter (stating that a low level 44 Comment Letter of Lowenstein Sandler PC (Jan. commenters urged us to accommodate of 15% would ‘‘allow innovation and job creation 4, 2011) (‘‘Lowenstein Letter’’); Comment Letter of to flourish within the venture capital industry’’); Keith Bishop (Jan. 17, 2011). Sevin Rosen Letter (a 20% limit would be ‘‘flexible 50 45 See Proposing Release, supra note 26, at n.72 See Proposing Release, supra note 26, at n.69 enough not to severely impair the operations of and accompanying and preceding text. and accompanying and preceding text. bona fide [venture capital funds], a critically 51 46 Comment Letter of Preston DuFauchard, See, e.g., Comment Letter of the Committee on important resource for American innovation and job Commissioner for the California Department of Federal Regulation of Securities of the American creation’’). Corporations (Jan. 21, 2011) (‘‘DuFauchard Letter’’) Bar Association (Jan. 31, 2011) (‘‘ABA Letter’’); ATV 58 See, e.g., NVCA Letter (‘‘Because of the (further stating that ‘‘while regulators might have an Letter; BIO Letter; NVCA Letter; Comment Letter of consequence (i.e., Federal registration) of having interesting discussion on whether private equity Proskauer LLP (Jan. 23, 2011); Comment Letter of even one inadvertent, non-qualifying investment, funds contributed to the recent financial crisis, in Union Square Ventures, LLC (Jan. 24, 2011) allowance for unintended or insignificant light of the Congressional directives such a dialogue (‘‘Union Square Letter’’). deviations, or differences in interpretations, is would be academic.’’). 52 See, e.g., Comment Letter of Advanced appropriate.’’); Comment Letter of SV Life Sciences 47 See Proposing Release, supra note 26, at n.72 Technology Ventures (Jan. 24, 2011) (‘‘ATV (Jan. 21, 2011) (‘‘SV Life Sciences Letter’’) (the ‘‘lack and accompanying and preceding text. Letter’’); BIO Letter; NVCA Letter; Comment Letter of flexibility and ambiguity in certain definitions 48 See Comment Letter of National Association of of Sevin Rosen Funds (Jan. 24, 2011) (‘‘Sevin Rosen * * * could cause our firm or other venture firms Small Business Investment Companies and Small Letter’’). One commenter argued that the rule to inadvertently hold non-qualifying investments’’). Business Investor Alliance (Jan. 24, 2011) ‘‘should not bar the occasional, but also quite See also ATV Letter. (‘‘NASBIC/SBIA Letter’’) (supported a definition of ordinary, financial activities’’ of a venture capital 59 DuFauchard Letter (‘‘Only the VC Fund ‘‘small’’ company by reference to the standards set fund. Charles River Letter. advisers/managers are in a position to determine forth in the Small Business Investment Act 53 See, e.g., Comment Letter of Dechert LLP (Jan. what best form ‘down-round’ financing should take. regulations). But cf. Lowenstein Letter; Comment 24, 2011) (‘‘Dechert General Letter’’); Comment Whether that should be new capital, project Letter of Quaker BioVentures (Jan. 24, 2011) Letter of First Round Capital (Jan. 24, 2011) (‘‘First finance, a bridge loan, or some other form of equity (‘‘Quaker BioVentures Letter’’); Comment Letter of Round Letter’’); Sevin Rosen Letter. or debt, is neither a question for the regulators nor Venrock (Jan. 23, 2011) (‘‘Venrock Letter’’) (each of 54 See, e.g., Comment Letter of BioVentures should it be a question of strict regulatory which supported a definition of small company Investors (Jan. 24, 2011) (‘‘BioVentures Letter’’); control.’’); ESP Letter (‘‘There is no way a single based on the size of its public float). See also Charles River Letter; Comment Letter of Davis Polk regulation can determine what the appropriate level Comment Letter of Georg Merkl (Jan. 25, 2011) & Wardwell LLP (Jan. 24, 2011) (‘‘Davis Polk of leverage should be for every portfolio (‘‘Merkl Letter’’) (referring to ‘‘young, negative Letter’’); Merkl Letter. company.’’); Merkl Letter (‘‘The Commission should EBITDA [earnings before interest, taxes, 55 See, e.g., Comment Letter of Cardinal Partners not regulate from whom the [portfolio company] depreciation and amortization] companies’’). (Jan. 24, 2011) (‘‘Cardinal Letter’’); Davis Polk securities can be acquired or how the [company’s] 49 See Proposing Release, supra note 26, at section Letter; Comment Letter of Gunderson Dettmer capital can be used.’’). II.A.1.a. and n.69 and accompanying and following Stough Villeneuve Franklin & Hachigian (Jan. 24, 60 See, e.g., Oak Investment Letter; Sevin Rosen text. 2011) (‘‘Gunderson Dettmer Letter’’); Merkl Letter. Letter.

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expand the exemption beyond what we the amount of non-qualifying percent non-qualifying basket also believe was the intent of Congress.61 A investments, it allows the adviser to supported expanding some of the other number of commenters argued that choose how to allocate those elements of the definition, and thus it is defining a venture capital fund by investments. Thus, one venture capital unclear whether a 15 percent non- reference to multiple detailed criteria fund may take advantage of some qualifying basket alone would satisfy could result in ‘‘inadvertent’’ violations opportunities to invest in debt whereas their needs.70 On the other hand, those of the definitional criteria by a others may seek limited opportunities in supporting a much larger basket did not, qualifying fund.62 Another commenter publicly offered securities. The in our view, adequately address our acknowledged that providing de definition of ‘‘business development concern that an overly expansive minimis carve-outs to the multiple company’’ under the Advisers Act definition would provide room for criteria under the proposed rule could contains a similar basket for non- advisers to private equity funds to be ‘‘cumbersome,’’63 which could lead qualifying investments.66 remain unregistered, a consequence to the result, asserted by some Commenters suggested non-qualifying several commenters urged us to avoid.71 commenters, that an overly prescriptive baskets ranging from 15 to 30 percent of On balance, and after giving due rule could invite further unintentional a fund’s capital commitments, although consideration to the approaches violations of the registration provisions many of these same commenters wanted suggested by commenters, we are of the Advisers Act.64 us to expand the other criteria of the adopting a limit of 20 percent of a To balance these competing proposed rule.67 Several commenters in qualifying fund’s capital commitments considerations, we are adopting an favor of a non-qualifying basket asserted for non-qualifying investments. We approach suggested by several that setting the level for non-qualifying believe that a 20 percent limit will commenters that defines a venture investments at a sufficiently low provide the flexibility sought by many capital fund to include a fund that threshold would preclude advisers to venture capital fund commenters while invests a portion of its capital in other types of private funds from relying appropriately limiting the scope of the investments that would not otherwise on the venture capital exemption while exemption. We note that several satisfy all of the elements of the rule providing venture capital advisers the commenters recommended a non- 65 (‘‘non-qualifying basket’’). Defining a flexibility to take advantage of qualifying basket limit of 20 percent.72 venture capital fund to include funds investment opportunities.68 These We considered adopting a 40 percent engaged in some amount of non- commenters properly framed the basket for non-qualifying investments qualifying investment activity provides question before us. We did not, by analogy to the Advisers Act advisers to venture capital funds with however, receive specific empirical definition of BDC.73 That basket was greater investment flexibility, while analysis regarding the venture capital established by Congress rather than the precluding an adviser relying on the industry as a whole that would help us Commission, and it strikes us as too exemption from altering the character of determine the appropriate size of the large in light of our task of the fund’s investments to such extent basket.69 Many of those supporting a 15 implementing a statutory provision that that the fund could no longer be viewed does not specify a basket.74 We find a as a venture capital fund within the 66 Advisers Act section 202(a)(22) (defining a better analogy in a rule we adopted in intended scope of the exemption. To the ‘‘business development company’’ as any company 2001 under the Investment Company extent an adviser uses the basket to that meets the definition set forth in section 2(a)(48) of, and complies with section 55 of, the Investment Act. Under rule 35d–1 of that Act, invest in some non-qualifying commonly referred to as the ‘‘names investments, it will have less room to Company Act, except that a BDC under the Advisers Act is defined to mean a company that rule,’’ an investment company with a invest in others, but the choice is left to invests 60% of its total assets in the assets specified name suggesting that it invests in the adviser. While the definition limits in section 55 of the Investment Company Act). 67 See, e.g., NVCA Letter (more than 25 comment certain investments is limited to investing no more than 20 percent of its 61 For example, one commenter suggested that the letters expressed general support for the comments definition of venture capital fund include a fund raised in the NVCA Letter). Two commenters assets in other types of investments (i.e., that incurs leverage of up to 20% of fund capital expressed support for a 30% basket for non- qualifying investments. See Comment Letter of commitments without limit on duration and invests than never—- we invest in the form of a straight, up to 20% of fund capital commitments in publicly Shearman & Sterling LLP (Jan. 24, 2011) (‘‘Shearman Letter’’) (citing, in support of this non-convertible Demand Note.’’); Pine Brook Letter traded securities and an additional 20% of fund (‘‘Our fund documents provide for investments capital commitments in non-conforming position, the BDC definition under the Investment outside of our core investing practice of up to 25% investments. Charles River Letter. Under these Company Act, which specifies a threshold of 30% of our committed capital.’’). But cf. Mesirow guidelines, it would be possible to structure a fund for non-qualifying activity); Quaker BioVentures Financial Private Equity Advisors, Inc. (Jan. 24, that borrows up to 20% of the fund’s ‘‘capital Letter (citing, in support of this position, the BDC 2011) (‘‘Mesirow Letter’’) (a Commission-registered commitments’’ to acquire highly leveraged definition under the Investment Company Act and derivatives and publicly traded debt securities. If the BDC definition under the Advisers Act which adviser that advises funds that invest in other the fund only calls 20% of its capital, fund increased the non-qualifying activity threshold to venture capital and private equity funds stated that indebtedness would equal 100% of fund assets, all 40%). ‘‘[s]ince the main purpose of [venture capital funds] is to invest in and help build operating companies, of which would be in derivative instruments or 68 Norwest Letter; Sevin Rosen Letter (noting that we believe their participation in non-qualifying publicly traded debt securities. a 20% limit is ‘‘low enough to ensure that only true activity will be rare.’’). 62 See supra note 58. [venture capital funds] are able to qualify for the 70 63 First Round Letter. [venture capital] exemption.’’). See also NVCA See supra note 67. 71 64 See, e.g., generally NVCA Letter. See also Merkl Letter. See supra note 43. Letter. 69 We did, however, receive much anecdotal 72 See, e.g., ATV Letter; Charles River Letter; 65 See, e.g., Abbott Capital Letter; ATV Letter; evidence of particular advisers’ experiences with Sevin Rosen Letter. At least one commenter stated Bessemer Letter; BioVentures Letter; Cardinal non-qualifying investments. See, e.g., Cardinal that the minimum threshold limit for the non- Letter; Charles River Letter; Comment Letter of Letter (‘‘In a very limited number of cases, it has qualifying basket should be 20%. Charles River CompliGlobe Ltd. (Jan. 24, 2011) (‘‘CompliGlobe been necessary for us to purchase securities from Letter (‘‘we believe anything less than 20% would Letter’’); Davis Polk Letter; First Round Letter; current shareholders of the portfolio company in be inadequate’’). NVCA Letter; Comment Letter of PTV Sciences (Jan. order for the financing to be completed. However, 73 See supra note 66. 24, 2011) (‘‘PTV Sciences Letter’’); Quaker in NO case have purchases from existing 74 A larger non-qualifying basket of 40% could BioVentures; Comment Letter of Sante´ Ventures shareholders ever exceeded 15% of the total have the result of changing the fundamental (Jan. 24, 2011) (‘‘Sante´ Ventures Letter’’); Sevin investment by Cardinal in a proposed financing.’’); underlying nature of the investments held by a Rosen Letter; SV Life Sciences; Comment Letter of Charles River Letter (‘‘The vast majority of our qualifying fund, such as for example increasing the U.S. Venture Partners (Jan. 24, 2011) (‘‘USVP investments are in the form of Convertible Preferred extent to which non-qualifying investments may Letter’’); Venrock Letter. Stock. * * * However, very rarely—but more often contribute to the returns of the fund’s portfolio.

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non-qualifying investments).75 In qualifying fund could invest without pooled investment funds (including adopting that rule, we explained that ‘‘if restriction up to 20 percent of the fund’s other venture capital funds) 89 and an investment company elects to use a capital commitments in non-qualifying publicly offered securities.90 name that suggests its investment investments and would still fall within Commenters argued that these types of policy, it is important that the level of the venture capital fund definition. investments facilitate access to capital required investments be high enough For purposes of the rule, a ‘‘qualifying for a company’s expansion,91 offer that the name will accurately reflect the investment,’’ which we discuss in qualifying funds flexibility to structure company’s investment policy.’’ 76 We greater detail below, generally consists investments in a manner that is most noted that having a registered of any equity security issued by a appropriate for the fund (and its investment company hold a significant qualifying portfolio company that is investors), including for example to amount of investments consistent with directly acquired by a qualifying fund obtain favorable tax treatment, manage its name is an important tool for and certain equity securities exchanged risks (such as bankruptcy protection), investor protection,77 but setting the for the directly acquired securities.81 maintain the value of the fund’s equity limit at 20 percent gives the investment investment or satisfy the specific a. Equity Securities of Portfolio company management flexibility.78 financing needs of a portfolio Companies While our policy goal today in defining company,92 and enable a portfolio a ‘‘venture capital fund’’ is somewhat Rule 203(l)–1 defines a venture company to seek such financing from different from our goal in prescribing capital fund as a private fund that, venture capital funds if the company is limitations on investment company excluding investments in short-term unable to obtain financing from names, the tensions we sought to holdings and non-qualifying traditional lending sources.93 reconcile are similar.79 investments, generally holds equity We recognize that a venture capital 1. Qualifying Investments securities of qualifying portfolio fund may, on occasion, make companies.82 investments other than in equity Under the rule, to meet the definition We proposed to define ‘‘equity securities.94 Under the rule, as of venture capital fund, the fund must security’’ by reference to the Exchange discussed above, a venture capital fund hold, immediately after the acquisition Act.83 Commenters did not generally may make these investments (as well as of any asset (other than qualifying object to our proposal to do so, although other types of investments that investments or short-term holdings), no many urged that we expand the commenters may not have suggested) to more than 20 percent of the fund’s definition of venture capital fund to the extent there is room in the fund’s capital commitments in non-qualifying include investments in other types of non-qualifying basket. Hence, we are investments (other than short-term securities.84 Commenters asserted that adopting the definition of equity holdings).80 Thus, as discussed above, a venture capital funds may invest in security as proposed. securities other than equity securities 75 Rule 35d–1(a)(2) under the Investment The final rule incorporates the Company Act (‘‘a materially deceptive and (including debt securities) for various definition of equity security in section misleading name of a [registered investment business reasons, including to provide 3(a)(11) of the Exchange Act and rule company] includes * * * [a] name suggesting that ‘‘bridge’’ financing to portfolio 3a11–1 thereunder.95 Accordingly, the [registered investment company] focuses its investments in a particular type of investment or companies between equity financing 85 86 investments, or in a particular industry or group of rounds, for working capital needs or (supported venture capital fund investments in industries, unless: (i) The [registered investment for tax or structuring reasons.87 Many of non-convertible debt without a time limit); Cook company] has adopted a policy to invest, under these commenters recommended that Children’s Letter; Leland Fikes Letter (each of normal circumstances, at least 80% of the value of which expressed general support). One commenter its [total assets] in the particular type of the rule also define a venture capital indicated that the proposed condition limiting investments, or in investments in the particular fund to include funds that invest in investments in portfolio companies to equity industry or industries, suggested by the [registered non-convertible bridge loans of a securities was too narrow. See Pine Brook Letter. investment company’s] name * * *’’). 17 CFR portfolio company,88 interests in other 89 See, e.g., Cook Children’s Letter; Leland Fikes 270.35d–1(a)(2). Letter; PEI Funds Letter; Comment Letter of SVB 76 Investment Company Names, Investment Financial Group (Jan. 24, 2011) (‘‘SVB Letter’’). Company Act Release No. 24828 (Jan. 17, 2001) [66 (other than qualifying investments or short-term 90 See, e.g., ATV Letter; BIO Letter (noted that FR 8509, 8511 (Feb. 1, 2001), correction 66 FR holdings)’’ no more than 20% of the fund’s investments by venture capital funds in ‘‘PIPEs’’ 14828 (Mar. 14, 2001)] (‘‘Names Rule Adopting aggregate capital contributions and uncalled (i.e., ‘‘private investments in public equity’’) are Release’’). committed capital may be held in assets (other than ‘‘common’’). 77 short-term holdings) that are not qualifying Names Rule Adopting Release, supra note 76, 91 See, e.g., Lowenstein Letter; Comment Letter of investments.’’ See infra Section II.A.1.c. for a at text accompanying n.3 and text following n.7. John G. McDonald (Jan. 21, 2011) (‘‘McDonald 78 discussion on the operation of the 20% limit. See Names Rule Adopting Release, supra note Letter’’); Quaker BioVentures Letter; Comment 81 76, at text accompanying n.14. See also NVCA See Sections II.A.1.b. Letter of Trident Capital (Jan. 24, 2011) (‘‘Trident Letter; Sevin Rosen Letter (citing rule 35d–1 in 82 Rule 203(l)–1(a)(2) (specifying the investments Letter’’). support of recommending that the rule adopt a non- of a venture capital fund); (c)(3) (defining 92 See, e.g., Merkl Letter; Oak Investments Letter; qualifying basket); Quaker BioVentures Letter ‘‘qualifying investment’’); and (c)(6) (defining Sevin Rosen Letter; Comment Letter of Vedanta (citing the approach taken by the staff generally ‘‘short-term holdings’’). Capital, LP (Jan. 24, 2011) (‘‘Vedanta Letter’’). limiting an investment company excluded by 83 Proposed rule 203(l)–1(c)(2). 93 NVCA Letter; Trident Letter. reason of section 3(c)(5)(C) of the Investment 84 Several commenters opposed any restriction on Company Act to investing no more than 20% of its 94 See, e.g., ESP Letter; Leland Fikes Letter; the definition of equity security. See, e.g., Bessemer McGuireWoods Letter; NVCA Letter; Oak assets in non-qualifying investments). Letter; ESP Letter; NVCA Letter. 79 A number of commenters recommended that Investment Letter. See also supra Section II.A. 85 ATV Letter; NVCA Letter. the rule specify a range for the non-qualifying 95 Rule 203(l)–1(c)(2) (equity security ‘‘has the 86 basket, arguing that this approach would provide Comment Letter of Cook Children’s Health Care same meaning as in section 3(a)(11) of the advisers to venture capital funds with better Foundation Investment Committee (Jan. 20, 2011) Securities Exchange Act of 1934 (15 U.S.C. flexibility to manage their investments over time. (‘‘Cook Children’s Letter’’); Comment Letter of 78c(a)(11)) and § 240.3a11–1 of this chapter.’’). See See, e.g., DLA Piper VC Letter; DuFauchard Letter; Leland Fikes Foundation, Inc. (Jan. 21, 2011) 15 U.S.C. 78c(a)(11) (defining ‘‘equity security’’ as Norwest Letter; Oak Investment Letter. As we (‘‘Leland Fikes Letter’’). ‘‘any stock or similar security; or any security future discuss in greater detail below, the non-qualifying 87 Bessemer Letter; Merkl Letter. on any such security; or any security convertible, basket is determined as of the time immediately 88 See, e.g., Comment Letter of CounselWorks LLC with or without consideration, into such a security, following each investment and hence a range is not (Jan. 24, 2011); ESP Letter; Comment Letter of or carrying any warrant or right to subscribe to or necessary. McGuireWoods LLP (Jan. 24, 2011) purchase such a security; or any such warrant or 80 Rule 203(l)–1(a)(2). The rule specifies that (‘‘McGuireWoods Letter’’); NVCA Letter; Oak right; or any other security which the Commission ‘‘immediately after the acquisition of any asset Investment Letter. See also BioVentures Letter Continued

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equity security includes common stock issued by the same qualifying portfolio this provision in our proposal in favor as well as preferred stock, warrants and company; and (iii) any equity security of the broader 20 percent limit for assets other securities convertible into issued by a company of which a that are not qualifying investments.103 common stock in addition to limited qualifying portfolio company is a Most commenters addressing the limit partnership interests.96 Our definition majority-owned subsidiary, or a on secondary market acquisitions of equity security is broad. The predecessor, and that is acquired by the supported changing the threshold from definition includes various securities in fund in exchange for directly acquired 80 percent of the fund’s investment in which venture capital funds typically equity.97 each portfolio company to either 50 invest and provides venture capital In the Proposing Release we percent in each portfolio company,104 or funds with flexibility to determine explained that one of the features of 80 percent of the fund’s total capital which equity securities in the portfolio venture capital funds that distinguish commitments.105 These commenters company are them from hedge funds and private argued that secondary acquisitions appropriate for the fund. Our use of the equity funds is that they invest capital provide liquidity to founders, angel definition of equity security under the directly in portfolio companies for the investors and employees/former Exchange Act acknowledges that purpose of funding the expansion and employees or align the interests of a venture capital funds typically invest in development of the companies’ business fund with those of a portfolio common stock and other equity rather than buying out existing security company.106 instruments that may be convertible into holders.98 Thus, we proposed that, to We believe that the limit on equity common stock but does not meet the definition, at least 80 percent secondary purchases remains an otherwise specify the types of equity of a fund’s investment in each portfolio important element for distinguishing instruments that a venture capital fund company must be acquired directly from advisers to venture capital funds from could hold in deference to the business the company, in effect limiting a advisers to the types of private equity judgment of venture capital funds. venture capital fund’s ability to acquire funds for which Congress did not secondary market shares to 20 percent 107 b. Capital Used for Operating and provide an exemption. However, as of the fund’s investment in each Business Purposes discussed above, a venture capital fund company.99 may purchase shares in secondary Rule 203(l)–1 defines a venture A few commenters objected to any markets to the extent it has room for capital fund as a private fund that holds limitation on secondary market such securities in its non-qualifying no more than 20 percent of the fund’s purchases of a qualifying portfolio basket. capital commitments in non-qualifying company’s shares,100 but did not Second, the final rule defines investments (other than short-term address the critical role this condition qualifying investments as including holdings). Under the final rule, played in differentiating venture capital equity securities issued by the qualifying investments are generally funds from other types of private funds, qualifying portfolio company that are equity securities that were acquired by such as leveraged funds, which received in exchange for directly the fund in one of three ways that acquire controlling equity interests in acquired equities issued by the same suggest that the fund’s capital is being operating companies through the qualifying portfolio company.108 This used to finance the operations of ‘‘buyout’’ of existing security holders.101 revision was suggested by a number of businesses rather than for trading in Nor did they offer an alternative method secondary markets. As discussed in in lieu of the direct acquisition criterion 103 Cf. proposed rule 203(l)–1(a)(2) and rule greater detail below, rule 203(l)–1 to distinguish venture capital funds 203(l)–1(a)(2). defines a ‘‘qualifying investment’’ as: from the buyout funds that are 104 See DLA Piper VC Letter; Davis Polk Letter; (i) Any equity security issued by a Sevin Rosen Letter (each supported lowering the considered private equity funds. We direct purchase requirement from 80% to 50% of qualifying portfolio company that is continue to believe that the limit on each qualifying portfolio company’s equity directly acquired by the private fund secondary purchases is an important securities); Dechert General Letter (argued that the from the company (‘‘directly acquired element for distinguishing advisers to 20% allowance for secondary purchases should be equity’’); (ii) any equity security issued increased to 45%, consistent with rules 3a–1 and venture capital funds from advisers to 3c–5 under the Investment Company Act). See also by a qualifying portfolio company in the types of private equity funds for ABA Letter (supported lowering the threshold from exchange for directly acquired equity which Congress did not provide an 80% to 70%); NVCA Letter; Mesirow Letter; Oak exemption.102 Therefore, we are not Investments Letter. Several commenters disagreed shall deem to be of similar nature and consider with the proposed direct acquisition criterion and modifying the definition of qualifying recommended that venture capital fund necessary or appropriate, by such rules and investment to broadly include equity regulations as it may prescribe in the public interest investments in portfolio company securities or for the protection of investors, to treat as an securities acquired in secondary through secondary transactions should not be equity security.’’); rule 3a11–1 under the Exchange transactions. subject to any limit. See, e.g., ESP Letter; Merkl Act (17 CFR 240.3a11–1) (defining ‘‘equity We are, however, making two changes Letter. 105 security’’ to include ‘‘any stock or similar security, in this provision in response to ATV Letter; Bessemer Letter; Charles River certificate of interest or participation in any profit Letter; Davis Polk Letter; First Round Letter; sharing agreement, preorganization certificate or commenters. First, we have eliminated Gunderson Dettmer Letter; InterWest Letter; subscription, transferable share, voting trust the 20 percent limit for secondary Mesirow Letter; Norwest Letter; NVCA Letter; Oak certificate or certificate of deposit for an equity market transactions that we included in Investment Letter; Sevin Rosen Letter; SVB Letter; security, interest, interest in a Union Square Letter; Vedanta Letter. See also joint venture, or certificate of interest in a business Comment Letter of Alta Partners (Jan. 24, 2011) 97 Rule 203(l)–1(c)(3). A security received as a trust; any security future on any such security; or (‘‘Alta Partners Letter’’); USVP Letter. dividend by virtue of the fund’s holding of a any security convertible, with or without 106 See, e.g., Bessemer Letter; Norwest Letter; qualifying investment would also be a qualifying consideration, into such a security, or carrying any Sevin Rosen Letter. investment. See generally infra note 480. warrant or right to subscribe to or purchase such 107 See Proposing Release, supra note 26, at n.112 98 a security; or any such warrant or right; or any put, Proposing Release, supra note 26, at text and accompanying text. accompanying n.104. call, straddle, or other option or privilege of buying 108 Under rule 203(l)–1(c)(3)(ii), ‘‘qualifying 99 such a security from or selling such a security to Proposed rule 203(l)–1(a)(2). investments’’ include any equity security issued by another without being bound to do so.’’). 100 See, e.g., ESP Letter; Merkl Letter. a qualifying portfolio company in exchange for an 96 See rule 3a11–1 under the Exchange Act (17 101 See also Proposing Release, supra note 26, at equity security issued by the qualifying portfolio CFR 240.3a11–1) (defining ‘‘equity security’’ to section II.A.1.d. company that is directly acquired. See infra note include any ‘‘limited partnership interest’’). 102 See id., at n.112 and accompanying text. 113.

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commenters to enable a qualifying fund company that became a majority-owned non-qualifying investment is made, to participate in the reorganization of subsidiary of the reporting company.113 based on the non-qualifying investments the capital structure of a portfolio 117 c. Operation of the 20 Percent Limit then held in the fund’s portfolio. We company, which may require the fund, understand that using a fund’s capital along with other existing security Under the rule, to meet the definition commitments for determining holders, to accept newly issued equity of venture capital fund, a qualifying investment thresholds is generally securities in exchange for previously fund must hold, immediately after the consistent with existing venture capital 109 acquisition of any asset (other than issued equity securities. fund practice,118 and nearly all of the qualifying investments or short-term The rule similarly treats as a commenters requesting a basket holdings), no more than 20 percent of qualifying investment any equity specified the basket as a percentage of security issued by another company in the fund’s capital commitments in non- the fund’s capital commitments.119 We exchange for directly acquired equities qualifying investments (other than expect that calculating the size of the of a qualifying portfolio company, short-term holdings).114 Under this provided that the qualifying portfolio approach, a fund need only calculate non-qualifying basket as a percentage of company becomes a majority-owned the 20 percent limit when the fund a qualifying fund’s capital subsidiary of the other company or is a acquires a non-qualifying investment commitments, which will remain predecessor company.110 This provision (other than short-term holdings); after relatively constant during the fund’s enables a qualifying fund to acquire the acquisition, the fund need not term, will provide advisers with a securities in connection with the dispose of a non-qualifying investment degree of predictability when managing acquisition (or merger) of a qualifying simply because of a change in the value the fund’s portfolio and determining portfolio company by another of that investment. A qualifying fund, how much of the basket remains company,111 without jeopardizing the however, could not purchase additional available for new investments. fund’s ability to satisfy the definition of non-qualifying investments until the We acknowledge that limiting non- venture capital fund. A venture capital value of its then-existing non-qualifying qualifying investments to a percentage fund’s acquisition of publicly offered investments fell below 20 percent of the of fund capital commitments could securities in these circumstances may fund’s committed capital. result in a qualifying fund that invests not present the same degree of As discussed above, most commenters supporting a basket for non-qualifying its initial in non-qualifying interconnectedness with the public investments; 120 but that ability would markets as secondary acquisitions investments recommended a limit be constrained by the adviser’s need to through the open markets that are expressed as a percentage of fund 115 reconcile that investment with the typical of other types of leveraged capital commitments. One 112 commenter further suggested that the fund’s required representation that it buyout private funds. As a result of 121 the modification to the proposed rule, a value of investments included in the pursues a venture capital strategy. An venture capital fund could hold equity non-qualifying basket be calculated at investment adviser that manages a fund securities of a company subject to the time each investment is made to in such a manner that renders the reporting under the Exchange Act, if include only those non-qualifying representation to investors and potential such equity securities were issued to the investments that are then held by the investors that the fund pursues a fund in exchange for directly acquired fund (thus excluding liquidated assets); venture capital strategy an untrue equities of a qualifying portfolio the commenter argued that this statement of material fact would violate approach would give funds certainty the antifraud provisions of the Advisers 109 See, e.g., NVCA Letter. See also Sevin Rosen that a qualifying investment would not Act.122 We understand that a venture Letter. Although we understand that the securities become ‘‘non-qualifying’’ and simplify capital fund is not typically required to received in an exchange are typically newly issued, the test for compliance.116 call or fully draw down all of its capital the rule would also cover exchanges for outstanding We are persuaded that the non- securities. See also infra note 113. commitments. However, only bona fide 110 Under rule 203(l)–1(c)(3)(iii), ‘‘qualifying qualifying basket should be based on a capital commitments may be included investments’’ include any equity security issued by qualifying fund’s total capital in the calculation under rule 203(l)– a company of which a qualifying portfolio company commitments, and the fund’s is a majority-owned subsidiary (as defined in compliance with the 20 percent limit section 2(a)(24) of the Investment Company Act), or 117 Capital commitments that have been called a predecessor company, and that is acquired by the should be calculated at the time any but returned to investors and subject to a future call private fund in exchange for an equity security would be treated as uncalled capital commitments. described in paragraph (c)(3)(i) or (c)(3)(ii) of the 113 Under the rule, a qualifying fund could Capital commitments that are no longer subject to rule. See infra note 113. separately purchase additional securities pursuant a call by the fund would not be treated as uncalled A ‘‘majority-owned subsidiary’’ is defined by to a public offering (or recapitalization) from a capital commitments. reference to section 2(a)(24) of the Investment company after it ceases to be a ‘‘qualifying portfolio 118 See generally infra notes 240–243 (discussing Company Act, (15 U.S.C. 80a2(a)(24), which defines company’’ (because for example such company has the use of a qualifying fund’s capital commitments a ‘‘majority-owned subsidiary’’ of any person as ‘‘a become a reporting or foreign traded company), to determine the fund’s compliance with the company 50 per centum or more of the outstanding subject to the non-qualifying basket. leverage criterion). See also DLA Piper VC Letter. voting securities of which are owned by such 114 Rule 203(l)–1(a)(2). The calculation of the 20% 119 See generally supra note 67. For purposes of person, or by a company which, within the meaning limit operates in a fashion similar to the reporting its ‘‘regulatory assets under management’’ of this paragraph, is a majority-owned subsidiary of diversification and ‘‘Second Tier Security’’ tests of on Form ADV, an adviser would include uncalled such person.’’ rule 2a–7 under the Investment Company Act. 17 capital commitments of a private fund advised by 111 See, e.g., Davis Polk Letter; Comment Letter of CFR 270.2a–7(a)(24). See Revisions to Rules the adviser. Institutional Venture Partners (Jan. 24, 2011) (‘‘IVP Regulating Money Market Funds, Investment 120 See AFL–CIO Letter; AFR Letter (discussing Letter’’); Mesirow Letter; PTV Sciences Letter. A Company Act Release No. 18005 (Feb. 20, 1991) [56 issues associated with specifying leverage as a number of commenters argued that without this FR 8113, 8118 (Feb. 27, 1991)]. percentage of fund capital commitments). expanded definition, typical transactions enabling a 115 See supra note 67. 121 See infra Section II.A.7. venture capital fund to restructure its investment in 116 Sevin Rosen Letter. See also BioVentures 122 The Commission does not need to demonstrate a portfolio company, exit its investment or obtain Letter (endorsing the NVCA Letter supporting a that an adviser violating rule 206(4)–8 acted with liquidity for itself and its investors, as well as non-qualifying basket determined as a percentage of scienter. See Prohibition of Fraud by Advisers to profits, would be precluded. See, e.g., NVCA Letter; fund capital commitments, but also arguing in favor Certain Pooled Investment Vehicles, Investment PTV Sciences Letter. of determining the basket ‘‘at any point in time, Advisers Act Release No. 2628 (Aug. 3, 2007) [72 112 See, e.g., Davis Polk Letter. See also Mesirow rather than in the aggregate over the life of the FR 44756 (Aug. 9, 2007)] (‘‘Pooled Vehicles Letter. fund’’). Release’’).

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1.123 For example, commitments made purpose, the 20 percent test is ERISA rule in connection with for the purpose of increasing the non- determined based on the qualifying comments on other proposed criteria,130 qualifying basket and with an fund’s non-qualifying investments after and hence we believe advisers’ understanding with investors that they taking into account the acquisition of familiarity with the ERISA rule will will not be called cannot be included.124 any newly acquired non-qualifying facilitate compliance with our approach Moreover, we believe that by applying investment.127 to the 20 percent limit and reduce the the 20 percent limit as of the time of To determine if a fund satisfies the 20 burdens associated with compliance. acquisition of each non-qualifying percent limit for non-qualifying 2. Short-Term Holdings investment, a fund is able to determine investments, the fund may use either prospectively how much it can invest in historical cost or fair value, as long as A qualifying fund may also invest in the non-qualifying basket. We believe the same method is applied to all cash and cash equivalents, U.S. that this simpler approach to investments of a qualifying fund in a Treasuries with a remaining maturity of determining the non-qualifying basket consistent manner during the term of 60 days or less and shares of registered 131 would better limit a qualifying fund’s the fund.128 Under the rule, a venture money market funds. A qualifying non-qualifying investments and ease the capital fund could use either historical fund need not include its investments in burden of determining compliance with cost or fair value, depending, for these short-term holdings when the criterion under the rule. example, on the fund’s approach to determining whether it satisfies the 20 To determine compliance with the 20 valuing investments since the fund’s percent limit for non-qualifying 132 percent limit, a venture capital fund inception. Under the final rule, a investments. would, immediately after the qualifying fund using historical cost Most commenters that addressed the acquisition of any non-qualifying need not account for changes in the cash element of the proposal did not investment, excluding any short-term value of its portfolio due to, for disagree with our approach to the cash 125 element but urged us to expand it to holdings, calculate the total value of example, market fluctuations in the include money market funds,133 any all of the fund’s assets held at that time, value of a non-qualifying investment or U.S. Treasury without regard to excluding short-term holdings, that are the sale or other disposition of a maturity,134 debt issued by foreign invested in non-qualifying investments, qualifying investment (including the governments,135 repurchase as a percentage of the fund’s total associated distribution of sale proceeds 126 agreements,136 and certain highly rated capital commitments. For this to fund investors). Requiring fair value corporate commercial paper.137 Many in this particular instance could make 123 commenters did not provide a rationale, See also Investment Adviser Performance investment planning difficult because Compensation, Investment Advisers Act Release other than business practice, for the amount of dollars allocated to the No. 3198 (May 10, 2011) [76 FR 27959 (May 13, expanding the cash element to include 2011)] at n.17 (in determining whether a person non-qualifying basket would vary these other types of investments or holds the requisite amount of assets under depending on changes in the value of management, an investment adviser may include discuss whether these changes would ‘‘assets that a client is contractually obligated to investments already made. In addition, also permit other types of funds to meet invest in private funds managed by the adviser. requiring fair value could complicate the definition. One commenter did note, Only bona fide contractual commitments may be compliance for those qualifying funds however, that short-term investments included, i.e., those that the adviser has a that make investments frequently, reasonable belief that the investor will be able to are typically held during the period meet.’’). because each investment would result between a capital call and funding by 124 Similarly, fee waivers or reductions for the in a requirement to value the fund’s purpose of inducing investors to increase the size assets. Because the rule specifies that valued at cost, invested in venture capital of their capital commitments with an understanding the valuation method must be investments. 29 CFR 2510.3–101(d). See also that they will not be called (and hence enable the Proposing Release, supra note 26, at n.70. adviser to increase the size of the non-qualifying consistently applied, this approach is 130 For example, a number of commenters urged basket) would indicate that the commitments are designed to prevent a qualifying fund, us to adopt the approach under ERISA that would not bona fide. In addition, the amount of capital or its adviser, from alternating between determine whether or not a fund has satisfied the commitments and contributions made by investors valuation methodologies in order to managerial assistance criterion. See infra note 225. and the investments made by the fund are 131 indispensable to the functioning of a venture capital circumvent the 20 percent limit. Rule 203(l)–1(c)(6). 132 fund, and we understand advisers to venture capital Our rule’s approach to the valuation Rule 203(l)–1(a)(2). As proposed, a venture funds typically maintain records reflecting them. method, which allows the use of capital fund would have been defined as a fund that See generally supra note 5 (describing the historical cost in determining invested solely in certain investments, including Commission’s authority to examine the records of specified cash instruments. Proposed rule 203(l)– advisers relying on the venture capital exemption). compliance with the non-qualifying 1(a)(2)(ii). In the final rule, a venture capital fund We note that a person claiming an exemption under basket limit, is similar in this respect to is defined as a fund that holds no more than 20% the Federal securities laws has the burden of rules under the Employee Retirement of its committed capital in assets that are not qualifying investments, excluding for this purpose proving it is entitled to the exemption. See, e.g., Income Security Act of 1974 (‘‘ERISA’’) SEC v. Ralston Purina Co., 346 U.S. 119, 126 (1953); short-term holdings (which is defined to include Gilligan, Will & Co. v. SEC, 267 F.2d 461, 466 (2d for funds qualifying as ‘‘venture capital specified cash instruments). Rule 203(l)–1(a)(2). Cir. 1959); Swenson v. Engelstad, 626 F.2d 421, 425 operating companies,’’ which generally The general focus of both the proposal and the final (5th Cir. 1980); SEC v. Wall St. Transcript Corp., specify that the value of a fund’s rule is on the types of investments in which a 454 F. Supp. 559, 566 (S.D.N.Y. 1978) (stating that qualifying fund may invest. As a result of the investments is determined on a cost modifications to the rule to incorporate a non- the defendant publisher ‘‘must register unless it can 129 be shown that it is’’ entitled to rely on an exclusion basis. Many commenters cited the qualifying basket, we are excluding short-term from the definition of ‘‘investment adviser’’). holdings from the calculation of qualifying and non-qualifying investments. 125 Rule 203(l)–1(c)(6) (‘‘Short-term holdings’’ by rule 203(l)–1(c)(3)(ii) and (iii) would not result 133 means cash and cash equivalents as defined in in a requirement to calculate the 20% limit under Comment Letter of Federated Investors, Inc. § 270.2a51–1(b)(7)(i), U.S. Treasuries with a rule 203(l)–1(a)(2). (Jan. 18, 2011); IVP Letter; Merkl Letter. remaining maturity of 60 days or less, and shares 127 Rule 203(l)–1(a)(2). 134 See, e.g., Dechert General Letter; IVP Letter. of an open-end management investment company 128 Id. See also Shearman Letter; SVB Letter (also argued registered under section 8 of the Investment 129 Under U.S. Department of Labor regulations, that Treasuries pose no systemic risk issues). Company Act of 1940 [15 U.S.C. 80a–8] that is a venture capital operating company (‘‘VCOC’’) is 135 Dechert General Letter; Commenter Letter of regulated as a money market fund under § 270.2a– any entity that, as of the date of the first investment European Fund and Asset Management Association 7 of this chapter.’’). (or other relevant time), has at least 50% of its (Jan. 24, 2011) (‘‘EFAMA Letter’’); Merkl Letter. 126 A qualifying investment that is acquired as a assets (other than short-term investments pending 136 IVP Letter; NVCA Letter. result of an exchange of equity securities provided long-term commitment or distribution to investors), 137 Sevin Rosen Letter.

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investors and invested in instruments an appropriate form of cash equivalent foreign traded’’ company (a ‘‘reporting that may provide higher returns than the for a venture capital fund to hold company’’) and does not control, is not cash items identified in the proposed pending investment in a portfolio controlled by or under common control rule.138 company or distribution to investors, with, a reporting company.148 Under the The Commission recognizes that a our rule includes short-term U.S. definition, a venture capital fund may broader definition of short-term Treasuries with a remaining maturity of continue to treat as a qualifying holdings could yield venture capital 60 days or less.145 investment any previously directly funds greater returns.139 The exclusion acquired equity security of a portfolio of short-term holdings from a qualifying 3. Qualifying Portfolio Company company that subsequently becomes a fund’s assets for purposes of the 20 Under the rule, qualifying reporting company.149 Moreover, after a percent test, however, recognizes that investments generally consist of equity company becomes a reporting company, such holdings are not ordinarily held as securities issued by a qualifying a qualifying fund could acquire the part of the fund’s investment portfolio portfolio company. A ‘‘qualifying company’s publicly traded (or foreign but as a cash management tool.140 portfolio company’’ is defined as any traded) securities in the secondary Advisers to venture capital funds that company that: (i) Is not a reporting or markets, subject to the availability of the wish to invest in longer-term or higher foreign traded company and does not fund’s non-qualifying basket. yielding debt may make use of the non- have a control relationship with a As we discussed in the Proposing qualifying basket for such investments. reporting or foreign traded company; (ii) Release, venture capital funds provide We are, however, modifying the does not incur leverage in connection operating capital to companies in the definition to include as short-term with the investment by the private fund early stages of their development with holdings shares of registered money and distribute the proceeds of any such the goal of eventually either selling the market funds that are regulated under borrowing to the private fund in company or taking it public.150 Unlike rule 2a–7 under the Investment exchange for the private fund Company Act,141 which we understand investment; and (iii) is not itself a fund 148 Rule 203(l)–1(c)(4)(i); rule 203(l)–1(c)(5) are commonly held for purposes of cash (i.e., is an operating company).146 We (defining a ‘‘reporting or foreign traded’’ company 142 as one that is subject to the reporting requirements management. are adopting the rule substantially as under section 13 or 15(d) of the Exchange Act, or The rule defines short-term holdings proposed, with modifications to the has a security listed or traded on any exchange or to include ‘‘cash and cash equivalents’’ leverage criterion in order to address organized market operating in a foreign by reference to rule 2a51–1(b)(7)(i) certain concerns raised by commenters. jurisdiction). This definition is similar to rule 2a51– 143 1 under the Investment Company Act (defining under the Investment Company Act. We describe each element of a ‘‘public company,’’ for purposes of the qualified We did not receive any comments on qualifying portfolio company below. We purchaser standard, as ‘‘a company that files reports this aspect of the proposal and are understand each of the criteria to be pursuant to section 13 or 15(d) of the Securities adopting it without modification. Rule Exchange Act of 1934’’), and rule 12g3–2 under the characteristic of issuers of portfolio Exchange Act (conditioning a foreign private 2a51–1, however, is used to determine securities held by venture capital issuer’s exemption from registering securities under whether an owner of an investment funds.147 Moreover, collectively, we section 12(g) of the Exchange Act if, among other company excluded by reason of section believe these criteria would operate to conditions, the ‘‘issuer is not required to file or 3(c)(7) of the Investment Company Act furnish reports’’ pursuant to section 13(a) or section exclude most private equity funds and 15(d) of the Exchange Act). 17 CFR 270.2a51–1; 17 meets the definition of a qualified hedge funds from the definition. CFR 240.12g3–2. Under the rule, securities of a purchaser by examining whether such ‘‘reporting or foreign traded company’’ include owner holds sufficient ‘‘investments’’ a. Not a Reporting Company securities of non-U.S. companies that are listed on a non-U.S. market or non-U.S. exchange. Rule (generally securities and other assets Under the rule, a qualifying portfolio 203(l)–1(c)(5). 144 held for investment purposes). We company is defined as a company that, 149 Rule 203(l)–1(c)(4)(i) (defining a qualifying are not defining a venture capital fund’s at the time of any investment by a portfolio company as any company that at the time cash holdings by reference to whether qualifying fund, is not a ‘‘reporting or of any investment by a venture capital fund is not the cash is held ‘‘for investment a reporting or foreign traded company). 150 See Testimony of James Chanos, Chairman, 145 We have treated debt securities with purposes’’ or to the net cash surrender Coalition of Private Investment Companies, July 15, maturities of 60 days or less differently than debt value of an policy. 2009, at 4 (‘‘[V]enture capital funds are an securities with longer maturities under our rules. In important source of funding for start-up companies Furthermore, since rule 2a51–1 does not particular, we have recognized that the potential for or turnaround ventures.’’); National Venture Capital explicitly include short-term U.S. fluctuation in those shorter-term securities’ market Association Yearbook 2010 (‘‘NVCA Yearbook Treasuries, which we believe would be value has decreased sufficiently that, under certain 2010’’), at 7–8 (noting that venture capital is a conditions, we allow certain open-end investment ‘‘long-term investment’’ and the ‘‘payoff [to the companies to value them using amortized cost 138 NVCA Letter. venture capital firm] comes after the company is value rather than market value. See Valuation of 139 acquired or goes public.’’); George W. Fenn, Nellie See, e.g., NVCA Letter. Debt Instruments by Money Market Funds and 140 We do not view investing in short-term Liang and Stephen Prowse, The Economics of the Certain Other Open-End Investment Companies, Private Equity Market, December 1995, 22, n.61 and holdings as being a venture capital strategy; Investment Company Act Release No. 9786 (May however, for purposes of the exemption, a accompanying text (‘‘Fenn et al.’’) (‘‘Private sales’’ 31, 1977) [42 FR 28999 (June 7, 1977)]. We believe are not normally the most important type of exit qualifying fund could invest in short-term holdings that the same consideration warrants treating U.S. as part of implementing its investment strategy. See strategy as compared to IPOs, yet of the 635 Treasury securities with a remaining maturity of 60 successful portfolio company exits by venture also infra Section II.A.7. days or less as more akin to cash equivalents than 141 capitalists between 1991–1993 ‘‘merger and Rule 203(l)–1(c)(6). Treasuries with longer maturities for purposes of acquisition transactions accounted for 191 deals 142 See, e.g., NVCA Letter. the definition of venture capital fund. and IPOs for 444 deals.’’ Furthermore, between 143 Rule 2a51–1(b)(7) under the Investment 146 Rule 203(l)–1(c)(4). In the Proposing Release, 1983 and 1994, of the 2,200 venture capital fund Company Act provides that cash and cash we used the defined term ‘‘publicly traded’’ exits, 1,104 (approximately 50%) were attributed to equivalents include foreign currencies ‘‘held for company, but are modifying the rule to use the of venture-backed firms.). investment purposes’’ and ‘‘(i) [b]ank deposits, defined term ‘‘reporting or foreign traded’’ company See also Jack S. Levin, Structuring Venture Capital, certificates of deposit, bankers acceptances and to match more closely the defined term and to make Private Equity and Entrepreneurial Transactions, similar bank instruments held for investment clear that certain companies that have issued 2000 (‘‘Levin’’) at 1–2 to 1–7 (describing the various purposes; and (ii) [t]he net cash surrender value of securities that are traded on a foreign exchange are types of venture capital and private equity an insurance policy.’’ 17 CFR 270.2a51–1(b)(7). covered by the definition. See proposed rule 203(l)– investment business but stating that ‘‘the phrase 144 See generally sections 2(a)(51) and 3(c)(7) of 1(c)(3) and (4). ‘venture capital’ is sometimes used narrowly to the Investment Company Act; 17 CFR 270.2a51–1(b) 147 See Proposing Release, supra note 26, sections refer only to financing the start-up of a new and (c). II.A.1.a.–II.A.1.e. Continued

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other types of private funds, venture a key consideration by Congress that led company becomes a reporting company, capital funds are characterized as not to the enactment of the venture capital the fund continued to hold at least a trading in the public markets, but may exemption.157 As we discussed in the majority of its original investment made sell portfolio company securities into Proposing Release, the rule we proposed when the company was a non-reporting the public markets once the portfolio sought to incorporate this Congressional company.161 Some of these commenters company has matured.151 As of year-end understanding of the nature of asserted that public offerings, which 2010, U.S. venture capital funds investments of a venture capital fund, trigger reporting requirements under the managed approximately $176.7 billion and these principles guided our Federal securities laws, were viewed as in assets.152 In comparison, as of year- consideration of the proposed venture an additional financing round, with pre- end 2010, the U.S. publicly traded capital fund definition.158 The proposed existing venture investors expected to equity market had a market value of rule would have required that a participate.162 Alternatively, several approximately $15.4 trillion,153 whereas qualifying fund invest primarily in commenters recommended that a global hedge funds had approximately equity securities of companies that are venture capital fund could limit its $1.7 trillion in assets under not capitalized by the public markets.159 investment in reporting companies, management.154 The aggregate amount Several commenters asserted that the such as 15 or 20 percent of the fund’s invested in venture capital funds is definition should not exclude securities capital commitments.163 considerably smaller.155 Congressional of reporting companies.160 Most, We understand that venture capital testimony asserted that these funds may however, did not object to the rule’s funds seek flexibility to invest in be less connected with the public limitation on investments in non- promising portfolio companies, markets and may involve less potential reporting companies, but instead sought including companies deemed for systemic risk.156 This appears to be a more flexible definition that would sufficiently profitable to become include some level of investments in reporting companies or companies that business’’); Anna T. Pinedo & James R. Tanenbaum, reporting companies under certain may be owned directly or indirectly by Exempt and Hybrid Securities Offerings (2009), Vol. conditions. For example, certain a public company. Rather than modify 1 at 12–2 (discussing the role initial public offerings commenters supported venture capital play in providing venture capital investors with the rule to impose additional criteria for liquidity). fund investments in reporting investing in reporting companies, 151 See Testimony of Trevor Loy, Flywheel companies only if, at the time the however, we have adopted a limit of 20 Ventures, before the Senate Banking Subcommittee percent for non-qualifying investments, on Securities, Insurance and Investment Hearing, that occurred in the financial system in the last which may be used to hold securities of July 15, 2009 (‘‘Loy Testimony’’), at 5 (‘‘We do not year, nor does it pose a future systemic risk to our trade in the public markets.’’). See also Testimony world financial markets or retail investors.’ ’’). See reporting companies. We believe that of Terry McGuire, General Partner, Polaris Venture also Loy Testimony, supra note 151, at 7 (noting the the 20 percent limit appropriately Partners, and Chairman, National Venture Capital factors by which the venture capital industry is balances commenters’ expressed desire Association, before the U.S. House of exposed to ‘‘entrepreneurial and technological risk for greater flexibility to accommodate Representatives Committee on Financial Services, not systemic financial risk’’); McGuire Testimony, October 6, 2009 (‘‘McGuire Testimony’’) at 11 supra note 151, at 6 (noting that the ‘‘venture existing business practices while (‘‘[V]enture capital funds do not typically trade in capital industry’s activities are not interwoven with providing sufficient limits on the extent the public markets and generally limit advisory U.S. financial markets’’). See also Group of Thirty, of investments that would implicate activities to the purchase and sale of securities of Financial Reform: A Framework for Financial Congressional statements regarding the private operating companies in private Stability, January 15, 2009, at 9 (discussing the need transactions’’); Levin, supra note 150, at 1–4 (‘‘A for registration of managers of ‘‘private pools of interconnectedness of venture capital 164 third distinguishing feature of venture capital/ capital that employ substantial borrowed funds’’ yet funds with the public markets. private equity investing is that the securities recognizing the need to exempt venture capital from purchased are generally privately held as opposed registration). 161 ATV Letter; BIO Letter; NVCA Letter. See also to publicly traded * * * a venture capital/private 157 See supra note 156. Davis Polk Letter; InterWest Letter; McDonald equity investment is normally made in a privately- 158 See Proposing Release, supra note 26, at n.43 Letter; Mesirow Letter; PTV Sciences Letter. A held company, and in the relatively infrequent and n.60 and following text. number of commenters supported expanding the cases where the investment is into a publicly-held 159 Most commenters did not express any proposed definition but without additional company, the [venture capital fund] generally holds objection to our proposed definition of ‘‘publicly conditions. See, e.g., BioVentures Letter; ESP Letter; non-public securities.’’) (emphasis in original). traded,’’ although one commenter did disagree with Quaker BioVentures Letter; SV Life Sciences Letter. 152 National Venture Capital Association the proposed definition’s approach to foreign traded 162 See, e.g., Alta Partners Letter; Gunderson Yearbook 2011 (‘‘NVCA Yearbook 2011’’) at 9, Fig. securities. This commenter argued that the Dettmer Letter; InterWest Letter; McDonald Letter; 1.0. proposed rule should be modified to ‘‘cover NVCA Letter; Quaker BioVentures Letter. See also 153 Bloomberg Terminal Database, WCAUUS securities that have been publicly offered to Bessemer Letter; BIO Letter; Lowenstein Letter. Bloomberg United States Exchange Market investors in a foreign jurisdiction and equity 163 Alta Partners Letter (supported limiting Capitalization). securities that are widely held and traded over-the- investments in public companies to 15% of fund 154 Credit Suisse, 2010 Hedge Fund Industry counter in a foreign jurisdiction.’’ Merkl Letter. We capital commitments); Gunderson Dettmer Letter Review, Feb. 2011 (‘‘Credit Suisse Report’’), at 1. decline to adopt this approach because the (supported limiting investments in public securities 155 In 2010, investors investing in newly formed definition would require us to define what to 20% of fund capital commitments). See also funds committed approximately $12.3 billion to constitutes a ‘‘public offering’’ notwithstanding the Davis Polk Letter (supported limiting investments venture capital funds compared to approximately laws of foreign regulators and legislatures. in public companies to 20% of fund capital $85.1 billion to private equity/buyout funds. NVCA 160 See Bessemer Letter; IVP Letter (also suggested commitments provided the fund continues to hold Yearbook 2011, supra note 152, at 20 at Fig. 2.02. additional conditions); Merkl Letter. One a majority of its original investment in the company In comparison, hedge funds raised approximately commenter also suggested that the definition when it was private); SVB Letter (supported $22.6 billion from investors in 2010. Credit Suisse should not exclude investments in companies that investments in public securities but did not identify Report, supra note 154, at 1. may be deemed to be ‘‘controlled’’ by a public a percentage threshold). 156 See S. Rep. No. 111–176, supra note 6, at 74– company (or its venture capital investment 164 See supra Section II.A.1.b. One commenter 5 (noting that venture capital funds ‘‘do not present division). See Comment Letter of Berkeley Center argued that, in addition to funds that would satisfy the same risks as the large private funds whose for Law, Business and the Economy (Feb. 1, 2011) the proposed definition, a venture capital fund advisers are required to register with the SEC under (‘‘BCLBE Letter’’). See also Dechert General Letter should include any fund that invests at least 75% this title [IV]. Their activities are not interconnected (argued that restricting the application of the of its capital in privately held ‘‘domestic small with the global financial system, and they generally control element may be necessary because an business’’ as defined in the Small Business rely on equity funding, so that losses that may occur adviser to a venture capital fund could be Investment Act (the ‘‘SBIA’’) regulations, regardless do not ripple throughout world markets but are controlled by a public company, and might itself be of the equity/debt nature of the investment. See borne by fund investors alone. Terry McGuire, deemed to control a portfolio company as a result NASBIC/SBIA Letter. In the Proposing Release, we Chairman of the National Venture Capital of its prior investments). Under our rule, a venture noted our concerns with adopting a definition for Association, wrote in congressional testimony that capital fund could invest in such companies under a ‘‘small’’ company, including reliance on the SBIA ‘venture capital did not contribute to the implosion the non-qualifying basket. regulatory standards for treatment as a ‘‘small’’

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Under our rule, a qualifying portfolio portfolio company that subsequently capital funds that provide capital to company is defined to include a becomes a reporting company. portfolio companies for operating and company that is not a reporting business purposes (in exchange for an b. Portfolio Company Leverage company (and does not have a control equity investment) and leveraged relationship with a reporting company) Rule 203(l)–1 defines a qualifying buyout funds, which acquire controlling at the time of each fund investment.165 portfolio company for purposes of the equity interests in operating companies However, one commenter observed that exemption as one that does not borrow through the ‘‘buyout’’ of existing an existing investment in a portfolio or issue debt obligations in connection security holders or which finance such company that ultimately becomes a with the venture capital fund’s investments or with borrowed successful venture capital investment investment in the company and money.173 We proposed these elements (such as when the company issues its distribute to the fund the proceeds of of the qualifying portfolio company such borrowing or issuance in exchange definition because of the focus on securities in a public offering or 169 becomes a reporting company) should for the fund’s investment. As a leverage in the Dodd-Frank Act as a not result in the investment becoming a consequence, certain types of funds that potential contributor to systemic risk as use leverage or finance their non-qualifying investment.166 We agree. discussed by the Senate Committee investments in portfolio companies or Under the rule, such an investment report,174 and the testimony before the buyout of existing investors with would not become a non-qualifying Congress that stressed the lack of borrowed money (e.g., investment because the definition leverage in venture capital investing.175 funds, which are a different subset of focuses on the time at which the venture Some commenters argued that private equity funds) would not meet defining a venture capital fund as a fund capital fund acquires the particular the rule’s definition of a venture capital that does not participate in buyouts was equity security issued by a portfolio fund.170 As discussed in greater detail too restrictive or too difficult to company and does not limit the below and in the Proposing Release, we apply.176 Most of the commenters who definition of qualifying portfolio believe that Congress did not intend the addressed the issue opposed a company solely to companies that are venture capital fund definition to apply definition that excluded any buyouts of and remain non-reporting companies. to these types of private equity funds.171 portfolio company securities by venture Under this approach, an adviser could We proposed to define a qualifying capital funds.177 continue to rely on the exemption even portfolio company as a company that Some commenters if the venture capital fund’s portfolio does not borrow ‘‘in connection’’ with a argued that because a venture capital ultimately consisted entirely of venture capital fund investment. We fund could, under the proposed rule, securities that become securities of also proposed to define a qualifying acquire up to 20 percent of portfolio reporting companies. We believe that portfolio company as a company that company securities in secondary our approach would give advisers to does not participate in an indirect transactions, indirect buyouts achieved venture capital funds sufficient at the portfolio company level should buyout involving a qualifying fund (as 178 flexibility to exercise their business a corollary to our proposed limitation not be precluded. Some commenters judgment on the appropriate time to on venture capital fund acquisitions of stated that buyouts are an important dispose of portfolio company portfolio company securities through means of providing liquidity to portfolio investments—whether that occurs at a secondary transactions, i.e., direct company founders, employees, former employees and vendors/service time when the company is or is not a buyouts).172 We proposed these 167 providers,179 reporting company. Moreover, under elements to distinguish between venture while others argued that the Federal securities laws, a person, 173 such as a venture capital fund, that is 169 Rule 203(l)–1(c)(4)(ii). See generally Proposing Release, supra note 26, at sections II.A.1.c. and d. deemed to be an affiliate of a company 170 Leveraged buyout funds are private equity 174 funds that will ‘‘borrow significant amounts from See S. Rep. No. 111–176, supra note 6, at 74 may be limited in its ability to dispose (‘‘The Committee believes that venture capital of the company’s securities.168 Under banks to finance their deals—increasing the debt-to- equity ratio of the acquired companies * * *’’ U.S. funds, a subset of private investment funds the final rule, a qualifying fund would Govt. Accountability Office, Private Equity: Recent specializing in long-term equity investment in small not be in the position of having to Growth in Leveraged Buyouts Exposed Risks that or start-up businesses, do not present the same risks dispose of securities of a qualifying Warrant Continued Attention (2008) (‘‘GAO Private as the large private funds whose advisers are Equity Report’’), at 1. A leverage buyout fund in required to register with the SEC under this title.’’); 2005 typically financed a deal with 34% equity and id. at 75 (concluding that private equity funds that company, which generally imposes specific tests for 66% debt. Id. at 13. See also Fenn et al., supra note use limited or no leverage at the fund level engage net worth, net income or number of employees for 150, at 23 (companies that have been taken private in activities that do not pose risks to the wider each type of company, depending on its geographic in a leveraged buyout (or ‘‘LBO’’) transaction markets through credit or counterparty location and industry classification. See Proposing generally ‘‘spend less on research and development, relationships). Release, supra note 26, at n.69 and accompanying relative to assets, and have a greater proportion of 175 See Proposing Release, supra note 26, at n.100. and following text. We have considered the issues fixed assets; their debt-to-assets ratios are high, 176 See, e.g., McGuireWoods Letter; NVCA Letter; raised in the NASBIC/SBIA Letter and continue to above 60 percent, and are two to four times those Pine Brook Letter. believe that a qualifying portfolio company should of venture-backed firms.’’ Moreover, compared to 177 One commenter sought interpretative not be defined by reference to whether a company venture capital backed companies, LBO-private guidance on which buyout transactions would be is ‘‘small’’ for the reasons cited in the Proposing equity backed companies that are taken public considered to be ‘‘in connection with’’ a venture Release. typically use proceeds from an IPO to reduce debt capital fund investment. Mesirow Letter. See also 165 See rule 203(l)–1(c)(4)(i). whereas new venture capital backed firms tend to McGuireWoods Letter; NVCA Letter (discussing 166 PTV Sciences Letter (stating that following a use proceeds to fund growth.); Testimony of Mark some interpretative issues with the ‘‘in connection merger or public offering of a qualifying portfolio Tresnowksi, General Counsel, Madison Dearborn with’’ language). company’s securities, the shares held by the fund Partners, LLC, on behalf of the Private Equity 178 ATV Letter; NVCA Letter. See also ABA Letter ‘‘are turned into profits to our investors’’). Council, before the Senate Banking Subcommittee (also recommending that the buyout bucket be 167 See Proposing Release, supra note 26, at n.55 on Securities, Insurance and Investment, July 15, increased to 30%); Charles River Letter (supported and following text. 2009, at 2 (indicating that portfolio companies in a 20% buyout limit to accommodate the increasing 168 See sections 2(a)(11) (defining ‘‘underwriter’’) which private equity funds invest typically have industry use of buyouts); First Round Letter and 5 of the Securities Act. See also E.H. Hawkins, 60% debt and 40% equity). (supported 25% buyout limit for each deal and a SEC Staff No-Action Letter (June 26, 1997) (staff 171 See discussion in section II.A.1.c. and d. of the 20% limit for all fund investments in order to explained how the term ‘‘underwriter’’ in the Proposing Release, supra note 26. facilitate liquidity to founders). Securities Act restricts resales of securities by 172 Proposed rules 203(l)–1(a)(2)(i); (c)(4)(ii) and 179 See, e.g., Davis Polk Letter; ESP Letter; SVB affiliates of issuing companies). (c)(4)(iii). Letter.

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buyouts occurring as a result of venture capital funds provide capital to venture capital funds, hold the recapitalizations180 or conversions of many types of businesses at different investment for shorter periods of permissible bridge loans 181 should not stages of development,185 generally with time.190 As a result of the use of the preclude a fund from relying on the the goal of financing the expansion of capital provided and the incurrence of definition.182 the company 186 and helping it progress this debt, following the buyout fund We have eliminated the proposed to the next stage of its development investment, the operating company may indirect buyout criterion in the final through successive tranches of carry debt several times its equity and rule. Because the non-qualifying basket investment (i.e., ‘‘follow-on’’ may devote significant levels of its cash does not exclude secondary market investments) if the company reaches flow and corporate earnings to repaying transactions (or other buyouts of agreed-upon milestones.187 the debt financing, rather than investing existing security holders), it would be In contrast, private equity funds that in capital improvement or business inconsistent to define a venture capital are identified as buyout funds typically operations.191 fund as a fund that does not participate provide capital to an operating company Some commenters agreed that in a buyout. in exchange for majority or complete distinguishing between venture capital We are retaining and clarifying, ownership of the company,188 generally and other private funds with reference however, the leveraged buyout criterion achieved through the buyout of existing to a portfolio company’s leverage and as it relates to qualifying portfolio shareholders or other security holders indirect buyouts is important.192 Many companies. We had proposed to define and financed with debt incurred by the commenters, however, urged a more a qualifying portfolio company as a portfolio company,189 and compared to narrowly drawn restriction on a company that, among other things, does portfolio company’s ability to borrow not borrow ‘‘in connection’’ with a 185 See, e.g., McGuire Testimony, supra note 151, (or issue debt) or to effect indirect venture capital fund investment. As at 1; NVCA Yearbook 2010, supra note 150; buyouts.193 Some argued that the noted above, we proposed this element PricewaterhouseCoopers/National Venture Capital Association MoneyTree Report, Q4 2009/Full-year manner in which proceeds from to distinguish venture capital funds 2009 Report (providing data on venture capital indebtedness are used by a portfolio from leveraged buyout funds, and we investments in portfolio companies); James Schell, company (e.g., distributed by the continue to believe that this remains an Private Equity Funds: Business Structure and company to the venture capital fund) important distinction. We believe that Operations (2010), at § 1.03[1] (‘‘Schell’’), at § 1.03[1]; Paul A. Gompers & Josh Lerner, The better distinguishes venture capital these differences (i.e., the use of buyouts Venture Capital Cycle, at 459 (MIT Press 2004), at funds from leveraged buyout private and associated leverage) distinguish 178, 180 table 8.2 (displaying percentage of annual equity funds.194 Nevertheless, the venture capital funds from buyout venture capital investments by stage of majority of commenters who addressed private equity funds for which Congress development and classifying ‘‘early stage’’ as seed, start-up, or early stage and ‘‘late stage’’ as this criterion supported a leverage 183 did not provide an exemption. expansion, second, third, or bridge financing). criterion that would be more specific, or One of the distinguishing features of 186 See McGuire Testimony, supra note 151, at 1; venture capital funds is that, unlike Loy Testimony, supra note 151, at 3 (‘‘Once the Institute (Nov. 2, 2007) at 2 (noting that in a many hedge funds and private equity venture fund is formed, our job is to find the most leveraged buyout ‘‘private equity investors use the funds, they invest capital directly in promising, innovative ideas, entrepreneurs, and proceeds of debt issued by the target company to companies that have the potential to grow acquire all the outstanding shares of a public portfolio companies for the purpose of exponentially with the application of our expertise company, which then becomes private’’). funding the expansion and development and venture capital investment.’’). See also William 190 Unlike venture capital funds, which generally of the company’s business rather than A. Sahlman, The Structure and Governance of invest in portfolio companies for 10 years or more, buying out existing security holders, Venture-Capital Organizations, Journal of Financial private equity funds that use leveraged buyouts Economics 27 (1990), at 473, 503 (‘‘Sahlman’’) invest in their portfolio companies for shorter otherwise purchasing securities from (noting venture capitalists typically invest more periods of time. See Loy Testimony, supra note 151, other shareholders, or leveraging the than once during the life of a company, with the at 3 (citing venture capital fund investments capital investment with debt expectation that each capital investment will be periods in portfolio companies of five to 10 years financing.184 Testimony received by sufficient to take the company to the next stage of or longer); van den Burg, supra note 189, at 19 development, at which point the company will (noting that LBO investors generally retain their Congress and our research suggest that require additional capital to make further progress). investment in a listed company for 2 to 4 years or 187 See Sahlman, supra note 186, at 503; Loy even less after the company goes public). See also 180 Alta Partners Letter; BioVentures Letter. Testimony, supra note 151, at 3 (‘‘[W]e continue to Paul A. Gompers, The Rise and Fall of Venture 181 ATV Letter; NVCA Letter. invest additional capital into those companies that Capital, Business And Economic History, vol. 23, 182 See also Pine Brook Letter (suggesting ‘‘careful are performing well; we cease follow-on no. 2, Winter 1994, at 17 (stating that ‘‘an LBO drafting’’ that would not preclude transactions in investments into companies that do not reach their investment is significantly shorter than that of a the normal course of business by defining a set of agreed upon milestones.’’). comparable venture capital investment. Assets are prohibited buyout transactions (e.g., ‘‘leveraged 188 GAO Private Equity Report, supra note 170, at sold off almost immediately to meet debt burden, dividend recapitalizations’’)). 8 (‘‘A private equity-sponsored LBO generally is and many companies go public again (in a reverse 183 See supra note 174 and accompanying text. defined as an investment by a private equity fund LBO) in a very short period of time.’’). 191 184 See Loy Testimony, supra note 151, at 2 in a public or private company (or division of a See Barrett et al., supra note 189. See also (‘‘Although venture capital funds may occasionally company) for majority or complete ownership.’’). Fenn et al., supra note 150, at 23 (companies that borrow on a short-term basis immediately preceding 189 See Annalisa Barrett et al., Prepared by the have been taken private in an LBO transaction the time when the cash installments are due, they Corporate Library Inc., under contract for the IRRC generally ‘‘spend less on research and development, do not use debt to make investments in excess of Institute, What is the Impact of Private Equity relative to assets, and have a greater proportion of the partner’s capital commitments or ‘lever up’ the Buyout Fund Ownership on IPO Companies’ fixed assets; their debt-to-assets ratios are high, fund in a manner that would expose the fund to Corporate Governance?, at 7 (June 2009) (‘‘Barrett et above 60%, and are two to four times those of losses in excess of the committed capital or that al.’’) (‘‘In general, VC firms provide funding to venture-backed firms.’’ Moreover, compared to would result in losses to counter parties requiring companies in early stages of their development, and venture capital backed companies, LBO-private a rescue infusion from the government.’’). See also the money they provide is used as working capital equity backed companies that are taken public infra notes 189–191; Mark Heesen & Jennifer C. for the firm. Buyout firms, in contrast, work with typically use proceeds from an IPO to reduce debt Dowling, National Venture Capital Association, mature companies, and the funds they provide are whereas new venture capital backed firms tend to Venture Capital & Adviser Registration (October used to compensate the firm’s existing owners.’’); use proceeds to fund growth.). 2010), materials submitted in connection with the Ieke van den Burg and Poul Nyrup Rasmussen, 192 See, e.g., AFL–CIO Letter; Sen. Levin Letter; Commission’s Government-Business Forum on Hedge Funds and Private Equity: A Critical Pine Brook Letter. Small Business Capital Formation (summarizing the Analysis (2007), at 16–17 (‘‘van den Burg’’); 193 See, e.g., ATV Letter; Charles River Letter; differences between venture capital funds and Sahlman, supra note 186, at 517. See also Tax NVCA Letter; Oak Investment Letter; Pine Brook buyout and hedge funds), available at http:// Legislation: CRS Report, Taxation of Hedge Fund Letter. www.sec.gov/info/smallbus/ and Private Equity Managers, Tax Law and Estate 194 See, e.g., NVCA Letter; Pine Brook Letter; SV 2010gbforumstatements.htm. Planning Course Handbook Series, Practicing Law Life Sciences Letter; Vedanta Letter.

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limited, in scope,195 focusing on the use limitation of the proposed rule and the qualifying portfolio company satisfies of proceeds derived from portfolio concerns raised by commenters, we are the definition. company leverage.196 Commenters modifying the qualifying portfolio c. Operating Company suggested that the rule define leverage company leverage criterion to define a as leverage incurred for the purpose of qualifying portfolio company as any Rule 203(l)–1 defines the term buying out shareholders at the demand company that does not both borrow (or qualifying portfolio company for the 197 of the venture capital fund or for issue debt) in connection with a venture purposes of the exemption to exclude 198 returning capital to the fund, and not, capital fund investment and distribute any private fund or other pooled for example, define leverage to include the proceeds of such borrowing or investment vehicle.202 Under the rule, a indebtedness incurred to pay for a issuance to the venture capital fund in qualifying portfolio company could not qualifying portfolio company’s exchange for the fund’s investment. In be another private fund, a commodity operating expenses.199 contrast to the proposed rule, the final Some commenters argued that the pool or other ‘‘investment rule more specifically delineates the companies.’’ 203 We are adopting this proposed ‘‘in connection with’’ element types of leveraged transactions would be difficult to apply, arguing that criterion because Congress did not involving a qualifying fund (i.e., a express an intent to include venture the standard was too vague or raised too company’s distribution of proceeds 200 capital funds of funds within the many interpretative issues. In received in a debt offering to the response to our request for comment, definition.204 In the Senate Report, qualifying fund) that would result in the Congress characterized venture capital many commenters sought confirmation company being excluded from the that the limitation on portfolio company as a subset of private equity definition of a qualifying portfolio leverage would be triggered only in the ‘‘specializing in long-term equity company. We believe that these instances of leverage provided to the investment in small or start-up modifications more closely achieve our portfolio company by the venture businesses’’ 205 and did not refer to goal of distinguishing advisers to capital fund or if portfolio company funds investing in other funds. venture capital funds from other types borrowing were effected in satisfaction Moreover, testimony to Congress of private funds for which Congress did of a contractual obligation with the described venture capital investments in not provide an exemption because it venture capital fund.201 operating companies rather than other looks to the substance, not just the form, After careful consideration of the private funds.206 intended purpose of the leverage of a transaction or series of transactions. Moreover, without this definitional This definition of qualifying portfolio criterion, a qualifying fund could 195 See, e.g., ATV Letter; Charles River Letter company would only exclude circumvent the intended scope of the (supports modifying the rule so that up to 20% of companies that borrow in connection fund capital commitments may be invested in with a venture capital fund’s investment rule by investing in other pooled portfolio companies that do not adhere to the investment vehicles that are not leverage condition provided that the venture capital and distribute such borrowing proceeds fund is not the party providing the leverage to the to the venture capital fund in exchange themselves subject to the definitional 207 company); NVCA Letter; Comment Letter of the for the investment, but would not criteria under our rule. For example, Securities Regulation Committee of the Business exclude companies that borrow in the without this criterion, a venture capital Law Section of the New York State Bar Association, fund could circumvent the intent of the Apr. 1, 2011 (‘‘NYSBA Letter’’); SVB Letter. ordinary course of their business (e.g., to 196 Although two commenters supported the finance inventory or capital equipment, rule by incurring off-balance sheet leverage limitation as proposed (see AFL–CIO Letter manage cash flows, meet payroll, etc.). leverage or indirectly investing in (also supporting a specific prohibition on borrowing Under the rule, a venture capital fund reporting companies in excess of the 20 by a portfolio company to pay dividends or fees to percent limit for non-qualifying the venture capital fund); Sen. Levin Letter could provide financing or loans to a (together with the equity investment requirement, portfolio company, provided that the the definition appropriately excludes leveraged financing meets the definition of equity 202 Rule 203(l)–1(c)(4)(iii). For this purpose, buyout funds)), two other commenters opposed it, pooled investment vehicles include investment arguing that qualifying portfolio company leverage security or is made subject to the 20 companies, issuers relying on rule 3a–7 under the should not be restricted at all (see ESP Letter (limits percent limit for non-qualifying Investment Company Act and commodity pools. 17 on leverage would prevent portfolio companies investments. Although we would CFR 270.3a–7. from receiving lending from funds and generally view any financing to a 203 Under the ‘‘holding out’’ criterion (discussed state governments and lenders rather than in Section II.A.7. below), a fund that represents regulators should determine the appropriate level of portfolio company that was provided itself as pursuing a venture capital strategy to portfolio company debt); Merkl Letter (young by, or was a condition of a contractual investors implies that the fund invests primarily in negative EBITDA companies would not be able to obligation with, a fund or its adviser as operating companies and not for example in entities obtain significant amounts of debt and hence no part of the fund’s investments in the that hold oil and gas leases. leverage prohibition is required)). See also NASBIC/ 204 company as being a type of financing One commenter agreed that ‘‘there is no SBIA Letter (portfolio companies should not be indication that Congress intended the venture precluded from accessing leverage); Sevin Rosen that is ‘‘in connection with’’ the fund’s capital exemption to apply to ‘funds of funds,’’’ but Letter, Pine Brook Letter (each expressed support investment, the definition’s limitation argued that the qualifying portfolio company for a use of proceeds approach). would only apply if the proceeds of definition was ‘‘unduly restrictive’’ because it 197 See, e.g., Gunderson Dettmer Letter; McDonald such financing were distributed to the would exclude such funds of funds and discourage Letter; NVCA Letter; SVB Letter. use of special purpose vehicles. ABA Letter. 198 See, e.g., McDonald Letter; NVCA Letter. venture capital fund in exchange for its 205 S. Rep. No. 111–176, supra note 6, at 74. 199 Gunderson Dettmer Letter; Pine Brook Letter; investment. Moreover, subsequent 206 See generally Loy Testimony, supra note 151, Trident Letter; Vedanta Letter. One commenter distributions to the venture capital fund and McGuire Testimony, supra note 151. suggested that a use of proceeds test would be solely because it is an existing investor 207 One commenter indicated that it was difficult to enforce because such a test would need would not be inconsistent with this ‘‘sympathetic’’ to the Commission’s concerns about to be extremely detailed in order to prevent the use of structures to circumvent circumvention. See Merkl Letter. criterion. We believe that this the intended purpose of the exemption, and agreed 200 See, e.g., Merkl Letter; Sevin Rosen Letter; modification to the rule adequately that such ‘‘investments would unacceptably SVB Letter. distinguishes between venture capital heighten the possibility for abuse.’’ See NVCA 201 See, e.g., ABA Letter; ATV Letter; Bessemer funds and leveraged buyout funds and Letter (suggesting that the Commission address this Letter; Mesirow Letter; NVCA Letter; SV Life concern by applying the venture capital fund Sciences Letter. See also Proposing Release, supra provides a simpler and clearer approach leverage limit on a full ‘‘look-through’’ basis to the note 26, discussion at section II.A.1.c. to determining whether or not a underlying funds).

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investments.208 Our exclusion is similar or do not pose systemic risk.215 Other did not use the existing BDC definitions to the approach of other definitions of commenters advocated a definition that when determining the scope of the ‘‘venture capital’’ discussed in the would permit investments in qualifying venture capital exemption, and the Proposing Release, which limit portfolio companies held through an primary policy considerations that led investments to operating companies and intermediate holding company structure to the adoption of the BDC exemptions thus would exclude investments in formed solely for tax, legal or regulatory differed from those under the Dodd- other private funds or securitized asset reasons.216 Frank Act.220 vehicles.209 For purposes of the definition of a Commenters presented several Many commenters opposed the qualifying portfolio company, we agree problems with the application of the that a fund may disregard a wholly managerial assistance criterion and its operating company criterion and owned intermediate holding company intended scope under the proposed rule. recommended that the rule include fund formed solely for tax, legal or regulatory Some objected to the managerial of venture capital fund structures.210 reasons to hold the fund’s investment in assistance criterion as proposed, arguing Some commenters supported no limits a qualifying portfolio company. Such that such assistance to (or control of) a on investments in other pooled structures are used to address the portfolio company is not a key or investment vehicles,211 while others particular needs of venture capital funds distinguishing characteristic of venture supported broadening the definition to or their investors and are not intended capital investing; 221 that relationships include funds that invest in other funds to circumvent the rule’s general between qualifying funds and qualifying if either (i) the underlying funds qualify limitation on investing in other portfolio companies may be less formal as venture capital funds (i.e., comply 217 212 investment vehicles. and may not constitute management or with rule 203(l)–1) or (ii) investment We do not agree, however, that control of a portfolio company under in underlying funds does not exceed a Congress viewed funds of venture the proposed rule; 222 or that the specified threshold (such as a capital funds as being consistent with 213 discretion to determine the extent of percentage of fund capital). the exemption, and continue to believe involvement with a portfolio company Commenters argued that broadening the that this criterion remains an important should not affect a qualifying fund’s definition of qualifying portfolio tool to prevent circumvention of the ability to satisfy the definitional company was necessary in order to intended scope of the venture capital criterion.223 accommodate current business exemption. A fund strategy of selecting Most commenters sought guidance on 214 practices, or was appropriate because a venture capital or other private fund determining what activities would funds of funds (including secondary in which to invest is different from a constitute managerial assistance or funds) provide investors with liquidity strategy of selecting qualifying portfolio ‘‘control.’’ 224 Other commenters companies. Nevertheless, we are specifically requested confirmation that 208 Similarly, a qualifying fund could not, for persuaded that a venture capital fund’s a management rights letter for purposes example, invest in an investment management entity (e.g., a general partner entity) that in turn limited ability to invest a limited of ‘‘venture capital operating company’’ invests in another pooled vehicle, except as an portion of its assets in other pooled status under ERISA would be investment under the non-qualifying basket. investment vehicles would not be sufficient.225 Finally, some commenters 209 See Proposing Release, supra note 26, at inconsistent with the intent of the rule recommended that the rule address nn.70–72 (discussing the California venture capital if the fund primarily invests directly in syndicated transactions,226 and provide exemption and the VCOC definition under ERISA, 29 CFR 2510.3–101(d)). qualifying portfolio companies. As a that the managerial assistance criterion 210 See, e.g., NVCA Letter; Sevin Rosen Letter; result, for purposes of the exemption, would be satisfied if one fund within Comment Letter of VCFA Group (Jan. 21, 2011). investments in other private funds or the syndicate provided the requisite 211 See, e.g., Cook Children’s Letter; Leland Fikes venture capital funds could be made assistance or control.227 Letter; Merkl Letter. using the non-qualifying basket. 212 See, e.g., ATV Letter, Charles River Letter, 220 See id., at section II.A.2. NVCA Letter, Sevin Rosen Letter (specifically in the 4. Management Involvement 221 Merkl Letter; SVB Letter (managerial context of funds of ‘‘seed’’ funds); SVB Letter, assistance criterion is unnecessary because it does Vedanta Letter (85% cap for investments in rule We are not adopting a managerial not distinguish venture capital funds from other 203(l)–1 compliant, unleveraged funds). See also assistance element of the rule, as types of funds providing managerial assistance). Dechert General Letter (suggested that funds originally proposed. We proposed that 222 investing solely in venture capital funds should be ESP Letter. permitted or, in the alternative, investments of up advisers seeking to rely on the rule have 223 Sevin Rosen Letter. to 20% of committed capital should be permitted a significant level of involvement in 224 BCLBE Letter; Gunderson Dettmer Letter; in ‘‘incubator’’ funds). developing a fund’s portfolio McGuireWoods Letter; Shearman Letter. Shearman 213 First Round Letter (supported investments in companies.218 We modeled our sought confirmation on whether control included both direct and indirect control, and BCLBE sought underlying funds representing no more than 10% proposed approach to managerial of a fund’s called capital, measured at the end of confirmation that board representation would be the fund’s term); ATV Letter and Charles River assistance in part on existing provisions sufficient for control purposes. Other commenters, Letter (supported investments in underlying funds under the Advisers Act and the however, acknowledged that the ‘‘offer-only’’ representing no more than 20% of a fund’s Investment Company Act dealing with element of the proposed rule would provide sufficient flexibility for a venture capital fund to committed capital subject to other conditions); PEI BDCs. These provisions were added Funds Letter (supports ‘‘substantial’’ investment in alter its relationship with a portfolio company over venture capital investments rather than a specific over the years to ease the regulatory time. See, e.g., First Round Letter; NVCA Letter. numerical threshold); Comment Letter of Private burden on venture capital and other The NVCA and one other commenter did not Equity Investors, Inc. and Willowbridge Partners, private equity investments.219 Congress support imposing specific requirements as to what Inc. (Jan. 7, 2011) (‘‘PEI/Willowbridge Letter’’) constituted managerial assistance. See NVCA Letter (supported investments in other qualifying funds (definitive requirements are not appropriate); Sevin 215 representing at least 50% of the qualifying fund’s See, e.g., PEI/Willowbridge Letter and VIA Rosen Letter (opposed requiring board seat or assets or committed capital) and Comment Letter of Letter. observer rights). Venture Investment Associates (Jan. 24, 2011) (‘‘VIA 216 See, e.g., ABA Letter; Davis Polk Letter; NVCA 225 ATV Letter; Charles River Letter; NVCA Letter; Letter’’) (supported investments in underlying Letter. Oak Investment Letter; Sante´ Ventures Letter; Sevin funds representing at least 50% of a qualifying 217 See, e.g., Davis Polk Letter for a discussion of Rosen Letter; Village Ventures Letter. fund’s capital commitments). these considerations. 226 ABA Letter; ESP Letter; McGuireWoods Letter. 214 See, e.g., ATV Letter, Charles River Letter, 218 See Proposing Release, supra note 26, section 227 ABA Letter (asserted that most deals are Cook Children’s Letter, Leland Fikes Letter (each of II.A.2. syndicated deals). See also Dechert General Letter; which cited the use of technology incubators). 219 See id., at n.123. ESP Letter (indicating that in syndicated

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We appreciate the difficulties of portfolio company is not subject to the criterion, arguing that venture capital applying the managerial assistance 120 calendar day limit.230 fund financing would generally not criterion under the proposed definition The 15 percent threshold is exceed 15 percent of fund capital and in particular the issues associated determined based on the venture capital commitments or remain outstanding for with a qualifying fund proving fund’s aggregate capital commitments. longer than 120 days.236 compliance when it participates in a In practice, this means that a qualifying We decline to increase the leverage syndicated transaction involving fund could leverage an investment threshold for a qualifying fund under multiple funds. We are persuaded that transaction up to 100 percent when the rule or exclude other certain types to modify the rule to specify which acquiring equity securities of a of borrowings as requested by some activities constitute ‘‘managerial particular portfolio company as long as commenters. Our rule defines a venture assistance’’ would introduce additional the leverage amount does not exceed 15 capital fund by reference to a maximum complexity and require us to insert our percent of the fund’s total capital of 15 percent of borrowings based on judgment for that of a venture capital commitments. our understanding that venture capital funds typically would not incur fund’s adviser regarding the minimum Although a minority of commenters borrowings in excess of 10 to 15 percent level of portfolio company involvement generally supported the leverage 231 of the fund’s total capital contributions that would be appropriate for the fund, criterion as proposed, many and uncalled capital commitments,237 rather than enabling investors to select commenters sought to broaden it in several ways. Two commenters that which commenters have confirmed.238 venture capital funds based in part on We believe that imposing a maximum at 228 generally supported the leveraged their level of involvement. We also the upper range of borrowings typically appreciate that the offer of managerial criterion also recommended that the criterion exclude uncalled capital used by venture capital funds will assistance may not distinguish venture accommodate existing practices of the capital funds from other types of funds. commitments so that a qualifying fund could not incur excessive leverage.232 vast majority of industry participants. While many venture capital fund Although determining the leverage Our rule specifies that the 15 percent advisers do provide managerial criterion as a percentage of total fund calculation must be determined based assistance, we believe that the capital commitments may enable a on the fund’s aggregate capital managerial assistance criterion, as contributions and uncalled capital qualifying fund to incur a degree of 239 proposed, does not distinguish these leverage that represents a commitments. Unlike most registered advisers from other advisers, would be disproportionate percentage of the investment companies or hedge funds, difficult to apply and could be fund’s assets early in the life of the venture capital funds rely on investors unnecessarily prescriptive without fund, the leverage criterion is also funding their capital commitments from creating benefits for investors. As a time to time in order to acquire portfolio constrained by the 120 calendar day 240 consequence of our modification to the limit. Therefore, we do not believe it is companies. A capital commitment is proposed rule, a qualifying fund is not necessary to exclude uncalled capital a contractual obligation to acquire an required to offer (or provide) managerial commitments from the leverage interest in, or provide the total assistance to, or control any, qualifying criterion. commitment amount over time to, a portfolio company in order to satisfy the Other commenters proposed to fund, when called by the fund. definition. exclude from the 15 percent leverage Accordingly, an adviser to venture limitation capital call lines of credit capital funds manages the fund in 5. Limitation on Leverage (i.e., venture capital fund borrowings anticipation of all investors fully funding their commitments when due Under rule 203(l)–1, a venture capital repaid with proceeds of capital calls from fund investors),233 or borrowings and typically has the right to penalize fund is a private fund that does not investors for failure to do so.241 Venture borrow, issue debt obligations, provide by a venture capital fund in order to meet fee and expense obligations.234 guarantees or otherwise incur leverage, 236 NVCA Letter. See also Merkl Letter. One commenter sought to increase the in excess of 15 percent of the fund’s 237 See Loy Testimony, supra note 151, at 6 capital contributions and uncalled leverage threshold from 15 percent to 20 (‘‘[M]any venture capital funds significantly limit percent.235 One commenter, on behalf of borrowing such that all outstanding capital committed capital, and any such borrowed by the fund, together with guarantees of borrowing, indebtedness, guarantee or many venture capital advisers, however, agreed with the proposed leverage portfolio company indebtedness, does not exceed leverage is for a non-renewable term of the lesser of (i) 10–15% of total limited partner no longer than 120 calendar days.229 For commitments to the fund and (ii) undrawn limited 230 Id. purposes of this leverage criterion, any partner commitments.’’). 231 See Sen. Levin Letter; NVCA Letter. See also 238 NVCA Letter. See also Merkl Letter; Oak guarantee by the private fund of a AFL–CIO Letter, AFR Letter (generally supported Investments Letter. qualifying portfolio company’s the leverage limit but also supported excluding 239 Rule 203(l)–1(a)(3). obligations up to the value of the private uncalled capital commitments); Oak Investment 240 Schell, supra note 185, at § 1.03[8] (‘‘The Letter (generally supported the leverage limit, but fund’s investment in the qualifying typical Venture Capital Fund calls for Capital did not agree that the 120-day limit should apply Contributions from time to time as needed for to guarantees of portfolio company obligations by investments.’’); id. at § 2.05[2] (stating that transactions, there may be varying degrees of venture capital funds). ‘‘[venture capital funds] begin operation with managerial involvement by funds participating in 232 AFR Letter; AFL–CIO Letter. Capital Commitments but no meaningful assets. the transactions; one fund may take an active role, 233 Cook Children’s Letter; Leland Fikes Letter; Over a specific period of time, the Capital with the other funds taking a more passive role with SVB Letter. We would view a line of credit used Commitments are called by the General Partner and respect to portfolio companies). to advance anticipated committed capital that used to acquire Portfolio Investments.’’). 228 For example, one commenter indicated that remains available for longer than 120 days to be 241 See Loy Testimony, supra note 151, at 5 although it may seek to offer assistance to portfolio consistent with the criterion, if each drawdown is (‘‘[Limited partners] make their investment in a companies, not all of the companies have accepted. repaid within 120 days and subsequent drawdowns venture fund with the full knowledge that they Charles River Letter. Similarly, a number of venture relate to subsequent capital calls. generally cannot withdraw their money or change capital advisers stated that their funds may invest 234 Dechert General Letter. their commitment to provide funds. Essentially they in a significant but non-controlling stake in 235 See Charles River Letter (argued that a agree to ‘‘lock-up’’ their money for the life of the underlying portfolio companies. See, e.g., ATV qualifying fund should be able to borrow, without fund * * *’’). See also Stephanie Breslow & Phyllis Letter; First Round Letter. limit on duration, up to 20% of capital Schwartz, Private Equity Funds, Formation and 229 Rule 203(l)–1(a)(3). commitments with the consent of its investors). Continued

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capital funds are subject to investment during which a qualifying fund’s contrast with other types of private restrictions, and, during the initial years leverage could remain outstanding. funds such as hedge funds, which may of a fund, calculate fees payable to an Some recommended extending the 120- engage in trading strategies that may adviser as a percentage of the total day limit with respect to leverage to 180 contribute to systemic risk and affect the capital commitments of investors, days with one 180-day renewal in the public securities markets.252 For this regardless of whether or not the capital case of non-convertible bridge loans reason, our proposed rule was designed commitment is ultimately fully funded extended by the venture capital fund to to address concerns that financial by an investor.242 Venture capital fund a portfolio company.245 Others seeking leverage may contribute to systemic risk advisers typically report and market to accommodate business practices and by excluding funds that incur more than themselves to investors on the basis of provide maximum flexibility for venture a limited amount of leverage from the aggregate capital commitment amounts capital fund debt investments in definition of venture capital fund.253 We raised for prior or existing funds.243 portfolio companies recommended believe that the alternative approach to These factors would lead to the excluding guarantees of portfolio fund leverage we have adopted in the conclusion that, in contrast to other company debt by a venture capital fund final rule better reflects industry types of private funds, such as hedge from the 120-day limit.246 Other practice while still addressing Congress’ funds, which trade on a more frequent commenters argued that guarantees of concern that the use of financial basis, a venture capital fund would view portfolio company obligations would leverage may create the potential for the fund’s total capital commitments as not result in qualifying funds incurring systemic risk. extensive leverage.247 the primary metric for managing the 6. No Redemption Rights fund’s assets and for determining We understand that guarantees of compliance with investment guidelines. portfolio company leverage by a venture We are adopting as proposed the Hence, we believe that calculating the capital fund are typically limited to the definitional element under which a leverage threshold to include uncalled value of the fund’s investment in the venture capital fund is a private fund capital commitments is appropriate, company (often through a pledge of the that issues securities that do not provide 248 given that capital commitments are fund’s interest in the company). Such investors redemption rights except in already used by venture capital funds guarantees by a qualifying fund may ‘‘extraordinary circumstances’’ but that help a qualifying portfolio company entitle investors generally to receive pro themselves to measure investment 254 guideline compliance. obtain credit for working capital rata distributions. Unlike hedge Thus, we are retaining the 15 percent purposes, rather than be used by the funds, a venture capital fund does not typically permit investors to redeem leverage threshold, as proposed, so that fund to leverage its investment in the 249 their interests during the life of the a qualifying fund could only incur debt company. We are persuaded that fund,255 but rather distributes assets (or provide guarantees of portfolio such guarantees of portfolio company generally as investments mature.256 company obligations) subject to this indebtedness do not present the same threshold. However, we are modifying types of risks identified by Congress. that would expose the fund to losses in excess of the leverage criterion to exclude from Congress cited the implementation of trading strategies that use financial the committed capital or that would result in losses the 120-calendar day limit any to counter parties requiring a rescue infusion from leverage by certain private funds as the government.’’). guarantee of qualifying portfolio 250 company obligations by the qualifying creating a potential for systemic risk. 252 See S. Rep. No. 111–176, supra note 6, at 74– fund, up to the value of the fund’s In testimony before Congress, the 75. venture capital industry identified the 253 In proposing an exemption for advisers to investment in the qualifying portfolio lack of financial leverage in venture private equity funds, which would have required company.244 Commenters generally the Commission to define the term ‘‘private equity capital funds as a basis for exempting argued in favor of extending the period fund,’’ the Senate Banking Committee noted the advisers to venture capital funds 251 in difficulties in distinguishing some private equity funds from hedge funds and expected the Operation 2010 (‘‘Breslow & Schwartz’’), at § 2:5.6 245 Commission to exclude from the exemption private (discussing the various remedies that may be See, e.g., NVCA Letter; Davis Polk Letter; Bessemer Letter. equity funds that raise significant potential imposed in the event an investor fails to fund its systemic risk concerns. S. Rep. No. 111–176, supra 246 Cook Children’s Letter; Leland Fikes Letter; contractual capital commitment, including, but not note 6, at 75. See also G20 Working Group 1, Gunderson Dettmer Letter; Oak Investment Letter; limited to, ‘‘the ability to draw additional capital Enhancing Sound Regulation and Strengthening SVB Letter. See also ABA Letter. from non-defaulting investors;’’ ‘‘the right to force Transparency, at 7 (March 25, 2009) (noting that 247 a sale of the defaulting partner’s interests at a price See, e.g., SVB Letter. unregulated entities such as hedge funds may determined by the general partner;’’ and ‘‘the right 248 See also NVCA Letter. contribute to systemic risks through their trading to take any other action permitted at law or in 249 See, e.g., Oak Investments Letter; SVB Letter. activities). equity’’). 250 See Proposing Release, supra note 26, at n. 136 254 Rule 203(l)–1(a)(4). 242 See, e.g., Breslow & Schwartz, supra note 241, and accompanying text. 255 See Schell, supra note 185, at § 1.03[7] at § 2:5.7 (noting that a cap of 10% to 25% of 251 See McGuire Testimony, supra note 151, at 7 (venture capital fund ‘‘redemptions and remaining capital commitments is a common (‘‘Venture capital firms do not use long term withdrawals are rarely allowed, except in the case limitation for follow-on investments). See also leverage, rely on short term funding, or create third of legal compulsion’’); Breslow & Schwartz, supra Schell, supra note 185, at § 1.01 (noting that capital party or counterparty risk * * *. [F]rom previous note 241, at § 2:14.2 (‘‘the right to withdraw from contributions made by the investors are used to testimony submitted by the buy-out industry, the the fund is typically provided only as a last resort’’). ‘‘make investments * * * in a manner consistent typical capital structure of the companies acquired 256 Loy Testimony, supra note 151, at 2–3 (‘‘As with the investment strategy or guidelines by a buyout fund is approximately 60% debt and portfolio company investments are sold in the later established for the Fund.’’); id. at § 1.03 40% equity. In contrast, borrowing at the venture years of the [venture capital] fund—when the (‘‘Management fees in a Venture Capital Fund are capital fund level, if done at all, typically is only company has grown so that it can access the public usually an annual amount equal to a fixed used for short-term capital needs (pending markets through an (an IPO) percentage of total Capital Commitments.’’); see drawdown of capital from its partners) and does not or when it is an attractive target to be bought–the also Dow Jones, Private Equity Partnership Terms exceed 90 days. Not only are our partnerships run liquidity from these ‘exits’ is distributed back to the and Conditions, 2007 edition (‘‘Dow Jones Report’’) without debt but our portfolio companies are limited partners. The timing of these distributions at 15. usually run without debt as well.’’); Loy Testimony, is subject to the discretion of the general partner, 243 See, e.g., NVCA Yearbook 2010, supra note supra note 151, at 2 (‘‘Although venture capital and limited partners may not otherwise withdraw 150, at 16; John Jannarone, Private Equity’s Cash funds may occasionally borrow on a short-term capital during the life of the venture [capital] Problem, Wall St. J., June 23, 2010, http:// basis immediately preceding the time when the fund.’’). Id. at 5 (Investors ‘‘make their investment online.wsj.com/article/SB10001424052748704 cash installments are due, they do not use debt to in a venture [capital] fund with the full knowledge 853404575323073059041024.html#printMode. make investments in excess of the partner’s capital that they generally cannot withdraw their money or 244 Rule 203(l)–1)(a)(3). commitments or ‘lever up’ the fund in a manner change their commitment to provide funds.

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Although venture capital funds events for these rights are typically they operate today, from hedge funds.264 typically return capital and profits to beyond the control of the adviser and Congressional testimony cited an investors only through pro rata fund investor (e.g., tax and regulatory investor’s inability to withdraw from a distributions, such funds may also changes). venture capital fund as a key provide extraordinary rights for an Most commenters addressing the characteristic of venture capital funds investor to withdraw from the fund redeemability criterion did not oppose and a factor for reducing their potential under foreseeable but unexpected it, but rather sought clarification or for systemic risk.265 Although a fund circumstances or to be excluded from guidance on the scope of its prohibiting redemptions would satisfy particular investments due to regulatory application.259 For example, the redeemability criterion of the 257 or other legal requirements. These commenters specifically requested venture capital fund definition, the rule events may be ‘‘foreseeable’’ because confirmation that the lack of does not specify a minimum period of they are circumstances that are known redeemability criterion would not time for an investor to remain in the to occur (e.g., changes in law, corporate preclude a qualifying fund from (i) fund. events such as mergers, etc.) but are making distributions of unexpected in their timing or scope. to a general partner,260 (ii) specifying In the Proposing Release, we Thus, withdrawal, exclusion or similar redemption rights for certain categories expressed the general concern that a ‘‘opt-out’’ rights would be deemed of investors under certain venture capital fund might seek to ‘‘extraordinary circumstances’’ if they circumstances 261 or (iii) specifying opt- circumvent the intended scope of this are triggered by a material change in the out rights for investors.262 Several criterion by providing investors with tax law after an investor invests in the commenters, however, indicated that nominally ‘‘extraordinary’’ rights to fund, or the enactment of laws that may the term ‘‘extraordinary circumstances’’ redeem that effectively result in de facto prohibit an investor’s participation in is sufficiently clear,263 suggesting that redemption rights in the ordinary the fund’s investment in particular the proposal did not require further course.266 One commenter expressly countries or industries.258 The trigger clarification. disagreed with this view, asserting that We believe that the term in the case of transfers effected with the Essentially they agree to ‘lock-up’ their money for ‘‘extraordinary circumstances’’ is consent of a general partner, such the life of the fund, generally 10 or more years as I stated earlier.’’). See also Dow Jones Report, supra sufficiently clear. Whether or not transactions are intended to note 242, at 60 (noting that an investor in a private specific redemption or ‘‘opt out’’ rights accommodate an investor’s internal equity or venture capital fund typically does not for certain categories of investors under corporate restructurings, bankruptcies have the right to transfer its interest). See generally Proposing Release, supra note 26, section II.A.4. certain circumstances should be treated or portfolio allocations rather than to 257 See Hedge Fund Adviser Registration Release, as ‘‘extraordinary’’ will depend on the provide investors with liquidity from supra note 14, at n.240 and accompanying text particular facts and circumstances. the fund.267 While consents to transfer (‘‘Many partnership agreements provide the For these purposes, for example, a do not raise the same level of concern investor the opportunity to redeem part or all of its investment, for example, in the event continuing to fund that permits quarterly or other as de facto redemption rights, we do not hold the investment became impractical or illegal, periodic withdrawals would be believe that an adviser or its related in the event of an owner’s death or total disability, considered to have granted investors persons could, while relying on the in the event key personnel at the fund adviser die, redemption rights in the ordinary course become incapacitated, or cease to be involved in the venture capital exemption, create de management of the fund for an extended period of even if those rights may be subject to an facto periodic redemption or transfer time, in the event of a merger or reorganization of initial lock-up or suspension or rights by, for example, regularly the fund, or in order to avoid a materially adverse restrictions on redemption. We believe, identifying potential investors on behalf tax or regulatory outcome. Similarly, some and several commenters confirmed, that investment pools may offer redemption rights that of fund investors seeking to transfer or can be exercised only in order to keep the pool’s the phrase ‘‘extraordinary redeem fund interests.268 assets from being considered ‘plan assets’ under circumstances’’ is sufficiently clear to ERISA [Employee Retirement Income Security Act distinguish the terms for investor We are not modifying the rule to of 1974].’’). See, e.g., Breslow & Schwartz, supra liquidity of venture capital funds, as include additional conditions for fund note 241, at § 2:14.1 (‘‘Private equity funds redemptions, such as specifying a generally provide for mandatory withdrawal of a limited partner [i.e., investor] only in the case 259 A number of commenters agreed with the minimum holding or investment period where the continued participation by a limited redeemability criterion. See, e.g., ATV Letter; by investors or a maximum amount that partner in a fund would give rise to a regulatory or Charles River Letter; Gunderson Dettmer Letter. may be redeemed at any time. legal violation by the investor or the fund (or the However, one commenter argued that a fund’s Commenters generally did not support general partner [i.e., adviser] and its affiliates). Even redeemability is not necessarily characteristic of then, it is often possible to address the regulatory venture capital funds. Comment Letter of Cooley issue by excusing the investor from particular LLP (Jan. 21, 2011). 264 See, e.g., id. investments while leaving them otherwise in the 260 See, e.g., NVCA Letter. The rule specifies that 265 See supra notes 255–256 and accompanying fund.’’). a qualifying fund is a private fund that ‘‘issues text. 258 See, e.g., Breslow & Schwartz, supra note 241, securities the terms of which do not provide a 266 For example, in the Proposing Release, we at § 2:14.2 (‘‘The most common reason for allowing holder with any right, except in extraordinary stated that a private fund’s governing documents withdrawals from private equity funds arises in the circumstances, to withdraw * * *’’ If a general case of an ERISA violation where there is a might provide that investors do not have any right partner interest is not a ‘‘security,’’ then the substantial likelihood that the assets of the fund to redeem without the consent of the general redeemability criterion of the rule would not be would be treated as ‘plan assets’ of any ERISA partner. In practice, if the general partner typically implicated. Whether or not a general partner partner for purposes of Title I of ERISA or section permits investors to redeem their otherwise non- interest is a ‘‘security’’ depends on the particular 4975 of the Code.’’). See also Schell, supra note 185, redeemable interests on a periodic basis, then the facts and circumstances. See generally Williamson at § 9.04[3] (‘‘Exclusion provisions allow the fund would not be considered to have issued v. Tucker, 645 F.2d 404 (5th Cir. 1981), cert. denied, General Partner to exclude a Limited Partner from securities that ‘‘do not provide a holder with any 454 U.S. 897 (1981). participation in any or all investments if a violation right, except in extraordinary circumstances, to 261 of law or another material adverse effect would ABA Letter (sought guidance on whether withdraw.’’ Rule 203(l)–1(a)(4). See Proposing otherwise occur.’’); id. at Appendix D–31 (attaching granting redemption rights to certain types of Release, supra note 26, at n.154. model limited partnership agreement providing investors such as ERISA funds and state plans, in 267 See NVCA Letter (disagreeing with statements ‘‘The General Partner at any time may cancel the the event of certain ERISA, tax or regulatory in the Proposing Release regarding the de facto obligations of all Partners to make Capital changes would be considered extraordinary). creation of redemption rights but generally agreeing Contributions for Portfolio Instruments if * * * 262 McGuireWoods Letter. with the general prohibition on redemptions except changes in applicable law * * * make such 263 See Gunderson Dettmer Letter; Merkl Letter; in extraordinary circumstances). cancellation necessary or advisable * * *’’). SVB Letter. 268 Section 208(d) of the Advisers Act.

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the imposition of such conditions,269 funds.’’ 276 One commenter argued that qualifying fund has satisfied the holding and we agree that imposing such the proposed condition was too out criterion depends on all of the conditions would not appear to be restrictive because it focuses on the statements (and omissions) made by the necessary to achieve the purposes of the fund’s name rather than its investment fund to its investors and prospective rule. strategy and suggested that the investors. While this includes the fund definition instead exclude any fund that name, it is only part of the analysis. 7. Represents Itself as Pursuing a markets itself as a hedge fund, multi- This approach is similar to our Venture Capital Strategy strategy fund, buyout fund or fund of general approach to antifraud provisions Under the rule, a qualifying fund funds.277 under the Federal securities laws, must represent itself as pursuing a We believe that the ‘‘holding out’’ including Advisers Act rule 206(4)–8 venture capital strategy to its investors criterion remains an important regarding pooled investment and potential investors.270 Without this distinction between funds that are vehicles.280 The general antifraud rule element, a fund that did not engage in eligible to rely on the definition and under rule 206(4)–8 looks to the private typical venture capital activities could funds that are not, because an investor’s fund’s statements and omissions in light be treated as a venture capital fund understanding of the fund and its of the circumstances under which such simply because it met the other investment strategy must be consistent statements or omissions are made.281 elements specified in our rule (because with an adviser’s reliance on the Similarly, the holding out criterion for example it only invests in short-term exemption. However, we also recognize under our venture capital fund holdings, does not borrow, does not that it is not necessary (nor indeed definition looks to all of the relevant offer investors redemption rights, and is sufficient) for a qualifying fund to name statements made by the qualifying fund not a registered investment itself as a ‘‘venture capital fund’’ in regarding its investment strategy. company).271 We believe that only order for its adviser to rely on the 8. Is a Private Fund funds that do not significantly differ venture capital exemption. Hence, we from the common understanding of are modifying the proposed definition to We define a venture capital fund for what a venture capital fund is,272 and refer to the way a qualifying fund purposes of the exemption as a private that are actually offered to investors as describes its investment strategy to fund, which is defined in the Advisers funds that pursue a venture capital investors and prospective investors. Act, and exclude from the definition strategy, should qualify for the A qualifying fund name that does not funds that are registered investment exemption. Thus, for example, an use the words ‘‘venture capital’’ and is companies (e.g., mutual funds) or have adviser to a venture capital fund that is not inconsistent with pursuing a elected to be regulated as BDCs.282 We otherwise relying on the exemption venture capital strategy would not are adopting this provision as proposed. could not (i) identify the fund as a preclude a qualifying fund from There is no indication that Congress hedge fund or multi-strategy fund (i.e., satisfying the definition.278 Whether or intended the venture capital exemption venture capital is one of several to apply to advisers to these publicly not a fund represents itself as pursuing 283 strategies used to manage the fund) or a venture capital strategy, however, will available funds, referring to venture (ii) include the fund in a hedge fund capital funds as a ‘‘subset of private depend on the particular facts and 284 database or hedge fund index. circumstances. Statements made by a investment funds.’’ The comment As proposed, rule 203(l)–1 defined a letters that addressed this proposed fund to its investors and prospective 285 venture capital fund as a private fund investors, not just what the fund calls criterion generally supported it. that ‘‘represents itself as being a venture itself, are important to an investor’s 9. Application to Non-U.S. Advisers capital fund to its investors and understanding of the fund and its The final rule does not define a potential investors.’’ 273 Although 279 investment strategy. The appropriate venture capital fund as a fund advised several commenters generally supported framework for analyzing whether a by a U.S. adviser (i.e., an adviser with the ‘‘holding out’’ criterion as a principal office and place of business proposed,274 many sought confirmation 276 See, e.g., NVCA Letter; Pine Brook Letter. See also IVP Letter; PEI Funds Letter. that the use of specific self-identifying 280 277 See Pine Brook Letter. 17 CFR 275.206(4)–8. terminology by a fund in its name (e.g., 281 See Pooled Vehicles Release, supra note 122, ‘‘private equity’’ fund, ‘‘multi-strategy’’ 278 Similarly, misleadingly including the words ‘‘venture capital’’ in the name of a fund pursuing at n.27 (‘‘A fact is material if there is a substantial fund or ‘‘’’ fund) would a different strategy would not satisfy the definition. likelihood that a reasonable investor in making an investment decision would consider it as having not automatically disqualify the fund 279 One commenter requested confirmation and significantly altered the total mix of information 275 examples of what constituted appropriate under the definition. Several available,’’ citing Basic, Inc. v. Levinson, 485 U.S. representations to investors given that ‘‘many’’ commenters argued that historically, 224, 231–32 (1988)). venture capital funds do not use private placement 282 some funds have avoided referring to memoranda or other offering materials during Rule 203(l)–1(a) and (a)(5). See also discussion themselves as ‘‘venture capital fundraising. See Gunderson Dettmer Letter infra note 319. (expressed the view that the following would be 283 Legislative history does not indicate that Congress addressed this matter, nor does testimony 269 See, e.g., SVB Letter (expressing opposition to sufficient: (i) Checking the ‘‘venture capital’’ box on before Congress suggest that this was contemplated. a rule that would limit redemptions following a Form D or (ii) stating on the adviser’s Web site that See, e.g., McGuire Testimony, supra note 151, at 3 minimum investment period or limit redemptions all of the funds advised by the adviser are venture (noting that venture capital funds are not directly to a specified maximum threshold). capital funds). As we noted above, whether or not accessible by individual investors); Loy Testimony, 270 Rule 203(1)–1(a)(1). a venture capital fund satisfies the ‘‘holding out’’ criterion will depend on the particular facts and supra note 151, at 2 (‘‘Generally * * * capital for 271 We also note that a fund that represents to circumstances surrounding all of the statements and the venture fund is provided by qualified investors that it is one type of fund while pursuing omissions made by the fund in light of the institutional investors such as pension funds, a different type of fund strategy may raise concerns circumstances under which they were made. universities and endowments, private foundations, under rule 206(4)–8 of the Advisers Act. Moreover, a venture capital fund that seeks to rely and to a lesser extent, high net worth individuals.’’). 272 See Proposing Release, supra note 26, at n.157. on the safe harbor for non-public offerings under See generally section 202(a)(29) of the Advisers Act 273 Proposed Rule 203(l)–1(a)(1). rule 506 of Regulation D is subject to all of the (definition of ‘‘private fund’’). 274 See Gunderson Dettmer Letter; Sen. Levin conditions of such rule, including the prohibition 284 See S. Rep. No. 111–176, supra note 6, at 74 Letter; Merkl Letter. on general solicitation and general advertising (describing venture capital funds as a subset of 275 See, e.g., IVP Letter; Comment Letter of applicable to statements attributable to the fund on ‘‘private investment funds’’). MissionPoint Capital Partners, Jan. 24, 2011; PEI a publicly available Web site. See 17 CFR 285 Gunderson Dettmer Letter; Merkl Letter; Funds Letter. 230.502(c). NYSBA Letter; Sen. Levin Letter.

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the United States). Thus, a non-U.S. would be required to satisfy our does not use U.S. jurisdictional means adviser, as well as a U.S. adviser, may definition of a venture capital fund in to conduct an offering would not be a rely on the venture capital exemption order for the adviser to rely on the private fund and therefore could not provided that such adviser solely venture capital exemption.290 One qualify as a venture capital fund, even advises venture capital funds that commenter suggested that the same if it operated as a venture capital fund satisfy all of the elements of the rule or policy rationale underlying the private in a manner that would otherwise meet satisfy the grandfathering provision fund adviser exemption justified this the criteria under our definition.295 As (discussed in greater detail below). A approach to the venture capital a result, under the proposed rule, if a non-U.S. adviser may rely on the exemption.291 Two other commenters non-U.S. fund did not qualify as a venture capital exemption if all of its supported this approach arguing that venture capital fund, then the fund’s clients, whether U.S. or non-U.S., are non-U.S. funds may operate in a manner adviser would not be able to rely on the venture capital funds. that does not resemble venture capital exemption.296 Neither the statutory text of section fund investing in the United States or by In light of this result, we asked in the 203(l) nor the legislative reports provide U.S. venture capital fund advisers.292 Proposing Release whether we should an indication of whether Congress We do not agree that the private fund adopt a broader interpretation of the intended the exemption to be available adviser exemption is the appropriate term ‘‘private fund.’’ 297 In response, to advisers that operate principally framework for the venture capital commenters supported making the outside of the United States but that exemption in the case of non-U.S. venture capital exemption available to invest in U.S. companies or solicit U.S. advisers. Section 203(l) provides an non-U.S. advisers even if they advise investors.286 Testimony before Congress exemption for an investment adviser venture capital funds that are not presented by members of the U.S. based on the strategy of the funds that offered through the use of U.S. venture capital industry discussed the the adviser manages (i.e., venture jurisdictional means.298 We agree. industry’s role primarily in the U.S. capital funds). This exemption thus Accordingly, as adopted, rule 203(l)–1 economy including its lack of specifies the activities in which an contains a note indicating that an interconnection with the U.S. financial adviser’s clients may engage, and does adviser may treat as a ‘‘private fund’’— markets and ‘‘interdependence’’ with not refer to activities in the United and thus a venture capital fund, if it the world financial system.287 States.293 By contrast, section 203(m) is meets the rule’s other criteria—any non- Nevertheless, we expect that venture based upon the location where the U.S. fund that is not offered through the capital funds with advisers operating advisory activity is conducted. use of U.S. jurisdictional means but that principally outside of the United States Accordingly, we do not believe it would would be a private fund if the issuer may seek to access the U.S. capital be appropriate for an adviser relying on were to conduct a private offering in the 299 markets by investing in U.S. companies section 203(l) to disregard its non-U.S. United States. Moreover, a non-U.S. or soliciting U.S. investors; investors in activities. Moreover, a non-U.S. adviser fund that is treated as a private fund the United States may also have an could circumvent the intended scope of under these circumstances by an adviser interest in venture capital opportunities the exemption by merely sponsoring relying on the venture capital outside of the United States. and advising solely non-U.S. domiciled Commenters generally did not directly or indirectly, offer or sell any security of funds that are not venture capital funds. which it is the issuer and relies on either section support defining venture capital fund or Under our rule, only a private fund 3(c)(1) or 3(c)(7). See Hedge Fund Adviser qualifying portfolio company by may qualify as a venture capital fund. Registration Release, supra note 14, at n.226; Offer reference to the jurisdiction of formation As we noted in the Proposing Release, and Sale of Securities to Canadian Tax-Deferred of the fund or portfolio company.288 Retirement Savings Accounts, Securities Act a non-U.S. fund that uses U.S. Release No. 7656 (Mar. 19, 1999) [64 FR 14648 Several commenters, however, jurisdictional means in the offering of (Mar. 26, 1999)] (‘‘Canadian Tax-Deferred supported modifying the rule to apply the securities it issues and that relies on Retirement Savings Accounts Release’’), at nn.10, the venture capital exemption in the section 3(c)(1) or 3(c)(7) of the 20, 23; Statement of the Commission Regarding Use same manner as the proposed private of Internet Web Sites to Offer Securities, Solicit Investment Company Act would be a Securities Transactions or Advertise Investment 294 fund adviser exemption, with the result private fund. A non-U.S. fund that Services Offshore, Securities Act Release No. 7516 that a non-U.S. adviser could disregard (Mar. 23, 1998) [63 FR 14806 (Mar. 27, 1998)], at its non-U.S. activities when assessing 290 See EFAMA Letter (certain conditions of the n.41. See also Dechert LLP, SEC Staff No-Action eligibility for the venture capital proposed rule, such as the limitation on cash Letter (Aug. 24, 2009) at n.8; Goodwin, Procter & exemption.289 Under this approach, investments to U.S. Treasuries, are inconsistent Hoar LLP, SEC Staff No-Action Letter (Feb. 28, with practices outside the United States). We 1997) (‘‘Goodwin Procter No-Action Letter’’); only U.S.-domiciled private funds believe that these concerns are adequately Touche Remnant & Co., SEC Staff No-Action Letter addressed by the non-qualifying basket. (Aug. 27, 1984) (‘‘Touche Remnant No-Action 286 See section 203(l) of the Advisers Act; H. Rep. 291 See Shearman Letter. Letter’’); Proposing Release, supra note 26, at n.175 No. 111–517, supra note 6, at 867; S. Rep. No. 111– 292 See EFAMA Letter; McGuireWoods Letter. and accompanying text. 295 176, supra note 6, at 74–75. 293 See also infra note 322 and accompanying and See Proposing Release, supra note 26, at 287 See Loy Testimony, supra note 151, at 4–5; following text. nn.175 and 188 and accompanying text. 296 McGuire Testimony, supra note 151, at 5–6. 294 An issuer that is organized under the laws of Under the Advisers Act, an adviser relying on 288 See, e.g., Bessemer Letter; EVCA Letter; the United States or of a state is a private fund if the venture capital exemption must ‘‘solely’’ advise McDonald Letter; Merkl Letter; NVCA Letter; SV it is excluded from the definition of an investment venture capital funds and under our rule all of the Life Sciences Letter. company for most purposes under the Investment funds advised by the adviser must be private funds. 289 See McGuireWoods Letter; Shearman Letter. Company Act pursuant to section 3(c)(1) or 3(c)(7). 297 See Proposing Release, supra note 26, at See also EFAMA Letter (also noting that as a Section 7(d) of the Investment Company Act section II.A.8 (‘‘[S]hould a non-U.S. fund be a practical matter, the rule should account for non- prohibits a non-U.S. fund from using U.S. private fund under the proposed rule if the non- U.S. specific practices so that non-U.S. advisers jurisdictional means to make a public offering, U.S. fund would be deemed a private fund upon could rely on the exemption); Gunderson Dettmer absent an order permitting registration. A non-U.S. conducting a private offering in the United States Letter (exemption should be available to non-U.S. fund may conduct a private U.S. offering in the in reliance on sections 3(c)(1) or 3(c)(7)?’’). advisers even if non-U.S. funds do not satisfy United States without violating section 7(d) only if 298 See, e.g., Dechert General Letter; EFAMA definitional elements); Dechert General Letter (non- the fund complies with either section 3(c)(1) or Letter; Gunderson Dettmer Letter; McGuireWoods U.S. advisers that manage funds that are not venture 3(c)(7) with respect to its U.S. investors (or some Letter; Shearman Letter. capital funds outside of the U.S. should be able to other available exemption or exclusion). Consistent 299 As discussed below, this issue also is relevant rely on rule 203(l) for funds that are managed in the with this view, a non-U.S. fund is a private fund to the exemption provided by rule 203(m)–1. See U.S. or that are marketed to U.S. investors). if it makes use of U.S. jurisdictional means to, also infra note 319.

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exemption would also be treated as a among the definitional elements in rule type of adviser (or impose limits on private fund under the Advisers Act for 203(l)–1(a).304 advising any type of fund). Accordingly, all purposes. This element is designed As in the case of the holding out we believe that advisers have not had an to ensure that an adviser relying on the criterion discussed above, this element incentive to mis-characterize the venture capital exemption by operation of the grandfathering provision elicited investment strategies pursued by of the note is subject to the same the most comments. Generally, existing venture capital funds that have Advisers Act requirements as other commenters either (i) did not support a already been marketed to investors. As advisers relying on the venture capital grandfathering provision that defined a we note above, a fund that ‘‘represents’’ exemption without use of the note. venture capital fund as a fund that itself to investors as pursuing a venture identified itself (or called itself) capital strategy is typically one that 10. Grandfathering Provision ‘‘venture capital,’’ 305 or (ii) sought discloses it pursues a venture capital strategy and identifies itself as such.310 Under the rule, the definition of clarification or an expansive We do not expect existing funds ‘‘venture capital fund’’ includes any interpretation of the holding out identifying themselves as pursuing a private fund that: (i) Represented to element so that existing funds would ‘‘private equity’’ or ‘‘hedge’’ fund investors and potential investors at the not be excluded from the definition strategy would be able to rely on this time the fund offered its securities that merely because they have identified element of the grandfathering provision. it pursues a venture capital strategy; (ii) themselves as ‘‘growth capital,’’ ‘‘multi- strategy’’ or ‘‘private equity,’’ 306 which We believe that most funds previously has sold securities to one or more sold as venture capital funds likely investors prior to December 31, 2010; commenters asserted is typical of some older funds. No commenter addressed would satisfy all or most of the and (iii) does not sell any securities to, the dates proposed in the grandfathering conditions in the grandfathering including accepting any capital provision.307 provision. Nevertheless, we recognize commitments from, any person after As discussed above, we believe that that investment advisers that sponsored July 21, 2011 (the ‘‘grandfathering the ‘‘holding out’’ requirement is an new funds before the adoption of rule provision’’).300 A grandfathered fund important prophylactic tool to prevent 203(l)–1 faced uncertainty regarding the would thus include any fund that has circumvention of the intended scope of precise terms of the definition and accepted all capital commitments by the venture capital exemption. Thus, we hence uncertainty regarding their July 21, 2011 (including capital are adopting the grandfathering eligibility for the new exemption. Thus, commitments from existing and new provision as proposed, with the as proposed, the grandfathering investors) even if none of the capital modifications to the holding out provision specifies that a qualifying commitments has been called by such criterion discussed above.308 As noted fund must have commenced its offering date.301 The calling of capital after July above in the definition of a venture (i.e., initially sold securities) by 21, 2011 would be consistent with the capital fund generally, the holding out December 2010 and must have grandfathering provision, as long as the criterion in the grandfathering provision concluded its offering by the effective investor became obligated by July 21, has also been changed to refer to the date of Title IV (i.e., July 21, 2011). This 2011 to make a future capital strategy pursued by the private fund. A provision is designed to prevent contribution. As a result, any fund that seeks to qualify under our rule circumvention of the intended scope of investment adviser that solely advises should examine all of the statements the exemption. Moreover, requiring private funds that meet the definition in and representations made to investors existing venture capital funds to modify either rule 203(l)–1(a) or (b) would be and prospective investors to determine their investment conditions or exempt from registration. whether the fund has satisfied the characteristics, liquidate portfolio Although several commenters ‘‘holding out’’ criterion as it is company holdings or alter the rights of expressed support for the proposed incorporated into the grandfathering investors in the funds in order to satisfy rule,302 two commenters indicated that provision.309 the definition of a venture capital fund the proposed grandfathering provision Thus, under the rule, an investment would likely be impossible in many was too restrictive because of the adviser may treat any existing private cases and yield unintended holding out criterion.303 In contrast, the fund as a venture capital fund for consequences for the funds and their North American Securities purposes of section 203(l) of the investors.311 Administrators Association, Inc. Advisers Act if the fund meets the B. Exemption for Investment Advisers expressed its view that the proposed elements of the grandfathering Solely to Private Funds With Less Than grandfathering provision was too provision. The current private adviser $150 Million in Assets Under expansive and urged that the rule exemption does not require an adviser Management impose additional substantive to identify or characterize itself as any requirements similar to those included Section 203(m) of the Advisers Act 304 Comment Letter of North American Securities directs the Commission to exempt from 300 Rule 203(l)–1(b). Administrators Association, Inc., Feb. 10, 2011 registration under the Advisers Act any 301 See also Electronic Filing and Revision of (‘‘NASAA Letter’’). investment adviser solely to private Form D, Securities Act Release No. 8891(Feb. 6, 305 Davis Polk Letter; DLA Piper VC Letter; Pine funds that has less than $150 million in 2008) [73 FR 10592 (Feb. 27, 2008)], at section VIII, Brook Letter. assets under management in the United 306 Davis Polk Letter; Gunderson Dettmer Letter; Form D, General Instructions—When to File (noting 312 that a Form D is required to be filed within 15 days IVP Letter; Norwest Letter; NVCA Letter. States. Rule 203(m)–1, which we are of the first sale of securities which would include 307 The NVCA specifically stated that other than ‘‘the date on which the first investor is irrevocably clarification on the names that venture capital 310 See id. contractually committed to invest’’), n.159 (‘‘a funds may use to identify themselves, no ‘‘further 311 One commenter agreed that it may be difficult mandatory capital commitment call would not changes to the grandfathering proposal are for a qualifying fund seeking to rely on the constitute a new offering, but would be made under necessary or appropriate and [we] do not believe grandfathering provision to change fund terms and the original offering’’). that this criterion, as it exists for new funds, liquidate its positions to the possible detriment of 302 Comment Letter of AustinVentures (Jan. 21, presents problems to the industry.’’ See NVCA the fund and its investors. AV Letter. 2011) (‘‘AV Letter’’); Norwest Letter; NYSBA Letter. Letter. 312 Section 408 of the Dodd-Frank Act, which is See also NVCA Letter. 308 See supra discussion at Section II.A.7. codified in section 203(m) of the Advisers Act. See 303 DLA Piper VC Letter; Pine Brook Letter. 309 Id. supra note 19.

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adopting today, provides the exemption comity.316 Commenters supported the exemptions with rule 203(m)–1 so that, and, in addition, addresses several proposed rule’s treatment of non-U.S. for example, an adviser could advise interpretive questions raised by section advisers.317 venture capital funds with assets under 203(m). As noted above, we refer to this Some commenters urged that the rule management in excess of $150 million exemption as the ‘‘private fund adviser should also permit U.S. advisers relying in addition to other types of private exemption.’’ on the exemption to advise other types funds with less than $150 million in of clients.318 Section 203(m) directs us assets under management.321 We believe 1. Advises Solely Private Funds to provide an exemption to advisers that that the commenters’ proposed Rule 203(m)–1, like section 203(m), act solely as advisers to private funds.319 interpretation runs contrary to the limits an adviser relying on the Our treatment of non-U.S. advisers with language of section 203(m), which limits exemption to those advising ‘‘private respect to their non-U.S. clients, as we advisers relying on the exemption to funds’’ as that term is defined in the note above, establishes certain advising solely private funds with assets Advisers Act.313 An adviser that has one appropriate limits on the extraterritorial under management in the United States or more clients that are not private application of the Advisers Act.320 In of less than $150 million or solely funds is not eligible for the exemption contrast, permitting U.S. advisers with venture capital funds in the case of and must register under the Advisers additional types of clients to rely on the section 203(l).322 Act unless another exemption is exemption would appear to directly A few commenters also asked us to available. An adviser may advise an conflict with section 203(m), and we address whether a fund with a single unlimited number of private funds, therefore are not revising the rule as the investor could be a ‘‘private fund’’ for provided the aggregate value of the commenters proposed. purposes of the exemption.323 Whether assets of the private funds is less than Some commenters suggested that the a single-investor fund could be a private $150 million.314 rule permit advisers to combine other fund for purposes of the exemption In the case of an adviser with a depends on the facts and circumstances. principal office and place of business 316 These considerations have, for example, been We are concerned that an adviser incorporated in our rules permitting a non-U.S. simply could convert client accounts to outside of the United States (a ‘‘non- adviser relying on the private adviser exemption to U.S. adviser’’), the exemption is count only clients that are U.S. persons when single-investor funds in order to avoid available as long as all of the adviser’s determining whether it has 14 or fewer clients. Rule registering under the Advisers Act. 203(b)(3)–1(b)(5) (‘‘If you have your principal office These ‘‘funds’’ would be tantamount to clients that are United States persons and place of business outside the United States, you 315 separately managed accounts. Section are qualifying private funds. As a are not required to count clients that are not United consequence, a non-U.S. adviser may States residents, but if your principal office and 208(d) of the Advisers Act anticipates enter the U.S. market and take place of business is in the United States, you must these and other artifices and thus advantage of the exemption without count all clients.’’). See infra note 392. The Dodd- prohibits a person from doing, Frank Act repeals the private adviser exemption as indirectly or through or by another regard to the type or number of its non- of July 21, 2011, and we are rescinding rule U.S. clients or the amount of assets it 203(b)(3)–1 in the Implementing Adopting Release. person, any act or thing which it would manages outside of the United States. See Implementing Adopting Release, supra note 32, be unlawful for such person to do at section II.D.2.a. directly.324 We recognize, however, that Under the rule, a non-U.S. adviser 317 See, e.g., ABA Letter; Comment Letter of would not lose the private fund adviser Debevoise & Plimpton LLP (Jan. 24, 2011) 321 NASBIC/SBIA Letter; Seward Letter. (‘‘Debevoise Letter’’); Comment Letter of Dechert exemption as a result of the size or 322 nature of its advisory or other business LLP (on behalf of Foreign Adviser) (Jan. 24, 2011) The same analysis also would apply to non- (‘‘Dechert Foreign Adviser Letter’’); Gunderson U.S. advisers, which may not for example combine activities outside of the United States. Dettmer Letter; Merkl Letter; Comment Letter of the private fund adviser exemption and the foreign The rule reflects our long-held view that Katten Muchin Rosenman LLP (on behalf of Certain private adviser exemption (e.g., a non-U.S. adviser non-U.S. activities of non-U.S. advisers Non-U.S. Advisers) (Jan. 24, 2011) (‘‘Katten Foreign could not advise private funds that are United States persons with assets in excess of $25 million are less likely to implicate U.S. Advisers Letter’’); Comment Letter of MAp Airports Limited (Jan. 24, 2011) (‘‘MAp Airports Letter’’); in reliance on the private fund adviser exemption regulatory interests and that this Comment Letter of Wellington Financial LP (Jan. and also advise other clients in the United States territorial approach is in keeping with 24, 2011) (‘‘Wellington Letter’’). that are not private funds in reliance on the foreign general principles of international 318 See, e.g., Letter of Sadis & Goldberg (Jan. 11, private adviser exemption). We also note that 2011) (submitted in connection with the depending on the facts and circumstances, we may Implementing Proposing Release, avail. at http:// view two or more separately formed advisory 313 See rule 203(m)–1(a) and (b). Section www.sec.gov/comments/s7-36-10/s73610.shtml) entities, each of which purports to rely on a 202(a)(29) of the Advisers Act defines the term (‘‘Sadis & Goldberg Implementing Release Letter’’) separate exemption from registration, as a single ‘‘private fund’’ as ‘‘an issuer that would be an (exemption should be available to advisers who, in adviser for purposes of assessing the availability of investment company, as defined in section 3 of the addition to advising private funds, also have five or exemptions from registration. See infra note 506. Investment Company Act of 1940 (15 U.S.C. 80a– fewer clients that are separately managed accounts); See also section 208(d), which prohibits a person 3), but for section 3(c)(1) or 3(c)(7) of that Act.’’ A Comment Letter of Seward & Kissel LLP (Jan. 31, from doing, indirectly or through or by another ‘‘private fund’’ includes a private fund that invests 2011) (‘‘Seward Letter’’) (advisers should be person, any act or thing which it would be unlawful in other private funds. See also supra note 294; permitted to rely on multiple exemptions and for such person to do directly. Proposing Release, supra note 26, at n.175 and advisers relying on the private fund adviser 323 See ABA Letter (single-investor funds formed accompanying text. exemption should be permitted to engage in ‘‘some at the request of institutional investors should be 314 We note, however, that depending on the facts activities that do not involve advising clients and considered private funds if they are managed in a and circumstances, we may view two or more have no effect on assets under management,’’ such manner similar to the adviser’s related multi- separately formed advisory entities that each has as providing research to institutional investors). investor private funds, have audited financial less than $150 million in private fund assets under 319 One commenter argued that a U.S. adviser statements, and are treated as private funds for management as a single adviser for purposes of should be permitted to treat as a private fund for purposes of the custody rule); Comment Letter of assessing the availability of exemptions from purposes of rule 203(m)–1 a non-U.S. fund that has Alternative Investment Management Association registration. See infra note 506. See also section not made an offering to U.S. persons. See Comment (Jan. 24, 2011) (‘‘AIMA Letter’’) (sought guidance 208(d), which prohibits a person from doing, Letter of Fox Horan & Camerini LLP (Dec. 22, 2010). concerning single-investor funds and managed indirectly or through or by another person, any act See also supra notes 294 and 313. We agree. accounts structured as funds); Commenter Letter of or thing which it would be unlawful for such 320 In contrast to the foreign private adviser Managed Funds Association (Jan. 24, 2011) (‘‘MFA person to do directly. exemption discussed in Section II.C, a non-U.S. Letter’’) (asserted that single-investor funds are 315 Rule 203(m)–1(b)(1). As discussed below, we adviser relying on the private fund adviser ‘‘private funds’’). also are adding a note to rule 203(m)–1 that clarifies exemption may have a U.S. place of business, but 324 We would view a structure with no purpose that a client will not be considered a United States a non-U.S. adviser need not have a U.S. place of other than circumvention of the Advisers Act as person if the client was not a United States person business to rely on the private fund adviser inconsistent with section 208(d). See, e.g., Custody at the time of becoming a client. See infra note 403. exemption. Continued

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there are circumstances in which it may a private fund for purposes of the to Form ADV to provide a uniform be appropriate for an adviser to treat a exemption a fund that qualifies for an method to calculate assets under single-investor fund as a private fund exclusion from the definition of management for regulatory purposes, for purposes of rule 203(m)–1.325 investment company as defined in including determining eligibility for One commenter argued that advisers section 3 of the Investment Company Commission, rather than state, should be permitted to treat as a private Act in addition to the exclusions registration; reporting assets under fund for purposes of rule 203(m)–1 a provided by section 3(c)(1) or 3(c)(7).328 management for regulatory purposes on fund that also qualifies for another An adviser relying on this provision Form ADV; and determining eligibility exclusion from the definition of must treat the fund as a private fund for two of the new exemptions from ‘‘investment company’’ in the under the Advisers Act and the rules registration under the Advisers Act Investment Company Act in addition to thereunder for all purposes.329 This is to discussed in this Release.333 Under the section 3(c)(1) or 3(c)(7), such as section ensure that an adviser relying on the revised Form ADV instructions, as 3(c)(5)(C), which excludes certain real exemption as a result of our relevant here, advisers must include in estate funds.326 These funds would not modification of the definition of a their calculations proprietary assets and be private funds, because a ‘‘private ‘‘qualifying private fund’’ is subject to assets managed without compensation fund’’ is a fund that would be an the same Advisers Act requirements as as well as uncalled capital investment company as defined in other advisers relying on the exemption. commitments.334 In addition, an adviser section 3 of the Investment Company Therefore, an adviser to a fund that also must determine the amount of its Act but for section 3(c)(1) or 3(c)(7) of qualifies for another exclusion in private fund assets based on the market that Act.327 addition to section 3(c)(1) or 3(c)(7) may value of those assets, or the fair value The commenter argued, and we agree, treat the fund as a private fund and rely of those assets where market value is that an adviser should nonetheless be on rule 203(m)–1 if the adviser meets unavailable,335 and must calculate the permitted to advise such a fund and still the rule’s other conditions, provided assets on a gross basis, i.e., without rely on the exemption. Otherwise, for that the adviser treats the fund as a deducting liabilities, such as accrued example, an adviser to a section 3(c)(1) private fund under the Advisers Act and fees and expenses or the amount of any or 3(c)(7) fund would lose the the rules thereunder for all purposes borrowing.336 exemption if the fund also qualified for including, for example, reporting on Use of this uniform method will, we another exclusion, even though the Form ADV, which requires advisers to believe, result in more consistent asset adviser may be unaware of the fund so report certain information about the calculations and reporting across the qualifying and the fund does not private funds they manage.330 industry and, therefore, in a more purport to rely on the other exclusion. coherent application of the Advisers We do not believe that Congress 2. Private Fund Assets Act’s regulatory requirements and intended that an adviser would lose the a. Method of Calculation assessment of risk.337 In addition, the exemption in these circumstances. Under rule 203(m)–1, an adviser must uniform method of calculation is Accordingly, the definition of a aggregate the value of all assets of designed to ensure that, to the extent ‘‘qualifying private fund’’ in rule private funds it manages to determine if possible, advisers with similar amounts 203(m)–1 permits an adviser to treat as the adviser is below the $150 million of assets under management will be threshold.331 Rule 203(m)–1 requires treated similarly for regulatory of Funds or Securities of Clients by Investment purposes, including their ability to rely Advisers, Investment Advisers Act Release No. 2968 advisers to calculate the value of private (Dec. 30, 2009) [75 FR 1456 (Jan. 11, 2010)] at n.132 fund assets pursuant to instructions in (the use of a special purpose vehicle in certain Form ADV, which provide a uniform 333 See Implementing Adopting Release, supra note 32, discussion at section II.A.3 (discussing the circumstances could constitute a violation of method of calculating assets under section 208(d) of the Advisers Act). Thus, for rationale underlying the new instructions for example, an adviser would not be eligible for the management for regulatory purposes calculating assets under management for regulatory exemption if it advises what is nominally a ‘‘private under the Advisers Act.332 purposes). fund’’ but that in fact operates as a means for In the Implementing Adopting 334 See Form ADV: Instructions for Part 1A, instr. providing individualized investment advice Release, we are revising the instructions 5.b.(1), (4). Advisers also must include in their directly to the investors in the ‘‘private fund.’’ In ‘‘regulatory assets under management’’ assets of this case, the investors would also be clients of the non-U.S. clients. See Implementing Adopting adviser. Cf. Advisers Act rule 202(a)(30)–1(b)(1) (an 328 Rule 203(m)–1(d)(5). This provision may also Release, supra note 32, at n.76 (explaining that a adviser ‘‘must count an owner [of a legal apply to non-U.S. funds that seek to comply with domestic adviser dealing exclusively with non-U.S. organization] as a client if [it] provide[s] investment section 7(d) of the Investment Company Act and clients must register with the Commission if it uses advisory services to the owner separate and apart exclusions in addition to those provided by section any U.S. jurisdictional means in connection with its from the investment advisory services [it] provide[s] 3(c)(1) or 3(c)(7) of that Act. advisory business unless the adviser qualifies for an to the legal organization’’). 329 Rule 203(m)–1(d)(5). exemption from registration or is prohibited from 325 For example, a fund that seeks to raise capital 330 See Item 7.B of Form ADV, Part 1A. registering with the Commission). See also infra from multiple investors but has only a single, initial 331 Rule 203(m)–1(d)(4). note 415. investor for a period of time could be a private 332 See rules 203(m)–1(a)(2); 203(m)–1(b)(2); 335 This valuation requirement is described in fund, as could a fund in which all but one of the 203(m)–1(d)(1) (defining ‘‘assets under terms similar to the definition of ‘‘value’’ in the investors have redeemed their interests. management’’ to mean ‘‘regulatory assets under Investment Company Act, which looks to market 326 Dechert General Letter. See also Comment management’’ in item 5.F of Form ADV, Part 1A); value when quotations are readily available and, if Letter of Baker McKenzie LLP (Jan. 26, 2011) 203(m)–1(d)(4) (defining ‘‘private fund assets’’ to not, then to fair value. See Investment Company Act (submitted in connection with the Implementing mean the ‘‘assets under management’’ attributable section 2(a)(41). See also Implementing Adopting Proposing Release, avail. at http://www.sec.gov/ to a ‘‘qualifying private fund’’). In the case of a Release, supra note 32, at n.91 and accompanying comments/s7-36-10/s73610.shtml) (recommended subadviser, an adviser must count only that portion text. Other standards also may be expressed as that the Commission revise the calculation of assets of the private fund assets for which it has requiring that a determination of fair value be based under management on Form ADV to exclude assets responsibility. See Form ADV: Instructions for Part on market quotations where they are readily in certain funds relying on section 3(c)(5)(C) of the 1A, instr. 5.b.(2) (explaining that, if an adviser available. Id. Investment Company Act); Comment Letter of DLA provides continuous and regular supervisory or 336 See Form ADV: Instructions for Part 1A, instr. Piper LLP (US) (submitted by John H. Heuberger management services for only a portion of a 5.b.(2), (4). See also Implementing Adopting and Hal M. Brown) (similarly sought to exempt securities portfolio, it should include only that Release, supra note 32, discussion at section II.A.3. advisers to certain funds relying on section portion of the securities portfolio for which it 337 See Proposing Release, supra note 26, 3(c)(5)(C)). provides such services, and that an adviser should discussion at section II.B.2. See also Implementing 327 Section 202(a)(29) of the Advisers Act exclude, for example, the portion of an account Adopting Release, supra note 32, discussion at (defining the term ‘‘private fund’’). under management by another person). section II.A.3.

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on the private fund adviser exemption adviser.’’ 342 Although a person is not an of the assets managed should not affect and the foreign private adviser ‘‘investment adviser’’ for purposes of the availability of the exemptions. exemption, both of which refer to an the Advisers Act unless it receives We also do not expect that advisers’ adviser’s assets under management.338 compensation for providing advice to principals (or other employees) Many commenters expressed general others, once a person meets that generally will cease to invest alongside support for a uniform method of definition (by receiving compensation the advisers’ clients as a result of the from any client to which it provides inclusion of proprietary assets, as some calculating assets under management in 346 order to maintain consistency for advice), the person is an adviser, and commenters suggested. If private registration and risk assessment the Advisers Act applies to the fund investors value their advisers’ co- investments as suggested by these purposes.339 The proposals to use fair relationship between the adviser and commenters, we expect that the value of private fund assets and to any of its clients (whether or not the investors will demand them and their include uncalled capital commitments adviser receives compensation from 343 advisers will structure their businesses in private fund assets also received them). Both the private fund adviser 347 340 accordingly. support. As discussed below, exemption and the foreign private Other commenters objected to however, a number of commenters adviser exemption are conditioned upon calculating regulatory assets under disagreed with or sought changes to one an adviser not exceeding specified management on the basis of gross, rather or more of the elements of the proposed amounts of ‘‘assets under than net, assets.348 They argued, among method of calculating assets under management.’’ 344 Neither statutory other things, that gross asset management for regulatory purposes set exemption limits the types of assets that measurements would be confusing,349 341 forth in Form ADV. None of the should be included in this term, and we complex,350 and inconsistent with commenters, however, suggested do not believe that such limits would be industry practice.351 However, nothing alternative approaches that could appropriate.345 In our view, the source in the current instructions suggests that accommodate the specific changes they liabilities should be deducted from the sought and achieve our goals of 342 See, e.g., Dechert General Letter; Seward calculation of an adviser’s assets under consistent asset calculations and Letter. See also ABA Letter; AIMA Letter (suggested management. Indeed, since 1997, the reporting discussed above, and we are a 12-month exclusion for seed capital consistent instructions have stated that an adviser not aware of such an alternative with the Volcker rule); Dechert Foreign Adviser Letter; EFAMA Letter; Katten Foreign Advisers should not deduct securities purchased approach. Letter; MFA Letter. Under section 202(a)(11) of the on margin when calculating its assets For example, some commenters Advisers Act, the definition of ‘‘investment sought to exclude from the calculation adviser’’ includes, among others, ‘‘any person who, 346 See, e.g., ABA Letter; Katten Foreign Advisers for compensation, engages in the business of proprietary assets and assets managed Letter; Seward Letter. advising others * * * as to the value of securities 347 Moreover, we note that an adviser seeking to without compensation because such a or as to the advisability of investing in, purchasing, rely on rule 203(m)–1 may have only private fund requirement would be inconsistent with or selling securities * * *.’’ One commenter argued clients and must include the assets of all of its the statutory definition of ‘‘investment that including proprietary assets would deter non- private fund clients when determining if it remains U.S. advisers that manage large amounts of under the rule’s $150 million threshold. proprietary assets from establishing U.S. operations. 348 ABA Letter; Dechert General Letter; Merkl 338 See Proposing Release, supra note 26, Katten Foreign Advisers Letter. Such an adviser, Letter; MFA Letter; Seward Letter; Shearman Letter. discussion at section V.B.1 (explaining that, however, would not be ineligible for the private 349 Dechert General Letter. See also Implementing because the instructions to Form ADV previously fund adviser exemption merely because it Adopting Release, supra note 32, at n.80 and permitted advisers to exclude certain types of established U.S. operations. As discussed below, a accompanying text. managed assets, ‘‘it is not possible to conclude that non-U.S. adviser may rely on the private fund 350 two advisers reporting the same amount of assets adviser exemption while also having one or more MFA Letter. under management are necessarily comparable U.S. places of business, provided it complies with 351 See, e.g., Merkl Letter; Shearman Letter. One because either adviser may elect to exclude all or the exemption’s conditions. See infra Section II.B.3. commenter asserted that the ‘‘inclusion of borrowed some portion of certain specified assets that it 343 See Implementing Adopting Release, supra assets may create an incentive for an adviser to manages’’). note 32, at n.74 and accompanying text. Several reduce client borrowings to qualify for an 339 See, e.g., AFL-CIO Letter (‘‘We support the commenters also asserted that including proprietary exemption from registration even though reducing SEC’s proposal to require funds to use a uniform assets as proposed would in effect require a wholly leverage may not be in the best interest of its clients,’’ and that it ‘‘could encourage advisers to standard to calculate their assets under owned control affiliate to register as an investment use methods other than borrowing to obtain management and agree that it is important that the adviser. See, e.g., Comment Letter of American financial leverage for their clients (e.g., through calculation account for asset appreciation.’’); AFR Insurance Association (Jan. 24, 2011) (‘‘AIA swaps or other derivative products, which could be Letter (‘‘AFR supports the SEC’s proposal to require Letter’’); Comment Letter of Katten Muchin disadvantageous to clients due to the counterparty funds to use a uniform standard to calculate their Rosenman LLP (on behalf of APG Asset risks and increased costs that they entail).’’ Seward assets under management, and to account for asset Management US Inc.) (Jan. 21, 2011); Comment Letter. See also Gunderson Dettmer Letter. We note appreciation in those calculations’’); AIMA Letter Letter of Katten Muchin Rosenman LLP (Jan. 24, that advisers, as fiduciaries, may not subordinate (‘‘We agree that a clear and unified approach for 2011) (on behalf of Certain Non-U.S. Insurance clients’ interests to their own such as by altering calculation of AUM is necessary and we believe Companies) (‘‘Katten Foreign Insurance Letter’’). their investing behavior in a way that is not in the that using as a standard the assets for which an Whether a control affiliate is deemed to be an client’s best interest in an attempt to remain under adviser has ‘responsibility’ is appropriate.’’); ‘‘investment adviser’’ under the Advisers Act the exemption’s $150 million threshold. Another Dechert General Letter (commented on particular because, among other things, it ‘‘engages in the commenter argued that a gross assets calculation aspects of the proposed uniform method but stated business of advising others’’ will depend on the would make calculations of regulatory assets under ‘‘[w]e generally agree with the Commission’s particular facts and circumstances. The calculation management more volatile. See Dechert General initiative in creating a single uniform method of of regulatory assets under management, including Letter. As discussed in more detail below, we are calculating an adviser’s assets under management the mandatory or optional inclusion of specified permitting advisers relying on rule 203(m)–1 to (‘AUM’) for purposes of determining an adviser’s assets in that calculation, is applicable after the calculate their private fund assets annually, rather registration status (‘Regulatory AUM’)’’). See also entity is determined to be an investment adviser. than quarterly as proposed, and are extending the Implementing Adopting Release, supra note 32, at 344 See sections 203(m) and 202(a)(30) of the period during which certain advisers may file their n.68 and accompanying text. Advisers Act. registration applications if their private fund assets 340 See ABA Letter (supported use of fair value); 345 See also Implementing Adopting Release, exceed the exemption’s $150 million threshold. See AIMA Letter (supported including uncalled capital supra note 32, at n.75 and accompanying text infra Section II.B.2.b. We believe these measures commitments, provided that the adviser has full (explaining that ‘‘the management of ‘proprietary’ will substantially mitigate or eliminate any contractual rights to call that capital and would be assets or assets for which the adviser may not be volatility that may be caused by using a gross assets given responsibility for management of those compensated, when combined with other client measurement, as well as potential volatility in assets). assets, may suggest that the adviser’s activities are currency exchange rates identified by some 341 See also Implementing Adopting Release, of national concern or have implications regarding commenters. See CompliGlobe Letter; EVCA Letter; supra note 32, discussion at section II.A.3. the reporting for the assessment of systemic risk’’). O’Melveny Letter.

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under management.352 Whether a client One commenter opposed the standard,364 other advisers acting has borrowed to purchase a portion of requirement that advisers include in the consistently and in good faith may the assets managed does not seem to us calculation of private fund assets utilize another fair valuation a relevant consideration in determining uncalled capital commitments, asserting standard.365 While these other standards the amount an adviser has to manage, that the uncalled capital remains under may not provide the quality of the scope of the adviser’s business, or the management of the fund investor.358 information in financial reporting (for the availability of the exemptions.353 As we noted in the Proposing Release, example, of private fund returns), we Moreover, we are concerned that the in the early years of a private fund’s life, expect these calculations will provide use of net assets could permit advisers its adviser typically earns fees based on sufficient consistency for the purposes to highly leveraged funds to avoid the total amount of capital that regulatory assets under registration under the Advisers Act even commitments, which we presume management serve in our rules, though the activities of such advisers reflects compensation for efforts including rule 203(m)–1.366 may be significant and the funds they expended on behalf of the fund in Commenters also suggested advise may be appropriate for systemic preparation for the investments.359 alternative approaches to valuation, risk reporting.354 One commenter including the use of local accounting argued, in contrast, that it would be A number of commenters objected to principles; 367 the methodology used to ‘‘extremely unlikely that a net asset the requirement to determine private report to the private fund’s investors; 368 limit of $150,000,000 in private funds fund assets based on fair value, the methodologies described in a could be leveraged into total generally arguing that the requirement client’s governing documents or offering investments that would pose any would cause those advisers that did not materials; 369 historical cost; 370 and systemic risk.’’ 355 But a comprehensive use fair value methods to incur aggregate capital raised by a private view of systemic risk requires additional costs, especially if the private information about certain funds that funds’ assets that they manage are 364 Several commenters asked that we not require may not present systemic risk concerns illiquid and therefore difficult to fair advisers to fair value private fund assets in 360 when viewed in isolation, but value. We noted in the Proposing accordance with GAAP for purposes of calculating Release that we understood that many regulatory assets under management because many nonetheless are relevant to an funds, particularly offshore ones, do not use GAAP assessment of systemic risk across the private funds already value assets in and such a requirement would be unduly economy. Moreover, because private accordance with U.S. generally accepted burdensome. See, e.g., EFAMA Letter; Katten accounting principles (‘‘GAAP’’) or Foreign Advisers Letter. We did not propose such funds are not subject to the leverage a requirement, nor are we adopting one. See restrictions in section 18 of the other international accounting standards Implementing Adopting Release, supra note 32, at Investment Company Act, a private fund that require the use of fair value, citing n.98. with less than $150 million in net assets letters we had received in connection 365 See id., at n.99 and accompanying text. with other rulemaking initiatives.361 We Consistent with this good faith requirement, we could hold assets far in excess of that would expect that an adviser that calculates fair amount as a result of its extensive use are sensitive to the costs this new value in accordance with GAAP or another basis of of leverage. In addition, under a net requirement will impose. We believe, accounting for financial reporting purposes will assets test such a fund would be treated however, that this approach is also use that same basis for purposes of determining warranted in light of the unique the fair value of its regulatory assets under similarly for regulatory purposes as a management. Id. fundamentally different fund, such as regulatory purposes of the calculation 366 See id., at n.100 and accompanying text. In one that did not make extensive use of under the Advisers Act. We estimated addition, the fair valuation process need not be the leverage and had $140 million in net these costs in the Proposing Release 362 result of a particular mandated procedure and the assets. and we have taken several steps to procedure need not involve the use of a third-party 363 pricing service, appraiser or similar outside expert. The use of gross assets also need not mitigate them. An adviser could rely on the procedure for cause any investor confusion, as some While many advisers will calculate calculating fair value that is specified in a private commenters suggested.356 Although an fair value in accordance with GAAP or fund’s governing documents. The fund’s governing adviser will be required to use gross documents may provide, for example, that the another international accounting fund’s general partner determines the fair value of (rather than net) assets for purposes of the fund’s assets. Advisers are not, however, determining whether it is eligible for the assets calculation to mutual funds, short positions required to fair value real estate assets only in those private fund adviser or the foreign and leverage, we expect that advisers will continue limited circumstances where real estate assets are private adviser exemptions (among to calculate their gross assets as they do today, even not required to be fair valued for financial reporting purposes under accounting principles that if they currently only calculate gross assets as an other purposes), we would not preclude otherwise require fair value for assets of private intermediate step to compute their net assets. See an adviser from holding itself out to its funds. For example, in those cases, an adviser may Implementing Adopting Release, supra note 32, at instead value the real estate assets as the private clients as managing a net amount of n.83. In the case of pooled investment vehicles with fund does for financial reporting purposes. We note assets as may be its custom.357 a balance sheet, for instance, an adviser could that the Financial Accounting Standards Board include in the calculation the total assets of the (‘‘FASB’’) has a current project related to entity as reported on the balance sheet. Id. 352 See Form ADV: Instructions for Part 1A, instr. investment property entities that may require real 358 5.b.(2), as in effect before it was amended by the See Merkl Letter. estate assets subject to that accounting standard to Implementing Adopting Release (‘‘Do not deduct 359 Proposing Release, supra note 26, discussion be measured by the adviser at fair value. See FASB securities purchased on margin.’’). Instruction at section II.B.2. See also Implementing Adopting Project on Investment Properties. We also note that 5.b.(2), as amended in the Implementing Adopting Release, supra note 32, at n.90 and accompanying certain international accounting standards currently Release, provides ‘‘Do not deduct any outstanding text. permit, but do not require, fair valuation of certain indebtedness or other accrued but unpaid 360 See, e.g., Gunderson Dettmer Letter; Merkl real estate assets. See International Accounting liabilities.’’ See Implementing Adopting Release, Letter; O’Melveny Letter; Seward Letter; Wellington Standard 40, Investment Property. To the extent supra note 32, discussion at section II.A.3. Letter. that an adviser follows GAAP or another accounting 353 See id. 361 See Proposing Release, supra note 26, at n.196 standard that requires or in the future requires real 354 See id., at n.82 and preceding and and accompanying text. estate assets to be fair valued, this limited exception accompanying text. 362 See id., at n.326 and accompanying text. to the use of fair value measurement for real estate 355 ABA Letter. 363 We recognize that although these steps will assets would not be available. 367 356 See, e.g., Dechert General Letter. See also provide advisers greater flexibility in calculating Dechert Foreign Adviser Letter; EFAMA Implementing Adopting Release, supra note 32, at the value of their private fund assets, they also will Letter. n.80 and accompanying text. result in valuations that are not as comparable as 368 Merkl Letter; Wellington Letter. 357 In addition, in response to commenters they could be if we specified a fair value standard 369 AIMA Letter; MFA Letter; Seward Letter. seeking clarification of the application of the gross (e.g., as specified in GAAP). 370 O’Melveny Letter.

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fund.371 Use of these approaches would of an adviser’s private fund assets requirements of rule 203(m)–1, during limit our ability to compare data from between annual updating amendments this transition period.377 This 90-day different advisers and thus would be will not affect the availability of the transition period is not available to inconsistent with our goal of achieving exemption. advisers that have failed to comply with more consistent asset calculations and We proposed to require advisers all Commission reporting requirements reporting across the industry, as relying on the exemption to calculate applicable to an exempt reporting discussed above, and also could result their private fund assets each quarter to adviser as such or that have accepted a in advisers managing comparable determine if they remain eligible for the client that is not a private fund.378 amounts of assets under management exemption. Commenters persuaded us, These advisers therefore should plan to being subject to different registration however, that requiring advisers to register before becoming ineligible for requirements. Moreover, these calculate their private fund assets the exemption. alternative approaches could permit annually in connection with their Commenters who addressed the issue advisers to circumvent the Advisers annual updating amendments to Form generally supported the proposed Act’s registration requirements. ADV would be more appropriate transition period, but requested that we Permitting the use of any valuation because it would likely result in the extend the transition period beyond one standard set forth in the governing same advisers becoming registered each calendar quarter as proposed or documents of the private fund other year while reducing the costs and otherwise make it more broadly than fair value could effectively yield to burdens associated with quarterly available.379 Requiring annual the adviser the choice of the most calculations.374 In addition, annual calculations extends the transition favorable standard for determining its calculations provide a range of dates on period, as commenters recommended, registration obligation as well as the which an adviser may calculate its and is consistent with the amount of application of other regulatory private fund assets, addressing concerns time provided to state-registered requirements. raised by commenters about shorter- advisers switching to Commission For these reasons and as we proposed, term fluctuations in assets under registration. Advisers to whom the rule 203(m)–1 requires advisers to management.375 The rule as adopted transition period is available will have calculate the value of private fund assets also is consistent with the timeframes up to 180 days after the end of their pursuant to the instructions in Form for valuing assets under management fiscal years to register.380 ADV. and registering with the Commission One commenter argued that the applicable to state-registered advisers transition period should be available to b. Frequency of Calculation and all advisers relying on rule 203(m)–1, Transition Period switching from state to Commission registration.376 including those that had not complied 381 An adviser relying on the exemption As noted above, if an adviser reports with their reporting requirements. provided by rule 203(m)–1 must in its annual updating amendment that The transition period is a safe harbor annually calculate the amount of the it has $150 million or more of private that provides advisers flexibility in private fund assets it manages and fund assets under management, the report the amount in its annual adviser is no longer eligible for the 377 General Instruction 15 to Form ADV. See also Implementing Adopting Release, supra note 32, updating amendments to its Form exemption and must register under the ADV.372 If an adviser reports in its discussion at section II.B.5. We removed what was Advisers Act unless it qualifies for proposed rule 203(m)–1(d), which contained the annual updating amendment that it has another exemption. An adviser that has proposed transition period, and renumbered the $150 million or more of private fund final rule accordingly. The transition period as complied with all Commission reporting assets under management, the adviser is adopted is described in General Instruction 15 to requirements applicable to an exempt no longer eligible for the private fund Form ADV. Rule 203(m)–1(c) refers advisers to this reporting adviser as such, however, may instruction. This transition period is available to an adviser exemption.373 Advisers thus apply for registration with the adviser that has complied with ‘‘all [Commission] may be required to register under the reporting requirements applicable to an exempt Commission up to 90 days after filing Advisers Act as a result of increases in reporting adviser as such,’’ rather than ‘‘all the annual updating amendment, and applicable Commission reporting requirements,’’ as their private fund assets that occur from may continue to act as a private fund proposed. This condition reflects the importance of year to year, but changes in the amount adviser, consistent with the the Advisers Act reporting requirements applicable to advisers relying on the private fund adviser 371 Gunderson Dettmer Letter. exemption. 374 372 An adviser relying on rule 203(m)–1 must file A number of commenters argued, among other 378 General Instruction 15 to Form ADV. See also an annual updating amendment to its Form ADV things, that calculating private fund assets quarterly Implementing Adopting Release, supra note 32, within 90 days after the end of its fiscal year, and would: (i) Impose unnecessary costs and burdens discussion at section II.B.5. An adviser would lose must calculate its private fund assets in the manner on advisers, some of whom might not otherwise the exemption immediately upon accepting a client described in the instructions to Form ADV within perform quarterly valuations; and (ii) that is not a private fund. Accordingly, for the 90 days prior to the date it makes the filing. See inappropriately permit shorter-term fluctuations in adviser to comply with the Advisers Act, the rule 203(m)–1(c); rule 204–4(a); General Instruction assets under management to require advisers to adviser’s Commission registration must be 4 to Form ADV; Form ADV: Instructions for Part register. See ABA Letter; AIMA Letter; Dechert approved before the adviser accepts a client that is 1A, instr. 5.b. The adviser must report its private Foreign Adviser Letter; Dechert General Letter; not a private fund. Moreover, even an adviser to fund assets on Section 2.B of Schedule D to Form EFAMA Letter; Katten Foreign Advisers Letter; whom the transition period is available could not, ADV. Advisers also must report their private fund Merkl Letter; NASBIC/SBIA Letter; Seward Letter. consistent with the Advisers Act, accept a client assets when they file their initial reports as exempt 375 As discussed above, an adviser relying on rule that is not a private fund until the Commission reporting advisers. See Implementing Adopting 203(m)–1 must calculate its private fund assets in approves its registration. These same limitations Release, supra note 32, discussion at section II.B. the manner described in the instructions to Form apply to non-U.S. advisers with respect to their 373 Under Item 2.B of Part 1A of Form ADV, an ADV within 90 days prior to the date it files its clients that are United States persons. adviser relying on rule 203(m)–1 must complete annual updating amendment to its Form ADV. 379 ABA Letter; AIMA Letter; CompliGlobe Letter; Section 2.B of Schedule D, which requires the 376 See General Instruction 4 to Form ADV; Form Gunderson Dettmer Letter; Katten Foreign Advisers adviser to provide the amount of the ‘‘private fund ADV: Instructions for Part 1A, instr. 5.b.; rule Letter; Sadis & Goldberg Implementing Release assets’’ it manages. A note to Section 2.B of 203A–1(b). See also ABA Letter (‘‘We believe an Letter; Seward Letter; Shearman Letter. Schedule D provides that ‘‘private fund assets’’ has annual measurement would be most appropriate, 380 An adviser must file its annual Form ADV the same meaning as under rule 203(m)–1, and that especially since advisers exempt from registration updating amendment within 90 days after the end non-U.S. advisers should only include private fund because they do not meet the $100,000,000 asset of its fiscal year and, if the transition period is assets that they manage at a place of business in the threshold will calculate their assets for this purpose available, may apply for registration up to 90 days United States. See also infra notes 377–378 and annually, and an annual test for both purposes has after filing the amendment. See also supra note 378. accompanying text. a compelling consistency.’’). 381 Shearman Letter.

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complying with rule 203(m)–1, and we those assets managed at a U.S. place of move offshore or close U.S. offices to continue to believe that it would be business.386 One commenter did, avoid regulation.391 inappropriate to extend this benefit to however, urge us to presume that a non- As we explained in the Proposing advisers that have not met their U.S. adviser’s assets are managed from Release, we believe that our reporting requirements.382 its principal office and place of business interpretation recognizes that non-U.S. 3. Assets Managed in the United States to avoid the inherent difficulties in activities of non-U.S. advisers are less determining the location from which likely to implicate U.S. regulatory Under rule 203(m)–1, all of the any particular assets of a private fund interests and is in keeping with general private fund assets of an adviser with a are managed if an adviser operates in principles of international comity.392 principal office and place of business in multiple jurisdictions.387 As we stated The rule also is designed to encourage the United States are considered to be in the Proposing Release, this the participation of non-U.S. advisers in ‘‘assets under management in the commenter’s approach ignores the U.S. market by applying the U.S. United States,’’ even if the adviser has situations in which day-to-day securities laws in a manner that does 383 offices outside of the United States. A management of some assets of the not impose U.S. regulatory and non-U.S. adviser, however, need only private fund does in fact take place ‘‘in operational requirements on a non-U.S. count private fund assets it manages at the United States.’’ 388 It also would adviser’s non-U.S. advisory business.393 a place of business in the United States permit an adviser engaging in Non-U.S. advisers relying on rule toward the $150 million asset limit substantial advisory activities in the 203(m)–1 will remain subject to the 384 under the exemption. United States to escape our regulatory Advisers Act’s antifraud provisions and As discussed in the Proposing oversight merely because the adviser’s will become subject to the requirements Release, the rule deems all of the assets principal office and place of business is applicable to exempt reporting advisers. managed by an adviser to be managed outside of the United States. This One commenter proposed an ‘‘in the United States’’ if the adviser’s consequence is at odds not only with additional interpretation under which ‘‘principal office and place of business’’ section 203(m), but also with the foreign we would determine the ‘‘assets under is in the United States. This is the private adviser exemption discussed management in the United States’’ for location where the adviser controls, or below in which Congress specifically set U.S. advisers only by reference to the has ultimate responsibility for, the forth circumstances under which a non- amount of assets invested, or ‘‘in play,’’ management of private fund assets, and U.S. adviser may be exempt provided it in the United States.394 We decline to therefore is the place where all the does not have any place of business in adopt this approach because it would be adviser’s assets are managed, although the United States, among other difficult for advisers to ascertain and day-to-day management of certain assets conditions.389 monitor which assets are invested in the may also take place at another location.385 For most advisers, this In addition, some commenters United States, and this approach thus approach will avoid difficult attribution supported an alternative approach could be confusing and difficult to determinations that would be required if under which we would interpret ‘‘assets apply on a consistent basis. For assets are managed by teams located in under management in the United example, an adviser might invest in the multiple jurisdictions, or if portfolio States’’ by reference to the source of the American Depositary Receipts of a managers located in one jurisdiction assets (i.e., U.S. private fund company incorporated in Bermuda that: 390 rely heavily on research or other investors). One of the commenters (i) Engages in mining operations in advisory services performed by argued that our interpretation would Canada, the principal trading market for employees located in another disadvantage U.S.-based advisers by its common stock; and (ii) derives the jurisdiction. permitting non-U.S. advisers to accept majority of its revenues from exports to Most commenters who addressed the substantial amounts of money from U.S. the United States. It is not clear whether issue supported our proposal to treat investors without having to comply ‘‘assets under management in the with certain U.S. regulatory 391 Portfolio Manager Letter. See also Comment requirements, and cause U.S. advisers to Letter of Tuttle (Nov. 30, 2010) (submitted in United States’’ for non-U.S. advisers as connection with the Implementing Adopting Release, avail. at http://www.sec.gov/comments/s7– 382 See Proposing Release, supra note 26, 386 ABA Letter; Comment Letter of Association 35–10/s73510.shtml) (‘‘Tuttle Implementing Release discussion at n.223 and accompanying text. Franc¸aise de la Gestion financie`re (Jan. 24, 2011) Letter’’) (argued that businesses may move offshore 383 Rule 203(m)–1(a). The rule defines the (‘‘AFG Letter’’) (sought clarification that assets if they become too highly regulated in the United ‘‘United States’’ to have the same meaning as in rule managed from non-U.S. offices are exempted); States). 902(l) of Regulation S under the Securities Act, AIMA Letter; Comment Letter of Avoca Capital 392 See Proposing Release, supra note 26, at n.207 which is ‘‘the United States of America, its Holdings (Dec. 21, 2010) (‘‘Avoca Letter’’); (identifying Regulation S and Exchange Act rule territories and possessions, any State of the United Debevoise Letter; Dechert Foreign Adviser Letter; 15a–6 as examples of Commission rules that adopt States, and the District of Columbia.’’ Rule 203(m)– EFAMA Letter; Gunderson Dettmer Letter; Katten a territorial approach). 1(d)(7); 17 CFR 230.902(l). Foreign Advisers Letter; MAp Airports Letter; Merkl 393 See generally Division of Investment 384 Rule 203(m)–1(b). Any assets managed at a Letter; Comment Letter of Non-U.S. Adviser (Jan. Management, SEC, Protecting Investors: A Half U.S. place of business for clients other than private 24, 2011) (‘‘Non-U.S. Adviser Letter’’). Cf. Sen. Century of Investment Company Regulation, May funds would make the exemption unavailable. See Levin Letter (advisers managing assets in the United 1992 (‘‘1992 Staff Report’’), at 223–227 (recognizing also supra note 378. We revised this provision to States of funds incorporated outside of the United that non-U.S. advisers that registered with the refer to assets managed ‘‘at’’ a place of business in States ‘‘are exactly the type of investment advisers Commission were arguably subject to all of the the United States, rather than ‘‘from’’ a place of to which the Dodd-Frank Act’s registration substantive provisions of the Advisers Act with business in the United States as proposed. The requirements are intended to apply’’). respect to their U.S. and non-U.S. clients, which revised language is intended to reflect more clearly 387 Katten Foreign Advisers Letter. could result in inconsistent regulatory requirements the rule’s territorial focus on the location at which 388 See Proposing Release, supra note 26, at or practices imposed by the regulations of their the asset management takes place. nn.204–205 and accompanying text. local jurisdiction and the U.S. securities laws; in 385 This approach is similar to the way we have 389 See infra Section II.C. response, advisers could form separate and identified the location of the adviser for regulatory 390 Comment Letter of Portfolio Manager (Jan. 24, independent subsidiaries but this could result in purposes under our current rules, which define an 2011) (‘‘Portfolio Manager Letter’’); Merkl Letter U.S. clients having access to a limited number of adviser’s principal office and place of business as (suggested that it ‘‘may be useful’’ to look both to advisory personnel and reduced access by the U.S. the location where it ‘‘directs, controls and assets managed from a U.S. place of business and subsidiary to information or research by non-U.S. coordinates’’ its advisory activities, regardless of the assets contributed by U.S. private fund investors to affiliates). location where some of the advisory activities might address both investor protection and systemic risk 394 Comment Letter of Richard Dougherty (Dec. occur. See rule 203A–3(c); rule 222–1. concerns). 14, 2010) (‘‘Dougherty Letter’’).

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these investments should be considered investment adviser provides investment Regulation S under the Securities ‘‘in play’’ in the United States. advisory services, solicits, meets with, Act.403 Regulation S looks generally to Another commenter urged us to or otherwise communicates with the residence of an individual to exclude assets managed by a U.S. clients.’’ determine whether the individual is a adviser at its non-U.S. offices.395 This, Whether a non-U.S. adviser has a United States person,404 and also the commenter argued, would allow place of business in the United States addresses the circumstances under more U.S. advisers to rely on the depends on the facts and circumstances, which a legal person, such as a trust, exemption and allow us to focus our as discussed below in connection with partnership or a corporation, is a United resources on larger advisers more likely the foreign private adviser States person.405 Regulation S generally to pose systemic risk. But the exemption.399 For purposes of rule treats legal partnerships and management of assets at these non-U.S. 203(m)–1, however, the analysis corporations as United States persons if offices could have investor protection frequently will turn not on whether a they are organized or incorporated in implications in the United States, such non-U.S. adviser has a U.S. place of the United States, and analyzes trusts by as by creating conflicts of interest for an business, but on whether the adviser reference to the residence of the adviser between assets managed abroad manages assets, or has ‘‘assets under trustee.406 It treats discretionary and those managed in the United States. management,’’ at such a U.S. place of accounts generally as United States In addition, we sought comment as to business. Under the Advisers Act, persons if the fiduciary is a resident of whether, under the approach we are ‘‘assets under management’’ are the the United States.407 Commenters adopting today, some or most U.S. securities portfolios for which an generally supported defining ‘‘United advisers with non-U.S. branch offices adviser provides ‘‘continuous and States person’’ by reference to would re-organize those offices as regular supervisory or management Regulation S because, among other subsidiaries in order to avoid attributing services.’’ 400 This is an inherently reasons, the definition is well developed assets managed to the non-U.S. office.396 factual determination. We would not, and understood by advisers.408 No commenter suggested this would however, view providing research or Rule 203(m)–1 also contains a special occur. We continue to believe that rule conducting due diligence to be rule that requires an adviser relying on 203(m)–1 will have only a limited effect ‘‘continuous and regular supervisory or the exemption to treat a discretionary or on multi-national advisory firms, which management services’’ at a U.S. place of other fiduciary account as a United for tax or business reasons keep their business if a person outside of the States person if the account is held for non-U.S. advisory activities United States makes independent the benefit of a United States person by organizationally separate from their U.S. investment decisions and implements a non-U.S. fiduciary who is a related advisory activities. For these reasons, those decisions.401 person of the adviser.409 One and our substantial interest in regulating all of the activities of U.S. advisers, we 4. United States Person 403 Rule 203(m)–1(d)(8). We are adding a note to decline to revise rule 203(m)–1 as this Under rule 203(m)–1(b), a non-U.S. rule 203(m)–1 that clarifies that a client will not be commenter suggested. considered a United States person if the client was adviser may not rely on the exemption not a United States person at the time of becoming Several commenters asked that we if it has any client that is a United States a client of the adviser. This will permit a non-U.S. clarify whether certain U.S. activities or person other than a private fund.402 adviser to continue to rely on rule 203(m)–1 if a arrangements would result in an adviser Rule 203(m)–1 defines a ‘‘United States non-U.S. client that is not a private fund, such as having a ‘‘place of business’’ in the person’’ generally by incorporating the a natural person client residing abroad, relocates to 397 the United States or otherwise becomes a United United States. Commenters also definition of a ‘‘U.S. person’’ in States person. As one commenter recognized, this sought guidance as to whether limited- also will establish similar treatment in these purpose U.S. offices of non-U.S. 399 See infra Section II.C.4. circumstances for non-U.S. advisers relying on rule advisers would be considered U.S. 400 Section 203A(a)(2) of the Advisers Act. The 203(m)–1 or the foreign private adviser exemption, instructions to Item 5 of Form ADV provide which contains an analogous note. See EFAMA places of business (e.g., offices Letter. See also Comment Letter of Investment guidance on the circumstances under which an conducting research or due Funds Institute of Canada (Jan. 24, 2011) (‘‘IFIC adviser would be providing ‘‘continuous and 398 Letter’’). The note applicable to the foreign private diligence). regular supervisory or management services with adviser exemption generally describes the time Under rule 203(m)–1, if a non-U.S. respect to an account.’’ Form ADV: Instructions for when an adviser must determine if a person is ‘‘in Part 1A, instr. 5.b. The calculation of an adviser’s adviser relying on the exemption has a the United States’’ for purposes of that exemption. assets under management at a U.S. place of business place of business in the United States, See infra Section II.C.3. turns on whether the adviser is providing those 404 all of the clients whose assets the services with respect to a particular account or 17 CFR 230.902(k)(1)(i). adviser manages at that place of accounts at a U.S. place of business. 405 See, e.g., 17 CFR 230.902(k)(1) and (2). business must be private funds and the 401 See Form ADV: Instructions for Part 1A, instr. 406 17 CFR 230.902(k)(1)(ii) and (iv). assets managed at that place of business 5.b(3)(b) (an adviser provides continuous and 407 17 CFR 230.902(k)(1)(vii). must have a total value of less than $150 regular supervisory or management services with 408 AIMA Letter; CompliGlobe Letter; Debevoise respect to an account if it has ‘‘ongoing Letter; Dechert General Letter; Gunderson Dettmer million. Rule 203(m)–1 defines a ‘‘place responsibility to select or make recommendations, Letter; Katten Foreign Advisers Letter; O’Melveny of business’’ by reference to rule 222– based upon the needs of the client, as to specific Letter. As we explained in the Proposing Release, 1(a) as any office where the adviser securities or other investments the account may advisers to private funds and their counsel must ‘‘regularly provides advisory services, purchase or sell and, if such recommendations are today be familiar with the definition of ‘‘U.S. accepted by the client, [it is] responsible for person’’ under Regulation S in order to comply with solicits, meets with, or otherwise arranging or effecting the purchase or sale’’). These other provisions of the Federal securities laws. See communicates with clients,’’ and ‘‘any research or due diligence services, while not Proposing Release, supra note 26, at n.217 and other location that is held out to the ‘‘continuous and regular supervisory or accompanying text. general public as a location at which the management services,’’ may be investment advisory 409 Rule 203(m)–1(d)(8) provides that a ‘‘United services that, if performed at a U.S. location, would States person means any person that is a ‘U.S. cause the adviser to have a place of business in the person’ as defined in [Regulation S], except that any 395 Comment Letter of T.A. McKay & Co., Inc. United States. See infra note 493 and accompanying discretionary account or similar account that is held (Nov. 23, 2010). text. for the benefit of a United States person by a dealer 396 See Proposing Release, supra note 26, at 402 In response to commenters seeking clarity on or other professional fiduciary is a United States discussion following n.208. this point, we note that a non-U.S. adviser need not person if the dealer or professional fiduciary is a 397 See, e.g., EFAMA Letter. have one or more private fund clients that are related person of the investment adviser relying on 398 AIMA Letter; Dechert General Letter; EFAMA United States persons in order to rely on the [rule 203(m)–1] and is not organized, incorporated, Letter. See also ABA Letter; Vedanta Letter. exemption. Continued

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commenter expressed concern that the above, Regulation S provides a well- out generally to the public in the United special rule is unnecessary while developed body of law with which States as an investment adviser.417 another who supported the special rule advisers to private funds and their Section 202(a)(30) authorizes the as proposed noted that the special rule counsel must today be familiar in order Commission to increase the $25 million should be ‘‘narrowly drawn’’ to avoid to comply with other provisions of the threshold ‘‘in accordance with the frustrating legitimate subadvisory Federal securities laws. Incorporating purposes of this title.’’ 418 relationships between non-U.S. advisers this definition in rule 203(m)–1, Today we are adopting, substantially and their U.S. adviser affiliates.410 We therefore, makes rule 203(m)–1 easier to as proposed, new rule 202(a)(30)–1, believe that the special rule is narrowly apply and fosters consistency across the which defines certain terms in section drawn and necessary to prevent advisers Federal securities laws. Deviations from 202(a)(30) for use by advisers seeking to from purporting to rely on the the definition used in Regulation S, avail themselves of the foreign private exemption and establishing including an entirely different approach adviser exemption, including: (i) discretionary accounts for the benefit of to defining a ‘‘United States person,’’ ‘‘investor;’’ (ii) ‘‘in the United States;’’ U.S. clients with an offshore affiliate would detract from these benefits. (iii) ‘‘place of business;’’ and (iv) ‘‘assets that would then delegate the actual Moreover, a test that looks to a business under management.’’ 419 We are also management of the account back to the entity’s principal office and place of including in rule 202(a)(30)–1 the safe adviser.411 business, as suggested by the harbor and many of the client counting Another commenter suggested the commenter, would be difficult for rules that appeared in rule 203(b)(3)–1. rule apply a different approach with advisers to apply. It frequently is respect to business entities than that unclear where an investment fund 1. Clients under Regulation S, which as noted maintains its ‘‘principal office and place Rule 202(a)(30)–1 includes a safe above generally treats legal partnerships of business’’ because investment funds harbor for advisers to count clients for and corporations as U.S. persons if they typically have no physical presence or purposes of the definition of ‘‘foreign are organized or incorporated in the employees other than those of their private adviser’’ that is similar to the United States.412 The commenter advisers. safe harbor that has been included in suggested that advisers should instead rule 203(b)(3)–1.420 The commenter that C. Foreign Private Advisers look to a business entity’s principal generally addressed this aspect of our office and place of business in certain Section 403 of the Dodd-Frank Act proposed rule agreed with our instances because an entity organized replaces the current private adviser approach,421 which was designed to under U.S. law should not necessarily exemption from registration under the apply a well-developed body of law to be treated as a United States person if Advisers Act with a new exemption for it was formed by a non-United States a ‘‘foreign private adviser,’’ as defined and investors in the United States in private funds’’ person to pursue the entity’s investment in new section 202(a)(30).414 The new (emphasis added). As noted in the Proposing 413 exemption is codified as amended Release, we interpret these provisions consistently objectives. so that only clients in the United States and We decline to adopt this suggestion section 203(b)(3). investors in the United States would be counted for because we believe it is most Under section 202(a)(30), a foreign purposes of subparagraph (B). See Proposing appropriate to incorporate the definition private adviser is any investment Release, supra note 26, at n.225. of ‘‘U.S. person’’ in Regulation S with as adviser that: (i) Has no place of business 417 In addition, the exemption is not available to in the United States; (ii) has, in total, an adviser that ‘‘acts as (I) an investment adviser to few modifications as possible. As noted any investment company registered under the fewer than 15 clients in the United [Investment Company Act]; or (II) a company that or (if an individual) resident in the United States.’’ States and investors in the United States has elected to be a business development company In contrast, under Regulation S, a discretionary in private funds advised by the pursuant to section 54 of [that Act], and has not account maintained by a non-U.S. fiduciary (such investment adviser; 415 (iii) has withdrawn its election.’’ Section 202(a)(30)(D)(ii). as an investment adviser) is not a ‘‘U.S. person’’ As noted in the Proposing Release, we interpret even if the account is owned by a U.S. person. See aggregate assets under management subparagraph (II) to prohibit an adviser that advises 17 CFR 230.902(k)(1)(vii); 17 CFR 230.902(k)(2)(i). attributable to clients in the United a business development company from relying on 410 Katten Foreign Advisers Letter; AIMA Letter States and investors in the United States the exemption. See Proposing Release, supra note (noting that the special rule should be narrowly in private funds advised by the 26, at n.226. 418 drawn but also stating that ‘‘[w]e understand the investment adviser of less than $25 Section 202(a)(30)(C). rationale for the special rule proposed by the 419 416 Rule 202(a)(30)–1(c). Commission for discretionary accounts maintained million; and (iv) does not hold itself 420 Rule 203(b)(3)–1, which we are rescinding outside the US for the benefit of US persons and with the Implementing Adopting Release, provided we believe that that is an appropriate safeguard 414 Section 402 of the Dodd-Frank Act (providing a safe harbor for determining who may be deemed against avoidance of the registration requirement’’). a definition of ‘‘foreign private adviser,’’ to be a single client for purposes of the private adviser 411 See Proposing Release, supra note 26, codified at section 202(a)(30) of the Advisers Act). exemption. We are not, however, carrying over from discussion at section II.B.4. See supra notes 22 and 23 and accompanying text. rule 203(b)(3)–1 a provision that distinguishes 412 Debevoise Letter (noted that, for example, ‘‘a 415 One commenter suggested that a non-U.S. between advisers whose principal places of private fund, or an entity that is organized as part adviser with no place of business in the United business are inside or outside of the United States. of a private fund, may be organized under Delaware States would not be subject to the Advisers Act See rule 203(b)(3)–1(b)(5). Under the definition of law to meet certain regulatory and tax objectives, unless the adviser has at least one direct U.S. client. ‘‘foreign private adviser,’’ an adviser relying on the but the fund’s principal office and place of business See Katten Foreign Advisers Letter. See also ABA exemption may not have any place of business in in fact may be outside the U.S.’’). Letter. We note that section 203(a) of the Advisers the United States. See section 402 of the Dodd- 413 The commenter asserted that this approach Act provides that an adviser may not, unless Frank Act (defining ‘‘foreign private adviser’’). We ‘‘would not be inconsistent with Regulation S itself, registered, make use of any means or are also not including rule 203(b)(3)–1(b)(7), which which treats a partnership or corporation organized instrumentality of interstate commerce in specifies that a client who is an owner of a private under the laws of a foreign jurisdiction as a U.S. connection with its business as an investment fund is a resident where the client resides at the person if it was ‘[f]ormed by a U.S. person adviser. Hence, whether a non-U.S. adviser with no time of the client’s investment in the fund. The principally for the purpose of investing in securities place of business in the United States and no U.S. provision was vacated by a Federal court in not registered under the [Securities] Act, unless it clients would be subject to registration depends on Goldstein, supra note 14. As discussed below, we is organized or incorporated, and owned, by whether there is sufficient use of U.S. jurisdictional are including a provision in rule 202(a)(30)–1 that accredited investors * * * who are not natural means. See also supra note 334. addresses when an adviser must determine if a persons, estates or trusts.’’’ See also Comment Letter 416 Subparagraph (B) of section 202(a)(30) refers client or investor is ‘‘in the United States’’ for of Fulbright & Jaworski L.L.P. (on behalf of a to the number of ‘‘clients and investors in the purposes of the exemption. See infra note 476 and German asset manager) (Jun. 15, 2011) (‘‘Fulbright United States in private funds,’’ while subparagraph accompanying text. Letter’’). (C) refers to assets of ‘‘clients in the United States 421 See Katten Foreign Advisers Letter.

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give effect to a statutory provision with without compensation.425 Some is not required to count a person as an a similar purpose. commenters argued that an adviser investor if the adviser counts such New rule 202(a)(30)–1 allows an should not have to count such persons, person as a client of the adviser.431 adviser to treat as a single client a who may be employees and principals Thus, a client who is also an investor in natural person and: (i) That person’s of the firm and their family members.426 a private fund advised by the adviser minor children (whether or not they But as we explained in the Proposing would only be counted once. share the natural person’s principal Release, allowing an adviser not to 2. Private Fund Investor residence); (ii) any relative, spouse, count as clients persons in the United spousal equivalent, or relative of the States who do not compensate the Section 202(a)(30) provides that a spouse or of the spousal equivalent of adviser would allow certain advisers to ‘‘foreign private adviser’’ eligible for the the natural person who has the same avoid registration through reliance on new registration exemption cannot have principal residence; 422 (iii) all accounts the foreign private adviser exemption more than 14 clients ‘‘or investors in the of which the natural person and/or the despite the fact that, as those United States in private funds’’ advised person’s minor child or relative, spouse, commenters acknowledge, the adviser by the adviser. Rule 202(a)(30)–1 spousal equivalent, or relative of the provides advisory services to those defines an ‘‘investor’’ in a private fund spouse or of the spousal equivalent who persons.427 as any person who would be included has the same principal residence are the The new rule includes two provisions in determining the number of beneficial only primary beneficiaries; and (iv) all that clarify that advisers need not owners of the outstanding securities of trusts of which the natural person and/ double-count private funds and their a private fund under section 3(c)(1) of or the person’s minor child or relative, investors under certain the Investment Company Act, or spouse, spousal equivalent, or relative circumstances.428 One provision, as whether the outstanding securities of a of the spouse or of the spousal proposed, specifies that an adviser need private fund are owned exclusively by equivalent who has the same principal not count a private fund as a client if the qualified purchasers under section residence are the only primary adviser counted any investor, as defined 3(c)(7) of that Act.432 In addition, a beneficiaries.423 Rule 202(a)(30)–1 also in the rule, in that private fund as an beneficial owner of short-term paper permits an adviser to treat as a single investor in that private fund for issued by the private fund also is an ‘‘client’’ (i) a corporation, general purposes of determining the availability ‘‘investor,’’ notwithstanding that partnership, limited partnership, of the exemption.429 The other holders of short-term paper need not be limited liability company, trust, or other provision, recommended by counted for purposes of section legal organization to which the adviser commenters,430 clarifies that an adviser 3(c)(1).433 Finally, in order to avoid provides investment advice based on double-counting, the rule clarifies that the legal organization’s investment 425 See rule 203(b)(3)–1(b)(4). an adviser may treat as a single investor objectives, and (ii) two or more legal 426 See Dechert General Letter (‘‘In many any person who is an investor in two or organizations that have identical instances, advisers manage the assets of employees more private funds advised by the and principals of the firm and their family 434 shareholders, partners, limited partners, members, and use such services as a legitimate investment adviser. We are adopting members, or beneficiaries.424 compensation arrangement to retain talented rule 202(a)(30)–1 substantially as As proposed, we are omitting the employees.’’); Katten Foreign Advisers Letter proposed. In a modification to the ‘‘special rule’’ providing advisers with (‘‘Such persons are likely to be in a special proposal, however, we are not including relationship with the adviser that allows them to the option of not counting as a client benefit from the advisers’ investment advice knowledgeable employees in the any person for whom the adviser without having to pay.’’). See also ABA Letter. definition of ‘‘investor.’’ 435 provides investment advisory services 427 Cf. Form ADV: Glossary (stating that for The term ‘‘investor’’ is not currently purposes of Form ADV, the term ‘‘client’’ ‘‘includes defined under the Advisers Act or the clients from which [an adviser] receives no 422 As suggested by a commenter, we compensation * * *.’’). We also are adopting in the rules under the Advisers Act. We are incorporated in rule 202(a)(30)–1(a)(1) the concept Implementing Adopting Release a uniform method adopting the new definition to provide of a ‘‘spousal equivalent,’’ which we define by for calculating assets under management for for consistent application of the reference to rule 202(a)(11)(G)–1(d)(9) as ‘‘a regulatory purposes, including availability of the statutory provision and to prevent non- cohabitant occupying a relationship generally foreign private adviser exemption, that requires equivalent to that of a spouse.’’ See ABA Letter. advisers to include in that calculation assets they U.S. advisers from circumventing the 423 Rule 202(a)(30)–1(a)(1). If a client relationship manage without compensation. See Implementing limitations in section 203(b)(3). As involving multiple persons does not fall within the Adopting Release, supra note 32, discussion at discussed in the Proposing Release, we rule, whether the relationship may appropriately be section II.A.3. Requiring foreign private advisers to believe that defining the term ‘‘investor’’ treated as a single ‘‘client’’ depends on the facts and treat as clients persons from whom they receive no circumstances. compensation is consistent with the use of this new by reference to sections 3(c)(1) and 424 Rule 202(a)(30)–1(a)(2). In addition, rule uniform method of calculating assets under 3(c)(7) of the Investment Company Act 202(a)(30)–1(b)(1) through (3) contain the following management for regulatory purposes. will best achieve these purposes. related ‘‘special rules:’’ (1) An adviser must count 428 See rule 202(a)(30)–1(b)(4)–(5). Commenters who addressed the issue a shareholder, partner, limited partner, member, or 429 See rule 202(a)(30)–1(b)(4); 202(a)(30)–1(c)(2). agreed with our decision to define beneficiary (each, an ‘‘owner’’) of a corporation, See also infra Section II.C.2 (discussing the general partnership, limited partnership, limited definition of investor). This provision is applicable investor for purposes of this rule by liability company, trust, or other legal organization, only for purposes of determining whether an reference to the well-developed as a client if the adviser provides investment adviser has fewer than 15 clients in the United understanding of ownership under advisory services to the owner separate and apart States and investors in the United States in private

from the investment advisory services provided to funds it advises under section 202(a)(30)(B) of the 431 the legal organization; (2) an adviser is not required foreign private adviser exemption. It does not apply See rule 202(a)(30)–1(b)(5). 432 to count an owner as a client solely because the to the determination of the assets under See rule 202(a)(30)–1(c)(2)(i); supra notes 10 adviser, on behalf of the legal organization, offers, management relevant for purposes of that and 12 and accompanying text. We note that the promotes, or sells interests in the legal organization exemption under section 202(a)(30)(C). As a result, definition of ‘‘investor’’ in rule 202(a)(30)–1 is for to the owner, or reports periodically to the owners an adviser must include the assets of a private fund purposes of the foreign private adviser exemption as a group solely with respect to the performance that is a client in the United States even if the and does not limit the scope of that term for of or plans for the legal organization’s assets or adviser may exclude the private fund when purposes of rule 206(4)–8. similar matters; and (3) any general partner, determining whether the adviser has fewer than 15 433 See rule 202(a)(30)–1(c)(2)(ii). managing member or other person acting as an clients or investors in the United States. See also 434 See rule 202(a)(30)–1(c)(2), at note to investment adviser to a limited partnership or infra note 499. paragraph (c)(2). limited liability company must count the 430 See ABA Letter; Katten Foreign Advisers 435 See rule 202(a)(30)–1(c)(2). See also infra partnership or limited liability company as a client. Letter. notes 448–452 and accompanying text.

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sections 3(c)(1) and 3(c)(7).436 Funds adviser relying on the exemption would investors persons other than the and their advisers must determine who have to count such a person as an nominal holder of a security issued by is a beneficial owner for purposes of investor. a private fund is derived from section 3(c)(1) or whether an owner is For example, the adviser to a master provisions in both the Advisers Act and a qualified purchaser for purposes of fund in a master-feeder arrangement the Investment Company Act section 3(c)(7).437 More importantly, would have to treat as investors the prohibiting a person from doing defining the term ‘‘investor’’ by holders of the securities of any feeder indirectly, or through or by any other reference to sections 3(c)(1) and 3(c)(7) fund formed or operated for the purpose person, what is unlawful to do directly, places appropriate limits on the ability of investing in the master fund rather and from sections 3(c)(1) and 3(c)(7).445 of a non-U.S. adviser to avoid than the feeder funds, which act as Some commenters also argued that application of the registration conduits.442 In addition, an adviser ‘‘looking through’’ a total return swap or provisions of the Advisers Act by setting would need to count as an investor an similar instrument would be impractical up intermediate accounts through owner of a total return swap on the or unduly burdensome in certain which investors may access a private private fund because that arrangement circumstances, including situations in fund and not be counted for purposes of effectively provides the risks and which the adviser did not participate in the exemption. Advisers must ‘‘look rewards of investing in the private fund the swap’s creation or know of its through’’ nominee and similar to the swap owner.443 Whether an existence.446 An issuer relying on arrangements to the underlying holders owner of another type of instrument section 3(c)(7) may treat as a qualified of private fund-issued securities to referencing a private fund would be purchaser any person whom the issuer determine whether they have fewer than counted as the beneficial owner under reasonably believes is a qualified 15 clients and private fund investors in section 3(c)(1), or be required to be a purchaser, and the definition of investor the United States.438 Holders of both qualified purchaser under section that we are adopting today provides that equity and debt securities must be 3(c)(7), would depend on the facts and an adviser counts as investors those counted as investors.439 circumstances. persons who must be qualified Under the new rule, an adviser will Several commenters generally purchasers under section 3(c)(7). determine the number of investors in a disagreed that advisers should be Therefore, an adviser may treat as an private fund based on the facts and required to ‘‘look through’’ total return investor a person the adviser reasonably 447 circumstances and in light of the swaps or similar instruments or master- believes is the actual investor. applicable prohibition not to do feeder arrangements in at least certain Similarly, if an adviser reasonably indirectly, or through or by any other circumstances, arguing among other believes that an investor is not ‘‘in the person, what is unlawful to do things that these instruments or United States,’’ the adviser may treat the directly.440 Depending upon the facts arrangements serve legitimate business investor as not being ‘‘in the United and circumstances, persons other than purposes.444 As we explain above, States.’’ The final rule, unlike the proposal, the nominal holder of a security issued however, the requirement to count as by a private fund may be counted as the does not treat as investors beneficial beneficial owner under section 3(c)(1), is wholly owned by a Prospective Qualified owners who are ‘‘knowledgeable or be required to be a qualified Purchaser who makes all the decisions with respect employees’’ with respect to the private purchaser under section 3(c)(7).441 An to such investments), it would be appropriate to fund, and certain other persons related attribute the investments held by such entity to the to such employees (we refer to them, Prospective Qualified Purchaser.’’). 436 See ABA Letter; Dechert General Letter; Katten 442 collectively, as ‘‘knowledgeable A ‘‘master-feeder fund’’ is an arrangement in 448 Foreign Advisers Letter. which one or more funds with the same or employees’’). In formulating our 437 See supra notes 10 and 12 and accompanying consistent investment objectives (‘‘feeder funds’’) text. In the Proposing Release, we noted that invest all or substantially all of their assets in a 445 See supra notes 440–443 and accompanying typically a prospective investor in a private fund single fund (‘‘master fund’’) with the same or text. must complete a subscription agreement that consistent investment objective and strategies. We 446 See, e.g., Dechert General Letter; EFAMA includes representations or confirmations that it is have taken the same approach within our rules that Letter. qualified to invest in the fund and whether it is a require a private fund to ‘‘look through’’ any 447 Rule 202(a)(30)–1(c)(2) defines the term U.S. person. This information is designed to allow investor that is formed or operated for the specific ‘‘investor’’ generally to include persons that must the adviser (on behalf of the fund) to make the purpose of investing in a private fund. See rule be counted for purposes of section 3(c)(1) of the above determination. Therefore, an adviser seeking 2a51–3(a) under the Investment Company Act (17 Investment Company Act or qualified purchasers to rely on the foreign private adviser exemption will CFR 270.2a51–3(a)) (a company is not a qualified for purposes of section 3(c)(7) of that Act. See supra have ready access to this information. purchaser if it is ‘‘formed for the specific purpose notes 432–443 and accompanying text. Advisers to 438 Rule 202(a)(30)–1(c)(2). See generally sections of acquiring the securities’’ of an investment private funds relying on section 3(c)(7) may under 3(c)(1) and 3(c)(7) of the Investment Company Act. company that is relying on section 3(c)(7) of the Investment Company Act rule 2a51–1(h) treat as 439 Sections 3(c)(1) and 3(c)(7) of the Investment Investment Company Act, unless each of the qualified purchasers those persons they reasonably Company Act refer to beneficial owners and company’s beneficial owners is also a qualified believe are qualified purchasers. Persons who must owners, respectively, of ‘‘securities’’ (which is purchaser). See also NSMIA Release, supra note 441 be qualified purchasers for purposes of section broadly defined in section 2(a)(36) of that Act to (explaining that rule 2a51–3(a) would limit the 3(c)(7) generally would be the same as those who include debt and equity). possibility that ‘‘a company will be able to do must be counted for purposes of section 3(c)(1). 440 See section 208(d) of the Advisers Act; section indirectly what it is prohibited from doing directly Accordingly, advisers may, for purposes of 48(a) of the Investment Company Act. [by organizing] * * * a ‘qualified purchaser’ entity determining their investors in the United States 441 As noted above, we have recognized that in for the purpose of making an investment in a under rule 202(a)(30)–1, treat as an investor a certain circumstances it is appropriate to ‘‘look particular Section 3(c)(7) Fund available to person the adviser reasonably believes is the actual through’’ an investor (i.e., attribute ownership of a investors that themselves did not meet the investor. private fund to another person who is the ultimate definition of ‘qualified purchaser’ ’’). 448 See proposed rule 202(a)(30)–1(c)(1)(i) owner). See, e.g., Privately Offered Investment 443 One commenter argued that the swap (referencing rule 3c–5 under the Investment Companies, Investment Company Act Release No. counterparty is not required to hedge its exposure Company Act (17 CFR 270.3c–5(b)), which excludes 22597 (Apr. 3, 1997) [62 FR 17512 (Apr. 9, 1997)] by investing the full notional amount in the private from the determinations under sections 3(c)(1) and (‘‘NSMIA Release’’) (‘‘The Commission understands fund. See Dechert General Letter. We do not find 3(c)(7) of that Act any securities beneficially owned that there are other forms of holding investments this distinction persuasive in situations in which by knowledgeable employees of a private fund; a that may raise interpretative issues concerning the adviser knows or should know of the existence company owned exclusively by knowledgeable whether a Prospective Qualified Purchaser ‘owns’ of the swap. See infra discussion accompanying and employees; and any person who acquires securities an investment. For instance, when an entity that following note 447. originally acquired by a knowledgeable employee holds investments is the ‘alter ego’ of a Prospective 444 See, e.g., ABA Letter; Dechert General Letter; through certain transfers of interests, such as a gift Qualified Purchaser (as in the case of an entity that EFAMA Letter. or a bequest).

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proposal to include knowledgeable fund.454 These persons are not counted fund’s losses directly affect the interests employees in the definition of investor, as beneficial owners for purposes of of holders of short-term paper in the we were concerned that excluding section 3(c)(1) but must be qualified fund just as they affect the interests of knowledgeable employees from the purchasers under section 3(c)(7).455 other debt holders in the fund.461 In definition of investor would allow Some commenters opposed this contrast to the treatment of certain advisers to avoid registration by approach, arguing that holders of short- knowledgeable employees, holders of relying on the foreign private adviser term paper do not make an investment short-term paper must be qualified exemption.449 A number of commenters decision but rather are creditors making purchasers under section 3(c)(7), the opposed our proposal.450 In particular, a credit risk evaluation.456 We disagree. more recent of the two exclusions under they argued that the proposed approach The acquisition of those instruments the Investment Company Act on which was inconsistent with Congressional involves an investment decision, private funds rely.462 Thus, we are and prior Commission determinations although the considerations involved in requiring advisers to count as investors that such employees do not need the that decision might differ from the all debt holders, including holders of protections of the Investment Company considerations involved in a decision to short-term paper. Act.451 make an equity investment. Some commenters expressed concern Upon further consideration, we have One commenter asserted that treating that the look-through requirement determined that the same policy holders of short-term paper as investors contained in the statutory definition of considerations that justify disregarding could result in a U.S. commercial lender a ‘‘foreign private adviser’’ could knowledgeable employees for purposes to a fund being treated as an investor, impose significant burdens on advisers of other provisions provide a valid basis leading non-U.S. advisers to avoid U.S. to non-U.S. funds, including non-U.S. for excluding them from the definition lenders.457 Unless the extension of retail funds publicly offered outside of of ‘‘investor’’ under the foreign private credit by a fund’s broker-dealer or the United States.463 Two of these adviser exemption.452 Treating custodian bank results in the issuance of commenters stated, for example, that in knowledgeable employees in the same a security by the fund to its creditor, the their view a non-U.S. fund could be manner for purposes of the definition of creditor would not be considered an considered a private fund as a result of investor and sections 3(c)(1) and 3(c)(7) investor for purposes of the foreign independent actions of U.S. investors, will also simplify compliance with private adviser exemption.458 such as if a non-U.S. shareholder of a regulatory requirements imposed by As we stated in the Proposing Release, non-U.S. fund moves to the United both the Advisers Act and the there appears to be no valid reason to States and purchases additional Investment Company Act. treat as investors all debt holders except shares.464 If these funds were ‘‘private The new rule requires advisers to treat holders of short-term paper.459 Certain as investors beneficial owners of ‘‘short- issuers continually roll over short-term August 2007. At that time, structured investment term paper’’ 453 issued by the private paper and effectively use it as a vehicles (‘‘SIVs’’), which are off-balance sheet permanent source of capital, further funding vehicles sponsored by financial 449 See Proposing Release, supra note 26, at n.250 supporting our view that there appears institutions, issued commercial paper to finance the and accompanying text. acquisition of long-term assets, including to be no reason to treat holders of short- residential mortgages. As a result of problems in the 450 See Dechert General Letter; Katten Foreign term paper differently than other longer- residential home mortgage market, short-term Advisers Letter; Seward Letter; Shearman Letter. investors began to avoid asset-backed commercial 451 See, e.g., Dechert General Letter (‘‘[The] term debt holders for purposes of the 460 paper tied to residential mortgages, regardless of Commission promulgated the knowledgeable exemption. Moreover, a private whether the securities had substantial exposure to employee safe-harbors for sections 3(c)(1) and sub-prime mortgages. Unable to roll over their 3(c)(7) in response to the Congressional mandate in rather than an investment character, as the commercial paper, SIVs suffered severe liquidity the National Securities Markets Improvement Act of Commission may designate by rules and problems and significant losses. See Money Market 1996 to allow certain informed insiders to invest in regulations’’). Fund Reform, Investment Company Act Release No. a private fund without causing the fund to lose its 454 See rule 202(a)(30)–1(c)(2)(ii). 28807 (June 30, 2009) [74 FR 32688 (July 8, 2009)] exception under the 1940 Act.’’); Shearman Letter 455 See sections 3(c)(1) and 3(c)(7) of the (‘‘Money Market Fund Reform Release’’) at nn. 37– (the proposed approach is ‘‘contrary to a long Investment Company Act. 39 and preceding and accompanying text; Marcin history of recognizing that knowledgeable 456 Kacperczyk And Philipp Schnabl, When Safe employees should be treated differently than other See ABA Letter (‘‘[H]olders of short-term investors and that their privileged status with their securities do not view themselves as making an Proved Risky: Commercial Paper During the organizations in terms of influence and access to investment decision in connection with their Financial Crisis Of 2007–2009 (Nov. 2009). information reasonably limits the public’s interest extension of credit, but rather assess the risk of 461 As discussed in the Proposing Release, various in their protection’’). holding a private fund’s short-term paper based on types of investment vehicles make significant use credit risk.’’); Shearman Letter (‘‘[A] lender to a 452 See Advisers Act rule 205–3(d)(1)(iii) of short-term paper for financing purposes so fund, while it makes a ‘credit analysis,’ does not (specifying that knowledgeable employees are holders of this type of security are, in practice, deploy capital based on the perceived skill of the included among the types of clients to whom the exposed to the investment results of the security’s fund manager and so is not an investor by any adviser may charge performance fees); Advisers Act issuer. See Proposing Release, supra note 26, at n. traditional measure.’’). rule 202(a)(11)(G)–1 (permitting a family office 251. See also Money Market Fund Reform Release, 457 excluded from the definition of investment adviser See Shearman Letter. supra note 460, at nn. 37–39 and preceding and under the Advisers Act to provide investment 458 See Reves v. Ernst & Young, 494 U.S. 56 accompanying text (discussing how money market advice to its knowledgeable employees). These (1990). funds were exposed to substantial losses during provisions reflect a policy determination that 459 See Proposing Release, supra note 26, at n. 251 2007 as a result of exposure to debt securities knowledgeable employees are likely to be in a and accompanying text. One commenter agreed that issued by structured investment vehicles). position or have a level of knowledge and we should not treat short- and longer-term debt 462 Congress added section 3(c)(7) to the experience in financial matters sufficient to be able holders differently for purposes of the exemption. Investment Company in 1996 as part of the National to evaluate the risks and take steps to protect See ABA Letter (asking that we exclude all holders Securities Markets Improvement Act of 1996. themselves. of conventional debt from the definition of Section 3(c)(1) was included in the Investment 453 See rule 202(a)(30)–1(c)(2)(ii) (referencing the investor). Company Act when it was enacted in 1940. definition of ‘‘short-term paper’’ contained in 460 As we noted in the Proposing Release, because 463 See AFG Letter; Dechert Foreign Adviser section 2(a)(38) of the Investment Company Act, commercial paper issuers often refinance the Letter; EFAMA Letter; Shearman Letter. which defines ‘‘short-term paper’’ to mean ‘‘any repayment of maturing commercial paper with 464 Dechert Foreign Adviser Letter; EFAMA note, draft, bill of exchange, or banker’s acceptance newly issued commercial paper, they may face roll- Letter. See also Comment Letter of Association payable on demand or having a maturity at the time over risk, i.e., the risk that investors may not be Franc¸aise de la Gestion financie`re (Jun. 14, 2011) of issuance of not exceeding nine months, exclusive willing to refinance maturing commercial paper. (recommended that ‘‘investment funds that already of days of grace, or any renewal thereof payable on See Proposing Release, supra note 26, at n. 134. are strictly regulated and supervised by European demand or having a maturity likewise limited; and These risks became particularly apparent for issuers Union regulators should be excluded from the such other classes of securities, of a commercial of asset-backed commercial paper beginning in Continued

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funds,’’ their advisers would, if seeking as to the relevant time for making the Similar to our approach in new rule to rely on the foreign private adviser related determination. 203(m)–1(d)(8) and as we proposed,474 exemption, be required to determine the New rule 202(a)(30)–1 defines ‘‘in the we are treating as persons ‘‘in the number of private fund investors in the United States,’’ as proposed, generally United States’’ for purposes of the United States and the assets under by incorporating the definition of a foreign private adviser exemption management attributable to them. ‘‘U.S. person’’ and ‘‘United States’’ certain persons that would not be under Regulation S.467 In particular, we considered ‘‘U.S. persons’’ under As we explain above, if an adviser are defining ‘‘in the United States’’ to Regulation S. For example, we are reasonably believes that an investor is mean: (i) With respect to any place of treating as ‘‘in the United States’’ any not ‘‘in the United States,’’ the adviser business, any such place that is located discretionary account owned by a U.S. may treat the investor as not being ‘‘in in the ‘‘United States,’’ as defined in person and managed by a non-U.S. the United States.’’ Moreover, we Regulation S;)468 (ii) with respect to any affiliate of the adviser in order to understand that non-U.S. private funds client or private fund investor in the discourage non-U.S. advisers from currently count or qualify their U.S. United States, any person who is a ‘‘U.S. creating such discretionary accounts investors in order to avoid regulation person’’ as defined in Regulation S,469 with the goal of circumventing the under the Investment Company Act.465 except that any discretionary account or exemption’s limitation with respect to A non-U.S. adviser would need to count similar account that is held for the advising assets of persons in the United the same U.S. investors (except for benefit of a person ‘‘in the United States.475 holders of short-term paper with respect States’’ by a non-U.S. dealer or other We also are including the note to to a fund relying on section 3(c)(1)) in professional fiduciary is deemed ‘‘in the paragraph (c)(3)(i) specifying that for order to rely on the foreign private United States’’ if the dealer or purposes of that definition, a person adviser exemption. In this respect, professional fiduciary is a related who is ‘‘in the United States’’ may be therefore, the look-through requirement person of the investment adviser relying treated as not being ‘‘in the United of the foreign private adviser exemption on the exemption; and (iii) with respect States’’ if the person was not ‘‘in the will generally not impose any new to the public, in the ‘‘United States,’’ as United States’’ at the time of becoming burden on advisers to non-U.S. funds. defined in Regulation S.470 a client or, in the case of an investor in We believe that the use of Regulation a private fund, each time the investor 3. In the United States S is appropriate for purposes of the acquires securities issued by the foreign private adviser exemption 476 Section 202(a)(30)’s definition of fund. As we explained in the because Regulation S provides more Proposing Release, the note is designed ‘‘foreign private adviser’’ employs the specific rules when applied to various term ‘‘in the United States’’ in several to reduce the burden of having to types of legal structures.471 Advisers, monitor the location of clients and contexts, including: (i) Limiting the moreover, already apply the Regulation number of—and assets under investors on an ongoing basis, and to S definition of U.S. person with respect avoid placing an adviser in a position management attributable to—an to both clients and investors for other adviser’s ‘‘clients’’ ‘‘in the United whereby it might have to choose purposes and therefore are familiar with between registering with the States’’ and ‘‘investors in the United 472 the definition. The references to Commission or terminating the States’’ in private funds advised by the Regulation S with respect to a place of relationship with any client that moved adviser; (ii) exempting only those business ‘‘in the United States’’ and the to the United States, or redeeming the advisers without a place of business ‘‘in public in the ‘‘United States’’ also interest in the private fund of any the United States;’’ and (iii) exempting allows us to maintain consistency across investor that moved to the United only those advisers that do not hold our rules. Two commenters specifically States.477 themselves out to the public ‘‘in the supported our approach.473 Several commenters supported the United States’’ as an investment inclusion of the note.478 Some 466 467 adviser. Today, we are defining the Rule 202(a)(30)–1(c)(3). As discussed above, commenters, however, advocated term ‘‘in the United States’’ to clarify we are also referencing Regulation S’s definition of a ‘‘U.S. person’’ for purposes of the definition of expanding the note to treat a private the term for all of the above purposes as ‘‘United States person’’ in rule 203(m)–1. See supra well as to provide specific instructions Section II.B.4. persons within the context of the private fund 468 See 17 CFR 230.902(l). adviser exemption. See supra Section II.B.4. scope of Title IV of the Dodd Frank Act and should 469 See 17 CFR 230.902(k). 474 See supra Section II.B.4 (discussing the not be considered as ‘private funds’’’ because, 470 See 17 CFR 230.902(l). definition of United States persons and the among other reasons, the commenter’s management 471 See supra notes 404–407 and accompanying treatment of discretionary accounts). company members ‘‘very often’’ do not know the text. 475 Rule 202(a)(30)–1(c)(3)(i). See supra note 409. identities of their funds’ investors, and ‘‘therefore 472 As we noted in the Proposing Release, many 476 Rule 202(a)(30)–1, at note to paragraph (c)(3)(i) should not [] be held responsible if, unbeknownst non-U.S. advisers identify whether a client is a (‘‘A person who is in the United States may be to them, US persons decide to invest in their ‘‘U.S. person’’ under Regulation S in order to treated as not being in the United States if such funds’’). determine whether the client may invest in certain person was not in the United States at the time of 465 This practice is consistent with positions our private funds and certain private placement becoming a client or, in the case of an investor in staff has taken in which the staff has stated it would offerings exempt from registration under the a private fund, each time the investor acquires not recommend enforcement action in certain Securities Act. See Proposing Release, supra note securities issued by the fund.’’). We revised the note circumstances. See, e.g., Goodwin Procter No- 26, at n. 259. With respect to ‘‘investors,’’ our staff to provide that it applies ‘‘each time’’ the investor Action Letter, supra note 294; Touche Remnant No- has generally taken the interpretive position that an acquires securities issued by the fund. Cf. proposed Action Letter, supra note 294. See also sections investor that does not meet that definition is not a rule 202(a)(30)–1, at note to paragraph (c)(2)(i). This 7(d), 3(c)(1), and 3(c)(7) of the Investment Company U.S. person when determining whether a non-U.S. change to the note as proposed more clearly reflects Act. See also, e.g., Canadian Tax-Deferred private fund meets the section 3(c)(1) and 3(c)(7) the note’s intended operation. Retirement Savings Accounts Release, supra note counting or qualification requirements. See id., at 477 See Proposing Release, supra note 26, at n.257 294, at n. 23 (‘‘The Commission and its staff have n. 217. Many non-U.S. advisers, moreover, and accompanying and following text. interpreted section 7(d) to generally prohibit a currently determine whether a private fund investor 478 See, e.g., Dechert General Letter (‘‘The note foreign fund from making a U.S. private offering if is a ‘‘U.S. person’’ under Regulation S for purposes provides helpful relief at a time when advisory that offering would cause the securities of the fund of the safe harbor for offshore offers and sales. clients often move across international borders to be beneficially owned by more than 100 U.S. 473 Dechert Foreign Adviser Letter; Dechert while keeping an existing relationship with a residents.’’). General Letter. Commenters generally addressed financial institution.’’). See also ABA Letter; 466 See section 402 of the Dodd-Frank Act. our proposal to rely on Regulation S to identify U.S. Dechert Foreign Adviser Letter.

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fund investor in the same way as a fund sold to Participants would be is logical as well as efficient to use the client so that additional investments in deemed a private fund if it conducted a rule 222–1(a) definition of ‘‘place of a fund made after moving to the United private offering in the United States,483 business’’ for purposes of the foreign States would not cause the investor to but we have previously stated that private adviser exemption. The two become a U.S. person.479 They argued Participants need not be counted toward commenters that considered the that, as discussed above, advisers to the 100-investor limit for purposes of proposed definition of ‘‘place of non-U.S. funds should not be required section 3(c)(1).484 As a result, and based business’’ by reference to rule 222–1 to ‘‘look through’’ these funds to ensure on the same policy considerations agreed with this analysis.489 that their investors who purchased embodied in rule 7d–2, we believe that Some commenters asked us to clarify shares while outside of the United a non-U.S. adviser should not be that a ‘‘place of business’’ would not States did not subsequently relocate to required to treat Participants as include an office in the United States the United States and purchase investors in the United States under rule where a non-U.S. adviser solely additional shares. 202(a)(30)–1 with respect to investments conducts research, communicates with As we explain above, if an adviser they make after moving to the United non-U.S. clients, or performs reasonably believes that an investor is States if the fund is in compliance with administrative services and back-office not ‘‘in the United States,’’ the adviser rule 7d–2.485 books and recordkeeping activities.490 Under rule 202(a)(30)–1, as under rule may treat the investor as not being ‘‘in 4. Place of Business the United States.’’ In addition, we 203(m)–1, an adviser must determine understand that, based on no-action New rule 202(a)(30)–1, by reference to whether it has a place of business, as 486 positions taken by our staff, non-U.S. rule 222–1, defines ‘‘place of defined in rule 222–1, in the United funds do not consider for purposes of business’’ to mean any office where the States in light of the relevant facts and section 3(c)(1) beneficial owners who investment adviser regularly provides circumstances.491 For example, any were not U.S. persons at the time they advisory services, solicits, meets with, office from which an adviser regularly invested in the fund, but do consider or otherwise communicates with clients, communicates with its clients, whether those beneficial owners if they make and any location held out to the public U.S. or non-U.S., would be a place of as a place where the adviser conducts business.492 In addition, an office or additional purchases in the same fund 487 after relocating to the United States.480 any such activities. We are adopting other location where an adviser The note is consistent with the funds’ this provision as proposed because we regularly conducts research would be a current practices, and thus generally believe the definition appropriately place of business because research is identifies a location where an adviser is should not impose any new burdens on intrinsic to the provision of investment doing business for purposes of section 493 non-U.S. funds. The note also is advisory services. A place of business 202(a)(30) of the Advisers Act and thus consistent with section 3(c)(7), which would not, however, include an office provides a basis for an adviser to requires an investor to be a qualified where an adviser solely performs determine whether it can rely on the purchaser at the time the investor administrative services and back-office exemption in section 203(b)(3) of the acquires the securities. activities if they are not activities Advisers Act for foreign private The Investment Funds Institute of intrinsic to providing investment advisers. As discussed in the Proposing Canada (IFIC) and the Investment advisory services and do not involve Release, because both the Commission Industry Association of Canada (IIAC) communicating with clients. and the state securities authorities use urged that, for purposes of the look- A number of commenters sought this definition to identify an through provision, the Commission guidance as to whether the activities of unregistered foreign adviser’s place of allow non-U.S. advisers not to count U.S. affiliates of non-U.S. advisers business for purposes of determining persons (and their assets) who invest in would be deemed to constitute places of regulatory jurisdiction,488 we believe it a foreign private fund through certain business in the United States of the non- Canadian retirement accounts U.S. advisers.494 There is no Accounts, Securities Act Release No. 7860 (June 7, presumption that a non-U.S. adviser has (‘‘Participants’’) after having moved to 2000) [65 FR 37672 (June 15, 2000)]. U.S. the United States.481 The commenters registration requirements were affecting those a place of business in the United States noted that this treatment would be Participants’ ability to purchase or exchange solely because it is affiliated with a U.S. consistent with rule 7d–2 under the securities for such accounts. Rule 7d–2 generally adviser.495 A non-U.S. adviser might be allows non-U.S. funds to treat as a private offering deemed to have a place of business in Investment Company Act and certain certain offerings to Participants who are in the related rules.482 We agree. A non-U.S. United States. 483 See supra notes 294 and 313. business’’ within, and has fewer than six clients resident in, the state). 479 See Dechert Foreign Adviser Letter; Dechert 484 See Canadian Tax-Deferred Retirement 489 General Letter; EFAMA Letter. Savings Accounts Release, supra note 294, at n.23. See ABA Letter (‘‘[W]e believe that the definition of place of business set forth in Rule 222– 480 See Investment Funds Institute of Canada, SEC 485 This interpretation only applies with respect 1 is appropriate * * *’’); AIMA Letter (‘‘We Staff No-Action Letter (Mar. 4, 1996) (staff also to Participants’ investments in Eligible Securities consider the definition of ‘place of business’ by stated its belief that, to the extent that a dividend issued by a Qualified Company, as these terms are reference to Rule 222–1 of the Advisers Act both reinvestment plan of a non-U.S. fund is consistent defined in rule 7d–2. logical and appropriate.’’). with the requirements of Securities Act Release No. 486 Rule 222–1(a) (defining ‘‘place of business’’ of 490 929 (July 29, 1936), such a plan would not involve an investment adviser as: ‘‘(1) An office at which See, e.g., ABA Letter; AIMA Letter. an offer for purposes of Section 7(d) of the the investment adviser regularly provides 491 As discussed above, investment advisers will Investment Company Act). See also Goodwin investment advisory services, solicits, meets with, also apply this provision for purposes of the private Procter No-Action Letter, supra note 294; Touche or otherwise communicates with clients; and (2) fund adviser exemption. See supra Section II.B.3. Remnant No-Action Letter, supra note 294. Any other location that is held out to the general 492 Rule 222–1 does not distinguish between U.S. 481 See IFIC Letter; Comment Letter of Investment public as a location at which the investment adviser and non-U.S. clients. Industry Association of Canada (Jan. 18, 2011) provides investment advisory services, solicits, 493 That would include, for example, research (‘‘IIAC Letter’’). meets with, or otherwise communicates with conducted in order to produce non-public 482 We adopted rule 7d–2, along with rule 237 clients.’’). information relevant to the investments of, or the under the Securities Act, in order to allow 487 Rule 202(a)(30)–1(c)(4). investment recommendations for, any of the Participants who move to the United States to 488 See Proposing Release, supra note 26, at n.265 adviser’s clients. continue to manage their Canadian retirement (explaining that, under section 222(d) of the 494 See, e.g., Debevoise Letter; Dechert Foreign accounts. See Offer and Sale of Securities to Advisers Act, a state may not require an adviser to Adviser Letter; EFAMA Letter. Canadian Tax-Deferred Retirement Savings register if the adviser does not have a ‘‘place of 495 See infra note 506.

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the United States, however, if the non- of risk.500 One commenter specifically subadviser eligible to rely on rule U.S. adviser’s personnel regularly agreed that the uniform method should 203(m)–1 if the subadviser’s services to conduct activities at an affiliate’s place be applied for purposes of the foreign the primary adviser relate solely to of business in the United States.496 private adviser exemption.501 Most private funds and the other conditions commenters addressed the components of the rule are met. Similarly, a 5. Assets Under Management of the new method of calculation in subadviser may be eligible to rely on For purposes of rule 202(a)(30)–1 we reference to the calculation of section 203(l) if the subadviser’s are defining ‘‘assets under ‘‘regulatory assets under management’’ services to the primary adviser relate management,’’ as proposed, by reference under Form ADV, or with respect to the solely to venture capital funds and the to the calculation of ‘‘regulatory assets calculation of private fund assets for other conditions of the rule are met. under management’’ for Item 5 of Form purposes of the private fund adviser We anticipated that an adviser with 502 advisory affiliates could encounter ADV.497 As discussed above, in Item 5 exemption. We address these interpretative issues as to whether it of Form ADV we are implementing a comments in the Implementing may rely on any of the exemptions uniform method of calculating assets Adopting Release and in Section 503 discussed in this Release without taking under management that can be used for II.B.2. into account the activities of its several purposes under the Advisers D. Subadvisory Relationships and affiliates. The adviser, for example, Act, including the foreign private Advisory Affiliates might have advisory affiliates that are adviser exemption and the private fund We generally interpret advisers as registered or that provide advisory adviser exemption.498 Because the including subadvisers,504 and therefore services that the adviser itself could not foreign private adviser exemption is also believe it is appropriate to permit provide while relying on an exemption. based on assets under management, we subadvisers to rely on each of the new In the Proposing Release, we requested believe that all advisers should use the exemptions, provided that subadvisers comment on whether any proposed rule same method for calculating assets satisfy all terms and conditions of the should provide that an adviser must under management to determine if they applicable rule. take into account the activities of its are required to register or may be We are aware that in many 499 advisory affiliates when determining eligible for the exemption. subadvisory relationships a subadviser eligibility for an exemption, by having We believe that uniformity in the has contractual privity with a private the rule, for example, specify that the method for calculating assets under fund’s primary adviser rather than the exemption is not available to an affiliate management will result in more private fund itself. Although both the of a registered investment adviser. consistent asset calculations and private fund and the fund’s primary Commenters that responded to our reporting across the industry and, adviser may be viewed as clients of the request for comment generally therefore, in a more coherent subadviser, we would consider a supported treating each advisory entity application of the Advisers Act’s separately without regard to the regulatory requirements and assessment 500 See supra Section II.B.2.a; Implementing activities of, or relationships with, its Adopting Release, supra note 32, discussion at 505 section II.A.3. affiliates. This approach, however, 496 We have provided guidance as to whether 501 See Seward Letter. would for example permit an adviser certain activities would result in an investment 502 See supra Section II.B.2.a; Implementing managing $200 million in private fund adviser representative having a place of business as Adopting Release, supra note 32, discussion at assets simply to reorganize as two defined in rule 203A–3(b), which we believe also section II.A.3. A few commenters raised the same separate advisers, each of which could is applicable to an adviser’s determination as to arguments in favor of revising the method of whether it has a U.S. place of business under rule calculation also with respect to the calculation purport to rely on the private fund 222–1 (and therefore under rule 203(m)–1 or rule under the foreign private adviser exemption. See, adviser exemption. Such a result would 203(a)(30)–1). We have explained that the definition e.g., ABA Letter; EFAMA Letter; Katten Foreign in our view be inconsistent with the in rule 203A–3(b) ‘‘encompasses permanent and Advisers Letter (arguing that the method should intent of Congress in establishing the temporary offices as well as other locations at exclude proprietary and knowledgeable employee which an adviser representative may provide assets, and assets for which the adviser receives no exemption’s $150 million threshold and advisory services, such as a hotel or auditorium.’’ compensation). would violate section 208(d) of the Rules Implementing Amendments to the Investment 503 See Implementing Adopting Release, supra Advisers Act, which prohibits any Advisers Act of 1940, Investment Advisers Act note 32, discussion at section II.A.3. In addition, person from doing indirectly or through Release No. 1633 (May 15, 1997) [62 FR 28112 (May several commenters requested that we exercise our 22, 1997)]. We further explained that whether a authority to increase the $25 million asset threshold or by any other person any act or thing temporary office or location is a place of business applicable to the foreign private adviser exemption. which would be unlawful for such ‘‘will turn on whether the adviser representative See, e.g., ABA Letter ($100 million); AFG Letter person to do directly. Accordingly, we has let it generally be known that he or she will ($150 million); AIMA Letter (at least $100 million); would treat as a single adviser two or conduct advisory business at the location, rather Comment Letter of Autorite´ des Marche´s Financiers than on the frequency with which the adviser (Jan. 18, 2011) ($150 million); EVCA Letter ($100 more affiliated advisers that are representative conducts advisory business there.’’ or $150 million); DLA Piper VC Letter ($250 separately organized but operationally Id. See also infra Section II.D. million); Fulbright Letter ($500 million). We integrated, which could result in a 497 See rule 202(a)(30)–1(c)(1); instructions to acknowledged in the Proposing Release that Section Item 5.F of Form ADV, Part 1A. As discussed above, requirement for one or both advisers to 204 of the Advisers Act provides us with the 506 we are taking the same approach under rule authority to raise the threshold, but we did not register. Some commenters 203(m)–1. See supra Section II.B.2.a. propose to do so. Therefore, we have not considered 498 See supra Section II.B.2.a; Implementing raising the threshold in connection with this 505 See, e.g., AFG Letter (in determining Adopting Release, supra note 32, discussion at rulemaking, but we will evaluate whether doing so exemption thresholds, each entity’s assets should section II.A.3. may be appropriate in the future, consistent with be determined separately; does not support 499 According to the statutory definition of a comment we received. See ABA Letter (asked that combining different entities with different business ‘‘foreign private adviser,’’ a non-U.S. adviser we ‘‘monitor this issue * * * undertake dialogue activities); Debevoise Letter (in the context of rule calculating the assets relevant for purposes of the with foreign regulators with respect to their 203(m)–1). foreign private adviser exemption would only supervisory regimes over investment advisers, and 506 Generally, a separately formed advisory entity include those assets under management (i.e., * * * consider proposing an increase in the that operates independently of an affiliate may be regulatory assets under management) that are exemption amount in the near future’’). eligible for an exemption if it meets all of the ‘‘attributable to clients in the United States and 504 See, e.g., Pay to Play Release, supra note 9, at criteria set forth in the relevant rule. However, the investors in the United States in private funds nn.391–94 and accompanying and following text; existence of separate legal entities may not by itself advised by the investment adviser.’’ See supra notes Hedge Fund Adviser Registration Release, supra be sufficient to avoid integration of the affiliated 416 and 429 and accompanying text and note 417. note 14, at n.243. entities. The determination of whether the advisory

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acknowledged this, but urged that, in provided assurances that it would not However, the Unibanco letters were the case of a non-U.S. advisory affiliate, recommend enforcement action of the developed by the staff in the context of the Commission affirm the staff’s substantive provisions of the Advisers the private adviser exemption,516 which positions developed in the Unibanco Act with respect to a non-U.S. adviser’s Congress repealed. Nothing in the rules line of no-action letters (‘‘Unibanco relationships with its non-U.S. we are today adopting in this Release is letters’’).507 In the Unibanco letters,508 clients.511 In addition, and as relevant intended to withdraw any prior the staff provided assurances that it here, the staff agreed not to recommend statement of the Commission or the would not recommend enforcement enforcement action if a non-U.S. views of the staff as expressed in the action, subject to certain conditions, advisory affiliate of a registered adviser, Unibanco letters. We expect that the against a non-U.S. unregistered adviser often termed a ‘‘participating affiliate,’’ staff will provide guidance, as that is affiliated with a Commission- shares personnel with, and provides appropriate, based on facts that may be registered adviser, despite sharing certain services through, the registered presented to the staff regarding the personnel and resources.509 adviser affiliate, without such affiliate application of the Unibanco letters in The Unibanco letters grew out of registering under the Advisers Act.512 the context of the new foreign private recommendations in a 1992 staff study, Many commenters asserted that adviser exemption and the private fund and sought to limit the extraterritorial affirming these positions would adviser exemption. application of the Advisers Act while accommodate established business III. Certain Administrative Law Matters also protecting U.S. investors and practices of global advisory firms markets.510 In these letters, the staff without reducing the Commission’s The effective date for rules 203(l)–1, ability to protect U.S. markets and 203(m)–1 and 202(a)(30)–1 is July 21, businesses of two separately formed affiliates may investors, because the Commission 2011. The Administrative Procedure Act be required to be integrated is based on the facts would continue to have access to generally requires that an agency and circumstances. Our staff has taken this position publish a final rule in the Federal in Richard Ellis, Inc., SEC Staff No-Action Letter records and personnel of unregistered (Sept. 17, 1981) (discussing the staff’s views of non-U.S. advisory entities that are Register not less than 30 days before its factors relevant to the determination of whether a involved in the U.S. advisory business effective date.517 This requirement does separately formed advisory entity operates of an affiliated and registered adviser.513 not apply, however, if the rule is a independently of an affiliate). See also discussion substantive rule which grants or infra following note 515. A number of commenters asserted 507 See, e.g., AIMA Letter, Commenter Letter of that the staff positions in the Unibanco recognizes an exemption or relieves a Bank of Montreal, Royal Bank of Canada and The letters are consistent with our approach restriction or is an interpretative rule.518 Toronto-Dominion Bank (Jan. 24, 2011) (‘‘Canadian to the territorial application of the As discussed above, effective July 21, Banks Letter’’); CompliGlobe Letter; Debevoise Advisers Act with respect to non-U.S. 2011, the Dodd-Frank Act amends the Letter; Dechert General Letter (also supported 514 Advisers Act to eliminate the private extending the Unibanco letters to U.S. advisers); advisers. As we stated in 2004, we do Dechert Foreign Adviser Letter; EFAMA Letter; not apply most of the substantive adviser exemption in pre-existing Katten Foreign Advisers Letter; McGuireWoods provisions of the Advisers Act to the section 203(b)(3), which will require Letter; MFA Letter; Comment Letter of MFS non-U.S. clients of a non-U.S. adviser advisers relying on that exemption to Investment Management (Jan. 24, 2011) (‘‘MFS 515 register with the Commission as of July Letter’’); Comment Letter of Ropes & Gray LLP (Jan. registered with the Commission. 24, 2011). 21, 2011 unless another exemption is 519 508 See, e.g., ABA Subcommittee on Private of the Dodd-Frank Act (directing the Commission available. Also effective July 21, Investment Entities, SEC Staff No-Action Letter to exempt private fund advisers with less than 2011, are the Dodd-Frank Act (Dec. 8, 2005) (‘‘ABA No-Action Letter’’); Royal ‘‘$150 million in assets under management in the amendments to the Advisers Act that Bank of Canada, SEC Staff No-Action Letter (Jun. 3, United States’’) (emphasis added); sections 402 and are described immediately below. 1998); ABN AMRO Bank, N.V., SEC Staff No-Action 403 of the Dodd-Frank Act (exempting from Letter (Jul. 7, 1997); Murray Johnstone Holdings registration foreign private advisers with no place Sections 203(l) and 203(b)(3) of the Limited, SEC Staff No-Action Letter (Oct. 7, 1994); of business in the United States that have a limited Advisers Act provide exemptions from Kleinwort Benson Investment Management Limited, number of clients in the United States and investors in the United States in private funds and a limited SEC Staff No-Action Letter (Dec. 15, 1993); Mercury to such advisers’ dealings with offshore funds and amount of assets attributable to these clients and Asset Management plc, SEC Staff No-Action Letter other offshore clients to the extent described in (Apr. 16, 1993); and Uniao de Bancos de Brasileiros investors, among other conditions). prior staff no-action letters and the Hedge Fund 511 S.A., SEC Staff No-Action Letter (Jul. 28, 1992) See supra note 508. See also infra note 515. Adviser Registration Release, supra note 14. The (‘‘Unibanco No-Action Letter’’). See also 1992 Staff 512 See supra note 508. staff noted, however, that an offshore adviser Report, supra note 393, at Section III.D. 513 See, e.g., Canadian Banks Letter; CompliGlobe registered with the Commission under the Advisers 509 Generally, the staff has provided assurances Letter; MFA Letter; MFS Letter. Act must comply with the Advisers Act and the that it will not recommend enforcement action in 514 See, e.g., Canadian Banks Letter; MFA Letter. Commission’s rules thereunder with respect to any situations in which the unregistered non-U.S. See also supra notes 510 and 316 and U.S. clients (and any prospective U.S. clients) it adviser, often termed a ‘‘participating affiliate’’ in accompanying text. may have.). these letters, and its registered affiliate are 515 See Hedge Fund Adviser Registration Release, 516 Our staff has provided assurances that it separately organized; the registered affiliate is supra note 14, at nn.211 and 216–222 and would not recommend enforcement action when no staffed with personnel (located in the U.S. or accompanying text (noting that this policy was first participating affiliate has any U.S. clients other than abroad) who are capable of providing investment set forth in the Unibanco No-Action Letter). clients of the registered affiliate, consistent with the advice; all personnel of the participating affiliate Although the rules contained in the Hedge Fund private adviser exemption, which was conditioned involved in U.S. advisory activities are deemed Adviser Registration Release were vacated by a on the number of a non-U.S. adviser’s U.S. clients. ‘‘associated persons’’ of the registered affiliate; and Federal court in Goldstein, supra note 14, the See supra notes 508–509; Hedge Fund Adviser the Commission has adequate access to trading and court’s decision did not address our statement in Registration Release, supra note 14, at n.211 and other records of the participating affiliate and to its that release that we do not apply most of the accompanying text. Under the Unibanco letters, personnel to the extent necessary to enable it to substantive provisions of the Advisers Act to the participating affiliates only share personnel with, identify conduct that may harm U.S. clients or non-U.S. clients of a non-U.S. adviser registered and provide certain services through, their markets. See supra note 508; Hedge Fund Adviser with the Commission. In addition, our staff registered adviser affiliates. See supra notes 508– Registration Release, supra note 14, at n.211 and expressed this view in a 2006 no-action letter 509. accompanying text. issued in response to a request for the staff’s views 517 See 5 U.S.C. 553(d). 510 See 1992 Staff Report, supra note 393, at on matters affecting investment advisers to certain 518 The statute also provides an exception if the section III.D. In enacting the private fund adviser private funds that arose as a result of the Goldstein agency finds good cause to make the rule effective exemption and the foreign private adviser decision. See ABA Subcommittee on Private less than 30 days after its date of publication in the exemption, both of which focus on an adviser’s Investment Companies, SEC Staff No-Action Letter Federal Register. Id. activities in, or contacts with, the United States, (Aug. 10, 2006) (Commission staff expressed the 519 See sections 403 of the Dodd-Frank Act; Congress has addressed issues similar to those view that the substantive provisions of the Advisers sections 203(b)(3) of the Advisers Act; Section I described in the 1992 Staff Report. See section 408 Act do not apply to offshore advisers with respect supra.

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registration for advisers to venture 203(b), an adviser relying on an other than limited short-term borrowing capital funds and foreign private exemption provided by section 203(l) of (excluding certain guarantees of advisers, respectively. Rule 203(l)–1 the Advisers Act or rule 203(m)–1 qualifying portfolio company defines venture capital fund, and rule thereunder may be subject to reporting obligations by the fund); (iii) does not 202(a)(30)–1 defines several terms in the and recordkeeping requirements.523 offer its investors redemption or other definition of ‘‘foreign private adviser’’ in Hence, the benefits and costs associated similar liquidity rights except in section 202(a)(30).520 Thus, these with being an exempt reporting adviser, extraordinary circumstances; (iv) interpretive rules implement the new relative to being an adviser that is represents itself as pursuing a venture venture capital and foreign private registered or specifically exempted by capital strategy to investors; and (v) is adviser exemptions added to the reason of section 203(b), are attributable not registered under the Investment Advisers Act by the Dodd-Frank Act. to the Dodd-Frank Act. The Commission Company Act and has not elected to be Section 203(m) of the Advisers Act, as has discretion, however, to adopt rules treated as a BDC.525 amended by the Dodd-Frank Act, directs to define the terms used in the Advisers We define ‘‘qualifying investments’’ the Commission to provide an Act, and we undertake below to discuss as: (i) Directly acquired equities; (ii) exemption for advisers solely to private the benefits and costs of the rules that equity securities issued by a qualifying funds with assets under management in we are adopting to implement the portfolio company in exchange for the United States of less than $150 exemptions discussed in this Release.524 directly acquired equities issued by the million. Rule 203(m)–1, which We are sensitive to the costs and same qualifying portfolio company; and implements section 203(m), grants an benefits imposed by our rules, and exemption and relieves a restriction and understand that there will be costs and (iii) equity securities issued by a in part has interpretive aspects. benefits associated with complying with company of which a qualifying portfolio Accordingly, we are making the rules the rules we are adopting today. We company is a majority-owned effective on July 21, 2011. recognize that certain aspects of these subsidiary, or a predecessor, and is rules may place burdens on advisers received in exchange for directly IV. Paperwork Reduction Analysis that seek to qualify for the various acquired equities of the qualifying The rules do not contain a ‘‘collection exemptions discussed in this Release. portfolio company (or securities of information’’ requirement within the We believe that these rules, as modified exchanged for such directly acquired 526 meaning of the Paperwork Reduction from the proposals, offer flexibility and equities). We define a ‘‘qualifying Act of 1995.521 Accordingly, the clarity for advisers seeking to qualify for portfolio company’’ as any company Paperwork Reduction Act is not the exemptions. We have designed the that: (i) Is not a reporting company and applicable. rules to balance these concerns with does not have a control relationship with a reporting company; (ii) does not V. Cost-Benefit Analysis respect to potential costs and burdens with what we understand was intended borrow or issue debt obligations in As discussed above, we are adopting by Congress. connection with the investment by the rules 203(l)–1, 203(m)–1 and 202(a)(30)– In the Proposing Release, we private fund and distribute proceeds of 1 to implement certain provisions of the identified possible costs and benefits of the borrowing or issuance to the private Dodd-Frank Act. As a result of the the proposed rules and requested fund in exchange for the private fund Dodd-Frank Act’s repeal of the private comment on the analysis, including investment; and (iii) is not itself a fund adviser exemption, some advisers that identification and assessment of any (i.e., is an operating company).527 previously were eligible to rely on that costs and benefits not discussed in the The final rule also grandfathers exemption will be required to register analysis. We requested that commenters existing funds by including in the under the Advisers Act unless they are provide analysis and empirical data to definition of ‘‘venture capital fund’’ any eligible for a new exemption. Thus, the support their views on the costs and private fund that: (i) Represented to benefits and costs associated with benefits associated with the proposals. investors and potential investors at the registration for advisers that are not In addition, we requested confirmation time the fund offered its securities that eligible for an exemption are of our understanding of how advisers it pursues a venture capital strategy; (ii) 522 attributable to the Dodd-Frank Act. that may seek to rely on the exemptions prior to December 31, 2010, has sold Moreover, the Dodd-Frank Act provides operate and manage private funds and securities to one or more investors that that, unlike an adviser that is how the proposals may affect them and are not related persons of any specifically exempt pursuant to section their businesses. investment adviser of the venture capital fund; and (iii) does not sell any 520 A. Definition of Venture Capital Fund As discussed above, the Dodd-Frank Act securities to, including accepting any amended the Advisers Act to define ‘‘foreign We define a venture capital fund as a private adviser’’ in section 202(a)(30). additional capital commitments from, 521 44 U.S.C. 3501. private fund that: (i) Holds no more than any person after July 21, 2011 (the 522 As we discuss above, although most venture 20 percent of the fund’s capital ‘‘grandfathering provision’’).528 An capital advisers agreed with our proposed approach commitments in non-qualifying adviser seeking to rely on the exemption to the definition of venture capital fund, a number investments (other than short-term under section 203(l) of the Advisers Act of commenters disagreed with our approach to the holdings) (‘‘qualifying investments’’ proposed definition, and argued that it should be would be eligible for the venture capital expanded to include investments in small generally consist of equity securities of exemption only if it exclusively advised companies (regardless of whether they satisfy our ‘‘qualifying portfolio companies’’ and venture capital funds that satisfy all of definition of qualifying portfolio company) and are discussed below); (ii) does not the elements of the definition of venture investments in other private funds. See, e.g., borrow or otherwise incur leverage, NASBIC/SBIA Letter; PEI Funds/Willowbridge capital fund or the grandfathering Letter; VIA Letter. We do not believe that these provision. more expansive positions are consistent with the 523 See supra note 5. intended scope of the venture capital exemption as 524 The benefits and costs of the reporting 525 expressed by Congress. See supra note 204 and requirements applicable to advisers relying on the Rule 203(l)–1(a). accompanying text. Thus, we believe that the costs venture capital exemption and the private fund 526 Rule 203(l)–1(c)(3). of registration for advisers to funds that would not adviser exemption are discussed in greater detail in 527 Rule 203(l)–1(c)(4). See also text satisfy the definition because they hold such the Implementing Adopting Release, supra note 32, accompanying note 148. investments are attributable to the Dodd-Frank Act. discussion at sections V.A.2 and V.B.2. 528 Rule 203(l)–1(b).

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We have identified certain costs and and related industry groups the definition not operate to foreclose benefits, discussed below, that may acknowledged that the proposed investment funds from investment result from our definition of venture definition would generally encompass opportunities that would benefit capital fund, including modifications to most venture capital investing activity investors but would not change the the proposal. As we discussed in the that typically occurs,536 but expressed character of the fund.546 We concluded Proposing Release, the proposed rule the concern that a venture capital fund that a non-qualifying basket limit of 20 was designed to: (i) Implement the may, on occasion, deviate from its percent would provide the flexibility directive from Congress to define the typical investing pattern with the result sought by many venture capital fund term venture capital fund in a manner that the fund could not satisfy all of the commenters while appropriately that reflects Congress’ understanding of definitional criteria under the proposed limiting the scope of the exemption.547 what venture capital funds are, and as rule with respect to each investment all We believe that the final rule distinguished from other private funds of the time.537 Several commenters also (including the modifications from the such as private equity funds and hedge expressed the concern that the final rule proposal) better describes the existing funds; and (ii) facilitate the transition to should provide sufficient flexibility to venture capital industry and provides the new exemption.529 As discussed accommodate future business practices venture capital advisers with greater above, we have modified the proposed that are not known or contemplated flexibility to accommodate existing (and 538 rule to give qualifying funds greater today. potentially evolving or future) business flexibility with respect to their For the reasons discussed above, we practices and take advantage of investments, partly in response to have modified the definition of venture investment opportunities that may arise. comments we received.530 The final rule capital fund. Our modifications include 539 We also believe that the criteria under defines the term venture capital fund specifying a non-qualifying basket the final rule will facilitate transition to consistently with what we believe and excluding from the 120-day limit the new exemption, because it Congress understood venture capital with respect to leverage certain minimizes the extent to which an funds to be,531 and in light of other guarantees of portfolio company adviser seeking to rely on the venture obligations by a qualifying fund.540 For concerns expressed by Congress with capital exemption would need to alter the reasons discussed in greater detail respect to the intended scope of the its existing business practices, thus, above, we are adopting a limit of 20 venture capital exemption.532 among other things, reducing the percent for non-qualifying Approximately 26 comment letters likelihood of inadvertent non- investments.541 In summary, the non- addressed the costs and benefits of the compliance.548 qualifying basket is designed to address proposed rule defining venture capital As we discuss in greater detail above, 533 commenters’ concerns regarding fund. As discussed below, most of many commenters arguing in favor of these commenters did not provide occasional deviations from typical 542 the modifications that we are adopting empirical data to support their views. venture capital investing activity, inadvertent violations of the definitional generally cited these benefits to support However, a number of venture capital 549 543 their views. Specifically, several advisers commenting on the proposed criteria and flexibility to address evolving or future business practices.544 commenters asserted that providing a rule offered observations based upon limited basket for non-qualifying their experiences managing venture We considered these comments in light of our concerns that the exemption not investments would benefit venture capital funds and presented views on capital advisers relying on the venture the potential impact of the proposed be expanded beyond what we believe was the intent of Congress 545 and that capital exemption, and the U.S. rule on their businesses and business economy, by facilitating job creation practices. 550 defined so as to prevent it from undermining the and capital formation and 1. Benefits requirement all other fund managers register. We minimizing the extent to which a believe that the language in the proposed rule meets venture capital fund would need to alter In the Proposing Release, we stated this goal * * *’’); Sen. Levin Letter (‘‘[T]he that based on the testimony presented to proposed definition captures the essence of venture 546 See supra note 60. Congress and our research, we believed capital firms whose mission is to encourage the development and expansion of new business.’’). See 547 See supra note 72 and following text. that venture capital funds currently in also DuFauchard Letter (‘‘Congressional directives 548 For example, the final rule does not specify existence would meet most, if not all, of require the SEC to exclude private equity funds, or that a qualifying fund must provide managerial the elements of our proposed definition any fund that pivots its investment strategy on the assistance or control each qualifying portfolio of venture capital fund.534 Several use of debt or leverage, from the definition of VC company in which the fund invests. A number of Fund.’’). commenters indicated that venture capital funds commenters agreed that the proposed 536 See, e.g., Cook Children’s Letter (‘‘The may not provide sufficient assistance or exercise rule is consistent with Congressional Commission’s definition of a venture capital fund sufficient control in order to satisfy this element of intent.535 Many venture capital advisers does a thorough job capturing many of the aspects the proposed definition. See, e.g., ESP Letter; Merkl that differentiate venture capital funds from other Letter. The final rule also allows a qualifying fund to exclude investments in money market funds from 529 See Proposing Release, supra note 26, types of private investment funds.’’); Leland Fikes the non-qualifying basket. A number of commenters discussion at text immediately preceding text Letter; NVCA Letter (‘‘[T]he Proposed Rules are indicated that money market funds are typically accompanying n.273. generally consistent with existing venture capital industry practice * * *’’). See also CompliGlobe used by venture capital funds for cash management 530 See generally Section II.A.1. Letter; DLA Piper VC Letter. purposes. See, e.g., NVCA Letter. We expect that 531 See supra notes 36–37 and accompanying and 537 See, e.g., ATV Letter; BIO Letter; NVCA Letter; these modifications to the rule would avoid the cost following text. See also infra note 535. Sevin Rosen Letter. of altering an adviser’s existing business practices. 532 See supra discussion at Section II.A. 549 538 See, e.g., NVCA Letter; Oak Investments See, e.g., NVCA Letter; Oak Investments 533 See, e.g., NVCA Letter; NYSBA Letter; Oak Letter. Letter; Quaker BioVentures Letter. See also supra Investments Letter; Sevin Rosen Letter; SVB Letter; 539 Rule 203(l)–1(a)(2). discussion at Section II.A.1. Trident Letter. 550 540 Rule 203(l)–1(a)(3). See, e.g., NVCA Letter (stating that a low level 534 Proposing Release, supra note 26, at section of 15% would ‘‘allow innovation and job creation 541 See generally Section II.A. IV.A.1. to flourish within the venture capital industry’’); 542 535 AFL–CIO Letter (‘‘[T]he SEC has * * * See supra note 56. Sevin Rosen Letter (a 20% limit would be ‘‘flexible generally provided appropriate definitions for each 543 See supra note 58. enough not to severely impair the operations of of the factors.’’); AFR Letter (‘‘[W]e believe that the 544 See supra note 56. bona fide [venture capital funds], a critically exemption ultimately created in the [Dodd-Frank 545 See supra notes 45 and 61 and accompanying important resource for American innovation and job Act] for venture capital funds must be narrowly text. creation’’).

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its typical business practices.551 Other funds 558 and prevent dilution of the The final rule excludes from the 120- commenters maintained that an venture capital fund’s investment in the day limit with respect to leverage any approach providing advisers some portfolio company.559 venture capital fund guarantees of flexibility on occasion to take advantage Under the final rule, the non- portfolio company indebtedness, up to of promising investment opportunities qualifying basket is determined as a the value of the fund’s investment in the that might not be typical of most percentage of a qualifying fund’s capital company.563 We agree with several venture capital activity would benefit commitments, and compliance with the commenters who stated that guarantees those funds and their investors.552 20 percent limit is determined each time of portfolio company indebtedness under these circumstances will facilitate We anticipate that a number of a qualifying fund makes any non- qualifying investment (excluding short- a portfolio company’s ability to obtain benefits, described by commenters, may term holdings). We expect that credit for working capital or business result from allowing qualifying funds calculating the size of the non- operations.564 Thus, we believe this limited investments in non-qualifying qualifying basket as a percentage of a provision, which is designed to investments, including publicly traded qualifying fund’s capital commitments, accommodate existing business securities, securities that are not equity which will remain relatively constant practices typical of venture capital securities (e.g., non-convertible debt during the fund’s term, will provide funds, may contribute to efficiency, instruments) and interests in other advisers with a degree of predictability competition and capital formation. private funds.553 For example, when managing the fund’s portfolio and The final rule excludes from the increasing the potential pool of determining how much of the basket definition of qualifying portfolio investors that could provide financing remains available for new investments. company any company that borrows or to publicly traded companies to include Moreover, we believe that by applying issues debt if the proceeds of such venture capital funds could facilitate the 20 percent limit as of the time of borrowing or debt are distributed to the access to capital for a portfolio venture capital fund in exchange for the 554 acquisition of each non-qualifying company’s expansion and growth. investment, a fund is able to determine fund’s investment in the company. This Including investments that are not prospectively how much it can invest in will allow qualifying funds to provide equity securities could offer funds the non-qualifying basket. We believe financing on a short-term basis to seeking to qualify as venture capital that this approach to determining the portfolio companies as a ‘‘bridge’’ funds the flexibility to structure an non-qualifying basket will appropriately between funding rounds.565 In addition, investment in a manner that is most limit a qualifying fund’s non-qualifying a portfolio company can obtain appropriate for the fund (and its investments and ease the burden of financing for working capital or investors), including for example to determining compliance with the expansion needs from typical lenders, obtain favorable tax treatment, manage criterion under the rule. effect shareholder buyouts and conclude risks (such as bankruptcy protection), As discussed above, a qualifying fund a simultaneous debt and equity offering, maintain the value of the fund’s equity can only invest up to 20 percent of its without affecting the adviser’s eligibility investment or satisfy the specific capital commitments in non-qualifying for the venture capital exemption. For financing needs of a portfolio the foregoing reasons, commenters 555 investments, as measured immediately company. Including non-convertible after it acquires any non-qualifying maintained, and we agree, that this bridge financing also would enable a investment.560 The final rule treats as a approach would facilitate compliance portfolio company to seek such qualifying investment any equity with the rule without restricting a financing from venture capital funds if security of a qualifying portfolio portfolio company’s access to financing it is unable to obtain financing from or other capital.566 We believe that this 556 company, or a company acquiring the traditional lending sources. In qualifying portfolio company, that is provision of the final rule will benefit addition, permitting qualifying funds to exchanged for directly acquired equities venture capital funds and their investors invest in other underlying private funds issued by the qualifying portfolio because it restricts a portfolio could facilitate capital formation and company. This definition should benefit company’s ability to incur debt that may enhance liquidity for the underlying implicate Congressional concerns 557 venture capital funds because it allows private funds. Under the final rule, funds to participate in the regarding the use of leverage and qualifying funds also would have reorganization of the capital structure of effectively distinguishes advisers to venture capital funds from advisers to increased flexibility to invest in a portfolio company.561 It also provides leveraged buyout private equity funds portfolio companies through secondary qualifying funds with liquidity and an for which Congress did not provide an market transactions. Commenters opportunity to take profits from their exemption.567 asserted that this would help align the investments because they can acquire interests of portfolio company founders securities in connection with the with the interests of venture capital limit the definition solely to common stock. See acquisition (or merger) of a qualifying supra notes 95–96 and accompanying text. Our portfolio company by another definition of qualifying portfolio company is 551 See, e.g., McDonald Letter; Pine Brook Letter. company—typical means by which similarly broad because it does not restrict 552 See, e.g., DuFauchard Letter; Merkl Letter. venture capital funds exit an qualifying companies to ‘‘small or start-up’’ 553 companies. As we have noted in the Proposing Rule 203(l)–1(a)(2) (specifying that a 562 qualifying fund must hold, immediately after the investment. Release and above, we believe that such definitions acquisition of any asset (excluding short-term would be too restrictive and provide venture capital holdings) no more than 20% of its committed 558 Sevin Rosen Letter. fund advisers with too little flexibility and limited capital in assets that are not qualifying 559 SVB Letter. options with respect to potential portfolio company investments); rule 203(l)–1(c)(3) (defining 560 The rule requires a qualifying fund at the time investments. See supra discussion in Section ‘‘qualifying investment’’). it acquires an asset, to have no more than 20% of II.A.1.a. 554 See, e.g., Lowenstein Letter; McDonald Letter; its capital commitments invested in assets that are 563 Rule 203(l)–1(a)(3). Mesirow Letter; Quaker BIO Letter; Trident Letter. not qualifying investments. Rule 203(l)–1(a)(2). 564 Oak Investments Letter; SVB Letter. 555 See, e.g., Merkl Letter; Oak Investments Letter; 561 See supra note 109 and following text. 565 See, e.g., supra note 181 and accompanying Sevin Rosen Letter; Vedanta Capital Letter. 562 See, e.g., NVCA Letter; PTV Sciences Letter. and following text. 556 NVCA Letter; Trident Letter. The final rule defines equity securities broadly to 566 See, e.g., NVCA Letter; SVB Letter. 557 See, e.g., Cook Children’s Letter; Leland Fikes cover many types of equity securities in which 567 As discussed above, we have imposed this Letter; Merkl Letter; SVB Letter. venture capital funds typically invest, rather than limitation on qualifying portfolio companies

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Our final rule clarifies that an adviser investments of a qualifying fund, but grandfathering provision because they seeking to rely on the venture capital creates a basket that will allow these would not have to incur these costs. We exemption may treat as a private fund funds flexibility to make limited believe that the grandfathering any non-U.S. fund managed by the investments that may vary from typical provision will promote efficiency adviser that does not offer its securities venture capital fund investing practices. because it will allow advisers to existing in the United States or to U.S. The final rule also provides an adviser venture capital funds to continue to rely persons.568 This treatment will enable flexibility and discretion to structure on the exemption without having to an adviser to rely on the exemption transactions in underlying portfolio restructure funds that may not meet the when it manages only funds that satisfy companies to meet the business definition.573 It also will allow advisers the venture capital fund definition, objectives of the fund without creating to funds that were launched by regardless of the funds’ jurisdiction of significant risks of the kind that December 31, 2010 and can meet the formation and investor base. We believe Congress suggested should require other requirements of the grandfathering that this treatment facilitates capital registration of the fund’s adviser. We provision to rely on the exemption formation and competition because it expect that this flexibility will benefit without the potential costs of having to would allow an adviser to sponsor and investment advisers that seek to rely on renegotiate with potential investors and advise funds in different jurisdictions in the venture capital exemption because restructure those funds within the order to meet the different tax or they will be able more easily to limited period before the rule is regulatory needs of the fund’s investors structure and operate funds that meet effective. After the effective date, without risking the availability of the the definition now and in the future, but advisers that seek to form new funds exemption. will not permit reliance on the will have sufficient time and notice to The final rule includes several other exemption by private fund advisers that structure those funds to meet the characteristics that provide additional Congress did not intend to exclude from definition should they seek to rely on flexibility to venture capital advisers registration. the exemption in section 203(l) of the and their funds. For example, a Our final rule also should benefit Advisers Act. qualifying fund cannot provide its advisers of existing venture capital Finally, we believe that our definition investors with redemption or other funds that fail to meet the definition of would include an additional benefit for liquidity rights except in extraordinary venture capital fund. Our grandfathering investors and regulators. Section 203(l) circumstances. Although venture capital provision permits an adviser to rely on of the Advisers Act provides an funds typically do not permit investors the exemption provided that each fund exemption specifically for advisers that to redeem their interests during the life that does not satisfy the definition (i) ‘‘solely’’ advise venture capital funds. of the fund,569 the approach of the final has represented to investors that it Currently none of our rules requires that rule allows a venture capital fund to pursues a venture capital strategy, (ii) an adviser exempt from registration respond to extraordinary events, has initially sold interests by December specify the basis for the exemption. We including redeeming investors from the 31, 2010, and (iii) does not sell any are adopting, however, rules that would fund, without resulting in a registration additional interests after July 21, require exempt reporting advisers to obligation for the fund’s adviser. Under 2011.571 We expect that most advisers to identify the exemption(s) on which they the final rule, a venture capital fund existing venture capital funds that are relying.574 Requiring that venture must affirmatively represent itself as currently rely on the private adviser capital funds represent themselves as pursuing a venture capital strategy to its exemption would be exempt from such to investors should allow the investors, a criterion designed to registration in reliance on the Commission and the investing public preclude advisers to certain private grandfathering provision.572 As a result (particularly potential investors in funds from claiming an exemption from of this provision, we expect that venture capital funds) to determine, and registration for which they are not advisers to existing venture capital confirm, an adviser’s rationale for eligible. We believe that this element funds that do not meet our definition remaining unregistered with the will allow the Commission and the will benefit because they can continue Commission. This element is designed investing public (particularly potential to manage existing funds without to deter advisers to private funds other investors) to determine and confirm an having to (i) weigh the relative costs and than venture capital funds from adviser’s rationale for remaining benefits of registration and modification claiming to rely on an exemption from unregistered with the Commission.570 of fund operations to conform existing registration for which they are not Because it takes into account existing funds with our definition and (ii) incur eligible. business practices of venture capital the costs associated with registration We believe that existing venture funds and permits some flexibility for with the Commission or modification of capital funds would meet most, if not venture capital funds (and their existing funds. Advisers to venture all, of the elements of the final managers) to adopt, or adapt to, new or capital funds that were launched by definition of venture capital fund. evolving business practices, we believe December 31, 2010 and meet the July Nevertheless, we recognize that some that the final rule will facilitate 21, 2011 deadline for sales of all advisers to existing venture capital advisers’ transition to the new securities also would benefit from the funds that seek to rely on the exemption exemption. The rule generally limits in section 203(l) of the Advisers Act 571 Rule 203(l)–1(b). might have to structure new funds because of the focus on leverage in the Dodd-Frank 572 A number of commenters specifically inquired differently to satisfy the definitional Act as a potential contributor to systemic risk as about the scope of the holding out criterion and criteria under the final rule. To the discussed by the Senate Committee Report, and the noted that under existing business practice venture extent that advisers choose not to testimony before Congress that stressed the lack of capital funds may refer to themselves as private leverage in venture capital investing. See supra equity funds. As we discuss in greater detail above, notes 174 and 175. we do not believe that the name used by a fund is 573 Many commenters supported the 568 See note accompanying rule 203(l)–1. the sole dispositive factor, and that satisfying the grandfathering provision, and one specifically cited 569 See supra notes 255–256 and accompanying holding out criterion will depend on all of the facts the benefit of avoiding the need to alter fund terms text. and circumstances. See supra Section II.A.7. This to the potential detriment of fund investors. AV 570 See Merkl Letter (stating that a description of criterion is similar to our general approach to Letter. the investment strategy is a key element of any antifraud provisions under the Federal securities 574 See Implementing Adopting Release, supra private placement memorandum). laws and our rules. note 32, at n.175 and accompanying text.

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change how they structure or manage contribute to a more efficient allocation We recognize, however, that advisers new funds they launch, those advisers of capital. to funds that were launched by December 31, 2010 but have not would have to register with the 2. Costs Commission,575 which offers many concluded offerings to investors may benefits to the investing public and Costs for advisers to existing venture incur costs to determine whether they facilitates our mandate to protect capital funds. As we discussed in the qualify for the grandfathering provision. investors. Registered investment Proposing Release and above, we do not For example, these advisers may need to advisers are subject to periodic expect that the definition of venture assess the impact on the fund of selling examinations by our staff and are also capital fund would result in significant interests to initial third-party investors subject to our rules including rules on costs for unregistered advisers to by December 31, 2010 and selling venture capital funds currently in recordkeeping, custody of client funds interests to all investors no later than existence and operating.579 We estimate 583 and compliance programs. We believe July 21, 2011. We do not expect that that currently there are 791 advisers to the cost of evaluating the grandfathering that in general Congress considered 580 venture capital funds. We expect that provision would be significant, registration to be beneficial to investors all these advisers, which we assume because of, among other things, the however, because we believe that most currently are not registered in reliance funds in formation represent themselves added protections offered by on the private adviser exemption, would registration. Accordingly, Congress as funds that pursue a venture capital continue to be exempt after the repeal strategy to their potential investors 584 limited the section 203(l) exemption to of that exemption on July 21, 2011 in advisers solely to venture capital funds. and the typical fundraising period for a reliance on the grandfathering venture capital fund is approximately 581 As noted above, we proposed, and are provision. We anticipate that such 12 months.585 Thus, we do not retaining in the final rule, certain advisers to grandfathered funds will anticipate that venture capital fund elements in the portfolio company incur minimal costs, if any, to confirm advisers would have to alter typical definition because of the focus on that existing venture capital funds business practices to structure or raise leverage in the Dodd-Frank Act as a managed by the adviser meet the capital for venture capital funds being potential contributor to systemic risk as conditions of the grandfathering formed. Nevertheless, we recognize that discussed by the Senate Committee provision. We estimate that these costs after the final rule goes into effect, report,576 and the testimony before would be no more than $800 to hire exempt advisers of such funds in Congress that stressed the lack of outside counsel to assist in this formation may forgo the opportunity to 577 determination.582 leverage in venture capital investing. accept investments from investors that We expect that distinguishing between may seek to invest after July 21, 2011 in venture capital funds and other private 579 Proposing Release, supra note 26, at text immediately preceding text accompanying n.273. order to comply with the grandfathering funds that pursue investment strategies 580 See NVCA Yearbook 2011, supra note 152, at provision. involving financial leverage that Fig. 1.04 (providing the number of ‘‘active’’ venture To the extent that an existing adviser Congress highlighted for concern would capital advisers, as of December 2010, that have could not rely on the grandfathering benefit financial regulators mandated by raised a venture capital fund within the past eight years; 456 of the total number of venture capital provision with respect to funds in the Dodd-Frank Act (such as the advisers manage less than $100 million in capital). formation, we also expect that the Financial Stability Oversight Council) 581 We estimate that these advisers (and any other adviser would not be required to modify with monitoring and assessing potential adviser that seeks to remain unregistered in reliance its business practices significantly in systemic risks. Because advisers that on the exemption under section 203(l) of the Advisers Act or rule 203(m)–1 thereunder) would order to rely on the exemption. Our manage funds with these characteristics incur, on average, $2,311 per year to complete and final rule includes many modifications would be required to register, we expect update related reports on Form ADV, including requested by commenters, such as the that financial regulators could more Schedule D information relating to private funds. non-qualifying basket, and as a result, easily obtain information and data See Implementing Adopting Release, supra note 32, at section V.B.2. This estimate includes internal we expect that these modifications regarding these financial market costs to the adviser of $2,032 to prepare and submit would reduce some of the costs participants, which should benefit those an initial report on Form ADV and $279 to prepare associated with modifying current regulators to the extent it helps to and submit annual amendments to the report. These estimates are based on the following calculations: business practices to satisfy the reduce the overall cost of systemic risk $2,032 = ($4,064,000 aggregate costs ÷ 2000 proposed definitional criteria that monitoring and assessment.578 We advisers); $279 = ($558,800 aggregate costs ÷ 2,000 commenters addressed.586 As we believe that investors will benefit from advisers). Id. at nn.579–581 and accompanying text. enhanced disclosure and oversight of We estimate that approximately two exempt Release, supra note 26, at n.293. We did not receive reporting advisers would file Form ADV–H the activities of private fund advisers by any comments on these cost estimates. annually at a cost of $189 per filing. Id., at n.596 583 regulators, which in turn could and accompanying text. We further estimate that We did not receive any comments on the dates three exempt reporting advisers would file Form specified in the grandfathering provision. See also ADV–NR per year at a cost of $188 per year. Id., supra note 307. 575 See infra text following notes 585, 597–600 at nn.598–602 and accompanying text. We 584 See supra note 572. and accompanying text for a discussion of potential anticipate that filing fees for exempt reporting 585 See Breslow & Schwartz, supra note 241, at 2– costs for advisers that would have to choose advisers would be the same as those for registered 22 (‘‘Once the first closing [of a private equity fund] between registering or restructuring venture capital investment advisers. See infra note 598. These has occurred, subsequent closings are typically held funds formed in the future. estimates, some of which differ from the estimates over a defined period of time [the marketing period] 576 See supra note 174. included in the Proposing Release, supra note 26, of approximately six to twelve months.’’). See also 577 See supra note 175. are discussed in more detail in the Implementing Dow Jones Report, supra note 242, at 22. 578 See S. Rep. No. 111–176, supra note 6, at 39 Adopting Release, supra note 32, at section V.B.2. 586 See, e.g., Charles River Letter; Gunderson (explaining the requirement that private funds 582 As discussed in the Proposing Release, we Dettmer Letter; NVCA Letter (arguing that as disclose information regarding their investment expect that a venture capital adviser would need no proposed the rule would have required venture positions and strategies, including information on more than 2 hours of legal advice to learn the capital fund advisers to modify their business fund size, use of leverage, counterparty credit risk differences between its current business practices practices in order to be eligible for the exemption). exposure, trading and investment positions and any and the conditions for reliance on the proposed See also ABA Letter; Davis Polk Letter; Oak other information that the Commission in grandfathering provision. We estimate that this Investment Letter; SVB Letter (discussing the consultation with the Financial Stability Oversight advice would cost $400 per hour per firm based on potential costs associated with complying with Council determines is necessary and appropriate to our understanding of the rates typically charged by various elements of the proposed rule such as protect investors or assess systemic risk). outside consulting or law firms. See Proposing managerial assistance, venture capital fund leverage

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discuss above, we believe that the final plan to launch would be from $64,400 register with the Commission. In any rule better reflects venture capital to $110,400.590 As they launch new case, each investment adviser would activity conducted by venture capital funds and negotiate with potential assess the costs associated with advisers that are likely to seek to rely on investors, these advisers would have to registering with the Commission relative the exemption, and provides flexibility determine whether it is more cost to the costs of remaining unregistered that will allow these funds to take effective to register or to structure the (and hence structuring funds to meet advantage of new investment venture capital funds they manage to our definition in order to be eligible for opportunities. To the extent that some meet the definition. Such considerations the exemption). We expect that this commenters expressed concerns that of legal or other requirements, however, assessment would take into account they would have to divert personnel comprise a typical business and many factors, including the size, scope time from other functions to monitoring operating expense of conducting new and nature of an adviser’s business and inadvertent failures to meet the business. New advisers that enter into investor base. Such factors will vary definitional elements, we believe that the business of managing venture from adviser to adviser, but each adviser the greater investment flexibility capital funds also would incur such would determine for itself whether provided by the rule would offset most ordinary costs of doing business in a registration, relative to other choices, is of these compliance costs. regulated industry.591 the most cost-effective or strategic Our rule does not provide separate In the Proposing Release, we stated business option. definitional criteria for non-U.S. that we believed that existing advisers The final rule may have effects on advisers seeking to rely on the to venture capital funds would meet competition and capital formation. To exemption. These advisers might incur most, if not all, of the elements of the the extent that advisers choose to costs to the extent that cash proposed definition.592 As discussed structure new venture capital funds to management instruments they typically above, most commenters generally conform to the definition, or choose not acquire may not be ‘‘short-term acknowledged that the proposed to form new funds in order to avoid holdings’’ for purposes of the definition would generally encompass registration, these choices could result definition.587 We expect that these costs most venture capital investing activity in fewer investment choices for would be mitigated, however, to the that typically occurs.593 Several noted, investors, less competition and less extent that these advisers can continue however, that they might deviate from capital formation.595 For example, to the to acquire these instruments using the typical investing patterns on occasion or extent that new venture capital funds do non-qualifying basket. wanted the flexibility to invest small not invest in non-qualifying investments Costs for new advisers and advisers to amounts of capital in investments that in excess of the 20 percent basket in new venture capital funds. We expect would be precluded by the proposed order to meet the definition, the final that existing advisers that seek to form definition.594 Under the final rule, rule could decrease competition and new venture capital funds and venture capital funds that qualify for the capital formation. If venture capital investment advisory firms that seek to definition may invest in non-qualifying funds invest less in non-qualifying enter the venture capital industry will investments subject to availability of the investments or more in qualifying incur one-time ‘‘learning costs’’ to non-qualifying basket, including portfolio company securities that are determine how to structure new funds investments specified by some qualifying investments, this could they may manage to meet the elements commenters. As a result of these increase competition among qualifying of our definition. We estimate that on modifications, the final definition is portfolio companies or private funds average, there are 23 new advisers to more closely modeled on current that invest in such companies. To the venture capital funds each year.588 We business practices of venture capital extent that funds invest more in less expect that the one-time learning costs funds and provides advisers with risky but lower yielding non-qualifying would be no more than between $2,800 flexibility to take advantage of investments, this could decrease and $4,800 on average for an adviser if investment opportunities. As a result, competition among investors that seek it hires an outside consulting or law we do not anticipate that many venture to invest in qualifying investments. To firm to assist in determining how the capital fund advisers would have to the extent that advisers choose to elements of our definition may affect change significantly the structure of register in order to structure new intended business practices.589 Thus, new funds they launch. venture capital funds without regard to we estimate the aggregate cost to We also recognize that some existing the definitional criteria or in order to existing advisers of determining how venture capital funds may have expand their businesses (e.g., pursue the definition would affect funds they characteristics that differ from the additional investment strategies beyond criteria in our definition. To the extent venture capital investing or expand the and solely investing in qualifying portfolio that investment advisers seek to form potential investor base to include companies). new venture capital funds with these investors that are required to invest with 587 See, e.g., EFAMA Letter (asserting that a non- registered advisers), these choices may U.S. fund could not invest in non-U.S. equivalent characteristics, those advisers would cash holdings under the proposed rule). have to choose whether to structure new result in greater investment choices for 588 This is the average annual increase in the venture capital funds to conform to the investors, greater competition and number of venture capital advisers between 1981 definition, forgo forming new funds, or greater capital formation.596 and 2010. See NVCA Yearbook 2010, supra note Investment advisers to new venture 150, at Fig. 1.04; NVCA Yearbook 2011, supra note 590 capital funds that would not meet the 152, at Fig. 1.04. This estimate is based on the following calculations: 23 × $2,800 = $64,400; 23 × $4,800 = definition would have to register and 589 We expect that a venture capital adviser $110,400. We did not receive any comments on would need between 7 and 12 hours of consulting these cost estimates. or legal advice to learn the differences between its 595 See, e.g., Lowenstein Letter; NVCA Letter; 591 current business practices and the definition, For estimates of the costs of registration for Venrock Letter. depending on the experience of the firm and its those advisers that would choose to register, see 596 See, e.g., ‘‘Asia’s Cash-Poor Small Hedge familiarity with the elements of the rule. We infra notes 597–600. Funds Vulnerable to U.S. Rules,’’ Bloomberg.com estimate that this advice would cost $400 per hour 592 Proposing Release, supra note 26, at Section (Feb. 23, 2011) (identifying two fund of funds per firm based on our understanding of the rates V.A.1. managers that either require or prefer to allocate typically charged by outside consulting or law 593 See supra note 51. client assets to advisers registered with the firms. 594 See supra note 52. Commission).

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incur the costs associated with the rules thereunder. These costs, themselves as advisers to venture registration (assuming the adviser could however, will vary significantly among capital funds, however, provided much not rely on the private fund adviser advisers depending on the adviser’s lower estimates for one-time registration exemption). We note that the costs of size, the scope and nature of its and compliance costs ranging from registration for advisers that do not business, and the sophistication of its $75,000 to $200,000, followed by qualify for the venture capital fund compliance infrastructure, but in any ongoing annual compliance costs adviser exemption flow from the Dodd- case would be an ordinary business and ranging from $50,000 to $150,000.603 Frank Act, which removed the private operating expense of entering into any Although some advisers may incur adviser exemption on which they business that is regulated. these costs, the costs of compliance for currently rely. We estimated in the Proposing a new registrant can vary widely among We estimate that the internal cost to Release that the one-time costs to new advisers depending on their size, register with the Commission would be registrants to establish a compliance activities, and the sophistication of their $15,077 on average for a private fund infrastructure would range from $10,000 existing compliance infrastructure. adviser,597 excluding the initial filing to $45,000, while ongoing annual costs Advisers, whether registered with us or fees and annual filing fees to the of compliance and examination would not, may have established compliance Investment Adviser Registration range from $10,000 to $50,000.601 Some infrastructures to fulfill their fiduciary Depository (‘‘IARD’’) system commenters suggested that these duties towards their clients under the operator.598 These registration costs estimates are too low. Commenters Advisers Act. Generally, costs will include the costs attributable to identifying themselves as ‘‘middle likely be less for new registrants that completing and periodically amending market private equity fund’’ advisers have already established sound Form ADV, preparing brochure estimated that they would incur one- compliance practices and more for new supplements, and delivering codes of time registration and compliance costs registrants that have not yet established ethics to clients.599 In addition to the ranging from $50,000 to $600,000, sound practices. internal costs described above, we followed by ongoing annual compliance For example, some commenters estimate that for an adviser choosing to costs ranging from $50,000 to specifically included in their cost 602 use outside legal services to complete its $500,000. Commenters identifying estimates compensation costs for hiring brochure, such costs would be a dedicated chief compliance officer 601 $5,000.600 See Proposing Release, supra note 26, at n.303 (‘‘CCO’’).604 Our compliance rule, New registrants would also face costs and accompanying text. Our estimate was based on the expectation that most advisers that might however, does not require advisers to to bring their business operations into choose to register for business reasons have already hire a new individual to serve as a full- compliance with the Advisers Act and built compliance infrastructures as a matter of good time CCO, and the question of whether business practice. Nevertheless, we expect advisers an adviser can look to existing staff to 597 This estimate is based upon the following will incur costs for outside legal counsel to evaluate their compliance procedures initially and on an fulfill the CCO requirement internally is calculations: $15,077 = ($9,627,871 aggregate costs 605 to complete Form ADV ÷ 750 advisers expected to ongoing basis. We estimate that the costs to advisers firm-specific. to establish the required compliance infrastructure register with the Commission) + ($8,509,000 will be, on average, $20,000 in professional fees and aggregate costs to complete private fund reporting Comment Letter of Crestview Advisors, LLC (Jan. $25,000 in internal costs including staff time. These requirements ÷ 3,800 advisers expected to provide 19, 2011) (‘‘Crestview Letter’’) (estimating annual estimates were prepared in consultation with private fund reports). See Implementing Adopting costs of $300,000–$500,000); Comment Letter of attorneys who, as part of their private practice, have Release, supra note 32, at nn.612–618 and Azalea Capital (Feb. 17, 2011) (‘‘Azalea Letter’’) counseled private fund advisers establishing their accompanying text for a more detailed discussion (estimating $50,000 to $100,000 per year); Comment registrations with the Commission. We included a of these costs. This also assumes that the Letter of Gen Cap America, Inc. (Jan. 21, 2011) range because we believe there are a number of performance of this function would most likely be (‘‘Gen Cap Letter’’) (estimating $150,000–$250,000 unregistered advisers of private funds whose equally allocated between a senior compliance per year). See also Memorandum to File No. S7–37– compliance operations are already substantially in examiner and a compliance manager. See id., at compliance with the Advisers Act and that would 10, dated March 17, 2011, concerning a meeting n.608. Data from SIFMA’s Management & therefore experience only minimal incremental with certain private fund representatives, avail. at Professional Earnings in the Securities Industry ongoing costs as a result of registration. In http://www.sec.gov/comments/s7-37-10/s73710- 2010, modified to account for an 1,800-hour work- connection with previous estimates we have made 124.pdf (‘‘File Memorandum’’) (estimating that year and multiplied by 5.35 to account for bonuses, regarding compliance costs for registered advisers, costs for small firms range from $100,000–$200,000 firm size, employee benefits and overhead, suggest we received comments from small advisers (exclusive of salary costs for a CCO)). that costs for these positions are $235 and $273 per estimating that their annual compliance costs 603 See VIA Letter (estimating an initial cost of hour, respectively. would be $25,000 and could be as high as $50,000. $75,000 or more and ongoing costs of $50,000 to 598 Filing fees paid for submitting initial and See, e.g., Comment Letter of Joseph L. Vidich (Aug. $150,000 per year); Pine Brook Letter (estimating annual filings through the IARD currently range 7, 2004). Cf. Comment Letter of Venkat Swarna initial costs of $125,000 to $200,000 and ongoing from $40 to $225 based on the amount of assets an (Sept. 14, 2004) (estimating costs of $20,000 to compliance costs of $100,000–150,000 per year). adviser has under management. The current fee $25,000). These comment letters were submitted in 604 See, e.g., Katten Foreign Insurance Letter (‘‘In schedule for registered advisers may be found on connection with the Hedge Fund Adviser addition, there are added salary costs for hiring a our Web site at http://www.sec.gov/divisions/ Registration Release, supra note 14, and are chief compliance officer. In all, costs could be investment/iard/iardfee.shtml. See Implementing available on the Commission’s Internet Web site at expected to total hundreds of thousands of dollars Adopting Release, supra note 32, at n.566–567 and http://www.sec.gov/rules/proposed/s73004.shtml. and hundreds of hours of personnel time for each accompanying text (assuming for purposes of the 602 See, e.g., Comment Letter of Atlas Holdings new registrant.’’); Comment Letter of Cortec Group analysis that exempt reporting advisers will pay a (Jan. 21, 2011) (‘‘Atlas Letter’’) (estimating $500,000 (Jan. 14, 2011) (‘‘Cortec Letter’’) (‘‘Furthermore, the fee of $225 per initial or annual report). in 2011 and $350,000 per year thereafter for Act requires we add a compliance officer (who has 599 Part 1 of Form ADV requires advisers to compliance manuals and oversight, employee to be a senior-level executive), at a minimum answer basic identifying information about their trading records, legal documentation, and the hiring annual compensation of $200,000, yet we do not business, their affiliates and their owners, of additional compliance employees); Comment engage in any activity the Act wishes to monitor.’’). information that is readily available to advisers, and Letter of Sentinel Capital Partners (Jan. 16, 2011) Other commenters may have included such costs in thus should not result in significant costs to (‘‘Sentinel Letter’’) (estimating between $500,000– their estimates although they did not provide complete. Registered advisers must also complete $600,000 in 2011 and more than $375,000 per year details on individual components. See, e.g., Part 2 of Form ADV and file it electronically with thereafter for compliance manuals and oversight, Crestview Letter (‘‘As part of these new regulations, us. Part 2 requires disclosure of certain conflicts of employee trading records, legal documentation, and we are required to develop a compliance program; interest and could be prepared based on the hiring of additional compliance employees); hire a compliance officer; custody our private information already contained in materials Comment Letter of Charlesbank Capital Partners company stock certificates, which are worthless to provided to investors, which could reduce the costs (Jan. 21, 2011) (‘‘Charlesbank Letter’’) (‘‘[A]lthough any party not part of the original purchase of compliance even further. impossible to quantify at this point given the agreement; and register with the SEC.’’) 600 See Implementing Adopting Release, supra absence of regulations, we anticipate a substantial 605 See Advisers Act rule 206(4)–(7) (requiring, note 32, at n.729. cost associated with ongoing compliance.’’); among other things, an adviser registered or

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Although we recognize that some We do not have access to information their administration should be much newly registering advisers will need to that would enable us to determine these less burdensome.612 designate someone to serve as CCO on additional ongoing costs, which are We also note that approximately 570 a full-time basis, we expect these will be predominantly internal to the advisers smaller advisers currently are registered larger advisers—those with many themselves. Incremental ongoing with us.613 These advisers have employees and a sizeable amount of compliance costs will vary from adviser absorbed the compliance costs investor assets under management. to adviser depending on factors such as associated with registration, Because there is no currently-available the complexity of each adviser’s notwithstanding the fact that their assets comprehensive database of unregistered activities, the business decisions it under management are likely to be advisers, we cannot determine the makes in structuring its response to its smaller than those of an adviser number of these larger advisers in compliance obligations, and the extent managing one venture capital fund of operation. These larger advisers that are to which it is already conducting its average size (e.g., with $107.8 million in not yet registered likely already have operations in compliance with the venture capital under management 614) personnel who perform similar Advisers Act. Indeed, the broad range of that may be required to register because functions to a CCO, in order to address estimated costs we received reflects the it cannot rely on the venture capital the adviser’s liability exposure and individualized nature of these costs and exemption or the private fund adviser protect its reputation. the extent to which they may vary even exemption. Moreover, as we explained in the Proposing Release, in connection In smaller advisers, the designated among the relatively small number of with previous estimates we have made CCO will likely also fill another commenters who provided cost regarding compliance costs for function in the adviser, and perform estimates.608 registered advisers, we received additional duties alongside compliance Some commenters expressed concern comments from small advisers matters. Advisers designating a CCO that compliance costs would be estimating that their annual compliance from existing staff may experience costs prohibitive in comparison to their costs would be $25,000 and could be as that result from shifting responsibilities revenues or in relation to their size or high as $50,000.615 Finally, as we noted among staff or additional compensation, activities.609 We note, however, that an in the Proposing Release, to the extent to the extent the individual is taking on adviser is required to adopt policies and there would be an increase in registered additional compliance responsibilities procedures that take into consideration advisers, there are benefits to or giving up other non-compliance the nature of that adviser’s registration for both investors and the responsibilities. Costs will vary from operations.610 We have explained that, Commission.616 adviser to adviser, depending on the accordingly, we would expect smaller We do not believe that the definition extent to which an adviser’s staff is advisers without conflicting business of venture capital fund is likely to affect already performing some or all of the interests to require much simpler whether advisers to venture capital requisite compliance functions, the policies and procedures than larger funds would choose to launch new extent to which the CCO’s non- advisers that, for example, have funds or whether persons would choose compliance responsibilities need to be multiple potential conflicts as a result of to enter into the business of advising lessened to permit allocation of more their other lines of business or their venture capital funds because, as noted time to compliance responsibilities, and affiliations with other financial service above, we believe the definition, as the value to the adviser of the CCO’s firms.611 The preparation of these revised, reflects the way most venture non-compliance responsibilities.606 simpler policies and procedures and capital funds currently operate. Thus, Some commenters asserted that the for example, we eliminated the costs of ongoing compliance would be 608 Compare Azalea Letter (estimated ongoing managerial assistance criterion in the substantial.607 We anticipate that there compliance costs of $50,000 to $100,000 per year) proposed definition, expanded the with Crestview Letter (estimated ongoing short-term instruments in which may be a number of currently compliance costs of $300,000 to $500,000 per year). unregistered advisers whose operations See also Charlesbank Letter (stating that costs venture capital funds can invest and are already substantially in compliance associated with ongoing compliance are impossible provided for a non-qualifying basket. with the Advisers Act and that would to quantify at this point). These elements in the proposal could therefore experience only minimal 609 See, e.g., Crestview Letter (‘‘The cost of have resulted in costs to advisers that complying with these new regulations is estimated manage venture capital funds with incremental ongoing costs as a result of to be $300,000–$500,000 per year, which is a registration. There likely are other significant sum for a firm that invests in two to business or cash management practices currently unregistered advisers, three private companies each year in relation to the inconsistent with those proposed however, who will face additional benefit it provides.’’); Azalea Letter (‘‘The cost of criteria and that sought to rely on the complying with these new regulations is estimated exemption.617 As a result, we expect ongoing costs to conduct their to be $50,000 to $100,000 per year, which is a operations in compliance with the significant sum for a firm that invests in two to that the definition is not likely to Advisers Act, and these costs may be three private companies each year.’’); Gen Cap significantly affect the way in which significant for some of these advisers. Letter (‘‘The cost of complying with these new investment advisers to these funds do regulations is estimated to be $150,000–$250,000 per year, which is a significant sum for a firm that 612 required to be registered under the Advisers Act to invests in two to three private companies each year Id., discussion at section II.A.1. designate an individual (who is a supervised in relation to the benefit it provides.’’). 613 See Implementing Adopting Release, supra person) responsible for administering the policies 610 See Compliance Programs of Investment note 32, at n.823 and accompanying text (noting and procedures). In determining whether existing Companies and Investment Advisers, Investment that, based on data from the Investment Adviser staff can fulfill the CCO requirement, advisers may Advisers Act Release No. 2204 (Dec. 17, 2003) [68 Registration Depository as of April 7, 2011, 572 consider factors such as the size of the firm, the FR 74714 (Dec. 24, 2003)], discussion at section advisers registered with the Commission were small complexity of its compliance environment, and the II.A.1. advisers). 614 qualifications of current staff. 611 Id. See also id. at n.13 (noting that even small See NVCA Yearbook 2011, supra note 152, at 606 Although some commenters noted that advisers may have arrangements, such as soft dollar 9, Fig. 1.0. requiring existing employees to assume agreements, that create conflicts; advisers of all 615 See Proposing Release, supra note 26, at n.303. compliance-related responsibilities would involve sizes, in designing and updating their compliance See also supra note 601. costs, they did not provide sufficient information programs, must identify these arrangements and 616 See supra text following note 575. on which we could estimate these costs. provide for the effective control of the resulting 617 See supra notes 548, 586 and accompanying 607 See supra note 602. conflicts). text.

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business and thus compete. For the A number of commenters expressed management in the United States. The same reason, we do not believe that our concerns with certain elements of the rule implements the private fund rule is likely to have a significant effect proposed rule, which we are not adviser exemption, as directed by on overall capital formation. modifying. Several commenters Congress, in section 203(m) of the Other Costs. Some commenters suggested that the rule specify that the Advisers Act and includes provisions argued in favor of a narrow definition of leverage limit of 15 percent be for determining the amount of an venture capital fund in order to calculated without regard to uncalled adviser’s private fund assets for preclude advisers to other types of capital commitments because they were purposes of the exemption and when funds from relying on the definition.618 concerned about the potential for those assets are deemed managed in the One commenter expressed the concern excessive leverage.622 We acknowledge United States.627 that a leverage limitation which that the definition should be narrow so 1. Benefits that advisers generally would be subject includes uncalled capital commitments to a consistent regulatory regime,619 and could result in a fund incurring, in the Method of Calculating Private Fund another supported incorporating early stages of the fund’s life, a Assets. As discussed in Section II.B.2 substantive Advisers Act rules, such as significant degree of leverage by the above and in the Implementing custody, as a condition for reliance on fund relative to the fund’s overall assets. Adopting Release, we are revising the the various exemptions in order to We believe, however, that the 120-day instructions to Form ADV to provide a protect investors.620 To the extent that limit would mitigate the effects of any uniform method for calculating assets our final rule includes broader criteria such leverage that is incurred by a under management that can be used for regulatory purposes, including and results in fewer registrants under venture capital fund seeking to satisfy determining eligibility for Commission, the Advisers Act, we acknowledge that the definition. rather than state, registration; reporting this could have an adverse impact on Several commenters also argued that assets under management for regulatory investors.621 the definition of qualifying portfolio company should include certain purposes on Form ADV; and Moreover, to the extent that our final subsidiaries that may be owned by a determining eligibility for the private rule includes broader criteria and publicly traded company, such as fund adviser exemption under section results in fewer registrants, this also research and development subsidiaries, 203(m) of the Advisers Act and rule could reduce the amount of information that may seek venture capital 203(m)–1 thereunder and the foreign available to regulators with respect to funding.623 As a result of our final rule, private adviser exemption under section venture capital advisers relying on the these types of subsidiaries may have 203(b)(3) of the Advisers Act.628 We exemption. Under the final rule, reduced access to capital investments by believe that this uniform approach will immediately after it acquires any non- qualifying funds, although this cost benefit regulators (both state and qualifying investment (excluding short- would be mitigated by a qualifying Federal) as well as advisers, because term holdings), no more than 20 percent fund’s investments made through the only a single determination of assets of a qualifying fund’s capital non-qualifying basket. under management is required for commitments may be held in non- Other commenters argued that the purposes of registration and exemption qualifying investments (excluding short- definition of venture capital fund from Federal registration. term holdings). As a result, initially, and should include funds of venture capital The instructions to Form ADV possibly for a period of time during the funds.624 We have not modified the rule previously permitted, but did not fund’s term (subject to compliance with to reflect this request, because we do not require, advisers to exclude certain the other elements of the rule), it may believe that defining the term in this types of managed assets.629 As a result, be possible for non-qualifying manner is consistent with the intent of it was not possible to conclude that two investments to comprise most of a Congress.625 To the extent that an advisers reporting the same amount of qualifying fund’s investment portfolio. adviser to a fund of venture capital assets under management were The proposal would have required a funds ceases business or ceases to offer necessarily comparable because either qualifying fund to be comprised entirely new funds in order to avoid registration adviser could have elected to exclude of qualifying investments, which would with the Commission, this could reduce all or some portion of certain specified have enabled regulators and investors to the pool of potential investors investing assets that it managed. We expect that confirm with relative ease at any point in venture capital funds,626 and specifying in rule 203(m)–1 that assets in time whether a fund satisfied the potentially reduce capital formation for under management must be calculated definition. Modifying the definition to potential qualifying portfolio according to the instructions to Form include a non-qualifying basket companies. ADV will increase administrative determined as a percentage of a B. Exemption for Investment Advisers efficiencies for advisers because they qualifying fund’s capital commitments will have to calculate assets under may increase the monitoring costs that Solely to Private Funds With Less Than $150 Million in Assets Under management only once for multiple regulators and investors may incur in purposes.630 In addition, we believe this order to verify that a fund satisfies the Management definition, depending on the length of As discussed in Section II.B, rule 627 See supra Sections II.B.2–3. the fund’s investment period and the 203(m)–1 exempts from registration 628 See supra notes 332–336 and accompanying frequency with which the fund invests under the Advisers Act any investment text. in non-qualifying investments. adviser solely to private funds that has 629 See Form ADV: Instructions to Part 1A, instr. less than $150 million in assets under 5.b(1), as in effect before the amendments adopted in the Implementing Adopting Release, supra note 618 See supra note 43. 32. 619 622 AFR Letter; AFL–CIO Letter. CalPERS Letter. See also NASAA Letter 630 See supra Section II.B.2. As discussed below, 623 (supported adding substantive requirements to the BCLBE Letter; Dechert General Letter; we are permitting advisers to calculate their private grandfathering provision). Gunderson Dettmer Letter. fund assets annually in connection with their 620 CPIC Letter. 624 See, e.g., Cook Children’s Letter; Merkl Letter; annual updating amendments to their Forms ADV, 621 See supra text accompanying and following SVB Letter. rather than quarterly as proposed. Requiring note 575 (discussing benefits that result from 625 See supra notes 204–206. annual, rather than quarterly, calculations will be registration). 626 See generally Merkl Letter; SVB Letter. less costly for advisers.

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will minimize costs relating to software advisers to fair value private fund assets should benefit these advisers by modifications, recordkeeping, and so that, for purposes of the exemption, allowing them to avoid the cost of more training required to determine assets advisers value private fund assets on a frequent valuations, including costs under management for regulatory meaningful and consistent basis. As we (such as third-party quotes) associated purposes. We also believe that the stated in the Proposing Release, we with valuing illiquid assets, which may consistent calculation and reporting of understand that many, but not all, be particularly difficult to value because assets under management will benefit advisers to private funds value assets of the lack of frequency with which investors and regulators because it will based on their fair value in accordance such assets are traded.637 Requiring provide enhanced transparency and with GAAP or other international annual, rather than quarterly, comparability of data, and allow accounting standards that require the calculations thus responds to concerns investors and regulators to analyze on a use of fair value.634 We acknowledged expressed by commenters who argued more cost effective basis whether any in the Proposing Release that some that quarterly calculations would (i) particular adviser may be required to advisers to private funds may not use impose unnecessary costs and burdens register with the Commission or is fair value methodologies, which may be on advisers, some of whom might not eligible for an exemption. more difficult to apply when the fund otherwise perform quarterly valuations; Many commenters generally holds illiquid or other types of assets and (ii) inappropriately permit shorter- expressed support for the that are not traded on organized term fluctuations in assets under implementation of a uniform method of markets.635 management to require advisers to calculating assets under management in Frequency of Calculations and the register.638 order to maintain consistency for Transition Period. Rule 203(m)–1(c) An adviser relying on the exemption registration and risk assessment specifies that an adviser relying on the that reports private fund assets of $150 purposes.631 Indeed, even some exemption must calculate its private million or more in its annual updating commenters who suggested that we fund assets annually, in accordance amendment to its Form ADV will not be revise aspects of the method of with General Instruction 15 to Form eligible for the exemption and must calculating regulatory assets under ADV, rather than quarterly, as proposed. register under the Advisers Act unless it management nonetheless recognized the Advisers registered with us and with the qualifies for another exemption. If the benefits provided by a uniform method states, and now advisers relying on rule adviser has complied with all of valuing assets for regulatory 203(m)–1, must calculate their assets Commission reporting requirements purposes.632 under management for regulatory applicable to an exempt reporting We believe that the valuation of purposes annually in connection with adviser as such, however, it may apply private fund assets under rule 203(m)– their annual updating amendments to for registration under the Advisers Act 1 will benefit advisers that seek to rely Form ADV. We expect that requiring up to 90 days after filing the annual on the private fund adviser exemption. these types of advisers to calculate their updating amendment, and may continue Under rule 203(m)–1, each adviser assets under management for regulatory to act as a private fund adviser, annually must determine the amount of purposes on the same schedule, and consistent with the requirements of rule its private fund assets, based on the using the same method, will increase 203(m)–1, during this transition market value of those assets, or the fair efficiencies for these advisers. period.639 value of those assets where market value The annual calculation also will allow 633 is unavailable. We are requiring advisers that rely on the exemption to Exemption assistance in avoiding issues arising maintain the exemption despite short- from temporary increases in asset values.’’); AIMA 631 See supra note 339. term market value fluctuations that Letter (‘‘Asset valuation is a substantial 632 administrative task and is currently undertaken See, e.g., AIMA Letter (suggested might result in the loss of the exemption modifications to the method of calculating annually for other purposes (for example, Form regulatory assets under management but also stated if, for example, the rule required daily ADV), so that a requirement for annual valuation ‘‘[w]e agree that a clear and unified approach for valuations or, to a less significant would appear to strike a fair balance between calculation of AUM is necessary and we believe extent, quarterly valuations as ensuring that firms whose AUM is at or above the applicable threshold are ‘captured’ and avoiding that using as a standard the assets for which an proposed.636 Annual calculations adviser has ‘responsibility’ is appropriate’’); both complications with short-term market value O’Melveny Letter (argued that the calculation of fluctuations and over-burdening investment regulatory assets under management as proposed circumstances. See supra note 366 and advisers.’’). ‘‘does not provide a suitable basis to determine accompanying text. 637 See, e.g., Dechert Foreign Adviser Letter whether a fund adviser should be subject to the 634 See Proposing Release, supra note 26, (‘‘[T]he Foreign Asset Manager submits that a yearly SEC’s regulation’’ but also ‘‘agree[s] with the SEC discussion at section V.B and n.196. See also ABA calculation (rather than a quarterly calculation) that ‘uniformity in the method for calculating assets Letter (recommending that the Commission would be more appropriate, as some private funds under management would result in more consistent consider using a standard of ‘‘fair value’’ for valuing may not provide for quarterly calculations of their asset calculations and reporting across the industry assets and further recommending that if assets were NAV.’’); Katten Foreign Advisers Letter (argued for and, therefore, in more coherent application of the calculated on a net basis, private funds should be annual calculations, noting that ‘‘[m]any advisers Advisers Act’s regulatory requirements and of the required to prepare audited annual financial only determine their aggregate assets under SEC staff’s risk assessment program’’’). statements in accordance with GAAP (or another management on an annual basis’’); NASBIC/SBIA 633 See rule 203(m)–1(c) (requiring an adviser to accounting standard acceptable to the Commission), Letter (‘‘Unless sought by the adviser, evaluations calculate private fund assets annually, in and to maintain such financial statements under on whether to register should be made no more accordance with General Instruction 15 to Form section 203(m)(2)); O’Melveny Letter (agreeing with often than an annual basis.’’); Seward Letter (‘‘We ADV, which together with rule 204–4 requires the statement in the Proposing Release that many believe that annual measurement of assets for advisers relying on the exemption to determine private funds value assets based on fair value, and purposes of determining an adviser’s ability to rely their private fund assets annually, in connection noting that private equity funds in particular are on the private fund adviser exemption would be with the adviser’s annual updating amendments to among the private funds that generally do not fair consistent with the approach established under its Form ADV). See also rules 203(m)–1(a)(2); value). NSMIA.’’). 203(m)–1(b)(2); 203(m)–1(d)(1) (defining ‘‘assets 635 See Proposing Release, supra note 26, 638 See AIMA Letter; Dechert Foreign Adviser under management’’ to mean ‘‘regulatory assets discussion at section V.B. See also infra Section Letter; Dechert General Letter; EFAMA Letter; under management’’ in item 5.F of Form ADV, Part V.B.2. Katten Foreign Advisers Letter; Merkl Letter; 1A); 203(m)–1(d)(4) (defining ‘‘private fund assets’’ 636 See, e.g., ABA Letter (‘‘[A] semi-annual or Seward Letter. to mean the ‘‘assets under management’’ annual measuring period would perhaps be more 639 See supra Section II.B.2.b; rule 203(m)-1(c) attributable to a ‘‘qualifying private fund’’). As appropriate, and [] a longer measuring period (requiring advisers to calculate their private fund discussed above, advisers are not required to fair would provide an adviser that is exempt from assets annually, in accordance with General value real estate assets in certain limited registration under the Private Fund Adviser Continued

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The transition period should benefit manages at a place of business in the Territorial Approach. Under rule certain advisers. As discussed above, an United States toward the $150 million 203(m)–1(b), a non-U.S. adviser with no adviser that has ‘‘complied with all limit under the exemption. U.S. place of business may avail itself of [Commission] reporting requirements As discussed below, we believe that the exemption even if it advises non- applicable to an exempt reporting this interpretation of ‘‘assets under U.S. clients that are not private funds, adviser as such’’ may apply for management in the United States’’ offers provided that it does not advise any registration with the Commission up to greater flexibility to advisers and U.S. clients other than private funds.647 90 days after filing an annual updating reduces many costs associated with We believe that this aspect of the rule, amendment reflecting that the adviser compliance.644 These costs could which looks primarily to the principal has private fund assets of $150 million include difficult attribution office and place of business of an or more, and may continue to act as a determinations that would be required if adviser to determine eligibility for the private fund adviser, consistent with the assets are managed by teams located in exemption, will increase the number of requirements of rule 203(m)–1, during multiple jurisdictions or if portfolio non-U.S. advisers that may be eligible this transition period.640 In addition, by managers located in one jurisdiction for the exemption. As with other requiring annual calculations of private rely heavily on research or other Commission rules that adopt a territorial fund assets, we are allowing advisers to advisory services performed by approach, the private fund adviser whom the transition period is available employees located in another exemption is available to a non-U.S. 180 days after their fiscal year-ends to jurisdiction. Most commenters who adviser (regardless of its non-U.S. register under the Advisers Act.641 We addressed the issue supported the advisory or other business activities) in expect that providing these advisers proposal to treat ‘‘assets under recognition that non-U.S. activities of additional time to register will reduce management in the United States’’ as non-U.S. advisers are less likely to the burdens associated with registration those assets managed at a U.S. place of implicate U.S. regulatory interests and by permitting them to register in a more business.645 in consideration of general principles of deliberate and cost-effective manner, as To the extent that this interpretation international comity. This aspect of the 642 suggested by some commenters. may increase the number of advisers rule is designed to encourage the Assets under Management in the subject to registration under the participation of non-U.S. advisers in the United States. Under rule 203(m)–1(a), Advisers Act, we anticipate that our rule U.S. market by applying the U.S. all of the private fund assets of an also will benefit investors by providing securities laws in a manner that does adviser with a principal office and place more information about those advisers not impose U.S. regulatory and of business in the United States are (e.g., information that would become operational requirements on a non-U.S. considered to be ‘‘assets under available through Form ADV, Part I). We adviser’s non-U.S. advisory business.648 management in the United States,’’ even further believe that this will enhance We believe that our interpretation of if the adviser has offices outside of the the availability of the private fund 643 investor protection by increasing the United States. A non-U.S. adviser number of advisers registering pursuant adviser exemption for non-U.S. must count only private fund assets it to the Advisers Act and by improving advisers, as reflected in the rule, will our ability to exercise our investor benefit those advisers by facilitating Instruction 15 to Form ADV); General Instruction 15 to Form ADV; rule 204–4. protection and enforcement mandates their continued participation in the U.S. 640 See supra note 378 (explaining that the over those newly registered advisers. As market with limited disruption to their transition period is available to an adviser that has discussed above, registration offers non-U.S. advisory or other business complied with ‘‘all [Commission] reporting benefits to the investing public, practices.649 This approach also should requirements applicable to an exempt reporting benefit U.S. investors and facilitate adviser as such,’’ rather than ‘‘all applicable including periodic examination of the Commission reporting requirements,’’ as proposed). adviser and compliance with rules competition in the market for advisory 641 An adviser must file its annual Form ADV requiring recordkeeping, custody of services to the extent that it maintains updating amendment within 90 days after the end client funds and compliance or increases U.S. investors’ access to of its fiscal year and, if the transition period is programs.646 potential advisers. Furthermore, because available, may apply for registration up to 90 days after filing the amendment. We proposed, in non-U.S. advisers that elect to avail contrast, to give advisers three months to register 644 See, e.g., Merkl Letter (stated that this themselves of the exemption would be with us after becoming ineligible to rely on the interpretation would be easier to apply than the subject to certain reporting exemption due to an increase in the value of their alternative interpretation about which we sought requirements,650 we believe that our private fund assets as reflected in the proposed comment which looks to the source of the assets). approach will increase the availability quarterly calculations. 645 See, e.g., Debevoise Letter (‘‘In particular, it is 642 See, e.g., Sadis & Goldberg Implementing our view that the discussion of the proposed of information publicly available to U.S. Release Letter (‘‘Three (3) months provides an definition of the term ‘assets under management in investors who invest in the private insufficient amount of time for an investment the United States’ is a fair reflection of the policy funds advised by such exempt but adviser to (i) complete its ADV Parts 1, 2A and 2B, underlying Section 203(m) of the Advisers Act (as reporting non-U.S. advisers. including the newly required narrative brochure amended by the Dodd-Frank Act) and is consistent and brochure supplement; (ii) submit its completed with prior Commission and Staff statements Most of the commenters who application to the Commission through IARD; and concerning the territorial scope of the Advisers considered this aspect of the rule (iii) receive its approval from the Commission, Act.’’); MAp Airports Letter; Non-U.S. Adviser supported it, citing, among other which may take up to forty-five (45) days.’’); Letter (‘‘By adopting a very pragmatic and sensible benefits, that this interpretation would Shearman Letter (‘‘Our experience is that registering jurisdictional approach to regulation, the an investment adviser firm in a thoughtful and Commission is appropriately recognizing general effectively protect U.S. markets and deliberate manner is often closer to a six-month task principles of international comity and the fact that investors and is consistent with the (that can sometimes take even longer depending on activities of non-U.S. advisers outside the United Commission’s overall territorial the need to engage new or additional service States are less likely to implicate U.S. regulatory providers to the firm or its funds), so that an at least interests.’’). Cf. Sen. Levin Letter (stated that 180-day transition period would be more advisers managing assets in the United States of 647 By contrast, a U.S. adviser may ‘‘solely advise appropriate.’’). funds incorporated outside of the United States ‘‘are private funds’’ as specified in the statute. Compare 643 As discussed above, the rule looks to an exactly the type of investment advisers to which the rule 203(m)-1(a)(1) with rule 203(m)-1(b)(1). adviser’s principal office and place of business as Dodd-Frank Act’s registration requirements are 648 See supra note 393 and accompanying text. the location where it directs, controls and intended to apply’’). See also supra note 386. 649 See supra Section II.B.3. coordinates its advisory activities. Rule 203(m)- 646 See supra text preceding, accompanying, and 650 See Implementing Adopting Release, supra 1(d)(3). following note 575. note 32, discussion at section II.B.

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approach to Advisers Act regulation.651 definition is well developed and qualified for another exclusion, even For example, one commenter stated that understood by advisers.656 though the adviser may be unaware of the ‘‘jurisdictional approach to only We also are adding a note to rule the fund so qualifying and the fund does considering U.S. activities for non-U.S. 203(m)–1 that clarifies that a client will not purport to rely on the other advisors is prudent as it focuses on what not be considered a United States exclusion. causes systematic [sic] risks to the person if the client was not a United Expanding the range of potential U.S.’’ 652 Another noted that non-U.S. States person at the time of becoming a ‘‘qualifying private funds,’’ therefore, persons dealing with non-U.S. advisers client of the adviser.657 This will benefit should benefit advisers to funds that would not expect to benefit from the non-U.S. advisers, which might, absent also qualify for other exclusions by protections provided by the Advisers this note, incur costs in trying to permitting these advisers to rely on the Act.653 Another stated that this determine whether they would be exemption.662 It also will prevent approach, together with our permitted to rely on rule 203(m)–1 if advisers from violating the Advisers interpretation of ‘‘assets under one of their existing non-U.S. clients Act’s registration requirements solely management in the United States,’’ will that is not a private fund becomes a because their funds qualify for another ‘‘avoid the issues associated with United States person, for example if a exclusion. In addition, advisers will not conflicting and overlapping natural person client residing abroad be required to incur the time and regulation.’’ 654 relocates to the United States.658 The expense required to assess whether the Rule 203(m)–1(b) uses the term non-U.S. adviser could at that time be funds they advise also qualify for an ‘‘United States person,’’ which generally considered to have a United States additional exclusion. incorporates the definition of a ‘‘U.S. person client other than a private fund. 2. Costs person’’ in Regulation S.655 We believe Definition of a Qualifying Private that generally incorporating the Fund. We proposed to define a Assets under Management in the definition of a ‘‘U.S. person’’ in ‘‘qualifying private fund’’ as ‘‘any United States. As noted above, under Regulation S will benefit advisers, private fund that is not registered under rule 203(m)–1, we look to an adviser’s because Regulation S provides a well- section 8 of the Investment Company principal office and place of business as developed body of law that, in our view, Act of 1940 (15 U.S.C 80a–8) and has the location where the adviser directs, appropriately addresses many of the not elected to be treated as a business controls or has responsibility for the questions that will arise under rule development company pursuant to management of private fund assets, and 203(m)–1. Moreover, advisers to private section 54 of that Act (15 U.S.C. 80a– therefore as the place where all the 663 funds and their counsel currently must 53).’’ 659 We are modifying rule 203(m)– adviser’s assets are managed. Thus, a be familiar with the definition of ‘‘U.S. 1 to also permit an adviser to treat as a U.S. adviser must include all of its person’’ under Regulation S in order to ‘‘private fund,’’ and thus as a private fund assets under management comply with other provisions of the ‘‘qualifying private fund,’’ an issuer that in determining whether it exceeds the Federal securities laws. Commenters qualifies for an exclusion from the $150 million limit under the exemption. generally supported defining ‘‘United definition of ‘‘investment company,’’ as We also look to where day-to-day States person’’ by reference to defined in section 3 of the Investment management of private fund assets may Regulation S, confirming that the Company Act, in addition to those occur for purposes of a non-U.S. adviser, whose principal office and 651 provided by section 3(c)(1) or 3(c)(7) of ABA Letter; Debevoise Letter; Dechert Foreign that Act.660 Absent this modification, an place of business is outside of the Adviser Letter; Gunderson Dettmer Letter; Katten 664 Foreign Advisers Letter; MAp Airports Letter; Merkl adviser to a section 3(c)(1) or 3(c)(7) United States. A non-U.S. adviser Letter; Wellington Letter. fund would lose the exemption if the therefore would count only the private 652 Wellington Letter. fund also qualified for another fund assets it manages at a place of 653 Debevoise Letter. See also ABA Letter (‘‘When, exclusion.661 For example, an adviser to business in the United States in in the private fund context, United States investors determining the availability of the invest with a non-United States-based investment a section 3(c)(1) or 3(c)(7) fund would manager, they understand they are not being lose the exemption if the fund also exemption. This approach is similar to afforded the investor protection safeguards of the the way we have identified the location United States Investment Advisers Act.’’); Avoca 656 AIMA Letter; CompliGlobe Letter; Debevoise of the adviser for regulatory purposes Letter (‘‘It is reasonable to assume that U.S. Letter; Dechert General Letter; Gunderson Dettmer under our current rules,665 and we investors who purchase shares of a private fund (as Letter; Katten Foreign Advisers Letter; O’Melveny believe it is the way in which most defined in section 202(a)(29)) will not expect an Letter. investment adviser that has no United States advisers would have interpreted the 657 See supra Section II.B.4. presence to be registered with the U.S. SEC as an 666 658 exemption without our rule. investment adviser.’’). See EFAMA Letter (argued that an analogous note in the foreign private adviser exemption, 654 ABA Letter. revised consistent with its comments, ‘‘also should 662 See, e.g., Dechert General Letter (argued that 655 Rule 203(m)–1(d)(8) (defining a ‘‘United States apply to the ‘private fund adviser exemption’ and advisers should be permitted to treat as a private person’’ as any person that is a ‘‘U.S. person’’ as the ‘venture capital fund exemption’ ’’); IFIC Letter fund for purposes of rule 203(m)–1 a fund that defined in Regulation S, except that any (‘‘We ask for clarification from the SEC as to qualifies for another exclusion from the definition discretionary account or similar account that is held whether it will apply the [analogous note to the of ‘‘investment company’’ in the Investment for the benefit of a United States person by a dealer foreign private adviser exemption] in other contexts Company Act in addition to section 3(c)(1) or or other professional fiduciary is a United States for purposes of compliance with the U.S. Federal 3(c)(7), such as section 3(c)(5)(C), which excludes person if the dealer or professional fiduciary is a securities laws, including compliance with Rule certain real estate funds). related person of the investment adviser relying on 12g3–2(b) of the 1934 Act.’’). 663 See supra note 385 and accompanying text. rule 203(m)–1 and is not organized, incorporated, 659 664 or (if an individual) resident in the United States). See proposed rule 203(m)–1(e)(5). See supra note 384 and accompanying text. As discussed above, two commenters that generally 660 Rule 203(m)–1(d)(5). An adviser relying on 665 See supra note 385 and accompanying text. supported our incorporation of the definition in this provision must treat the fund as a private fund 666 We do not believe that the statutory text refers Regulation S also urged us to modify our proposed under the Advisers Act and the rules thereunder for to where the assets themselves may be located or definition in certain respects. See supra notes 409– all purposes (e.g., reporting on Form ADV). Id. traded or the location of the account where the 413 and accompanying text. We decline to accept 661 A fund that qualifies for an additional assets are held. In today’s market, using the location these suggestions for the reasons discussed in exclusion would not be a private fund, because a of assets would raise numerous questions of where Section II.B.4, and we continue to believe that ‘‘private fund’’ is a fund that would be an a security with no physical existence is ‘‘located.’’ advisers will benefit from the efficiencies created by investment company as defined in section 3 of the Although physical stock certificates were once sent our general incorporation of the definition of ‘‘U.S. Investment Company Act but for section 3(c)(1) or to investors as proof of ownership, stock certificates person’’ in Regulation S. 3(c)(7) of that Act. See supra Section II.B.1. Continued

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We believe that our approach will non-U.S. location as long as the private those locations.672 This could result in promote efficiency because advisers are fund assets managed at a U.S. place of costs to U.S. investors in private funds familiar with it, and we do not business are less than $150 million. that are managed by these advisers anticipate that U.S. advisers to private This could affect competition with U.S. because they would not have the funds would likely change their advisers, which must register when they investor protection and other benefits business models, the location of their have $150 million in private fund assets that result from an adviser’s registration private funds or the location where they under management regardless of where under the Advisers Act. We do not manage assets as a result of the rule. As the assets are managed. expect that many advisers would be noted in the Proposing Release, we In contrast to the many commenters likely to relocate for purposes of expect that non-U.S. advisers may, who supported our approach, one avoiding registration, however, because, however, incur minimal costs to commenter argued that treating U.S. and as we explained in the Proposing determine whether they have assets non-U.S. advisers differently would Release, we understand that the primary under management in the United States. disadvantage U.S.-based advisers by reasons for advisers to locate in a We estimate that these costs would be permitting non-U.S. advisers to accept particular jurisdiction involve tax and no greater than $6,730 per adviser to substantial amounts of money from U.S. other business considerations.673 hire U.S. counsel and perform an investors without having to comply We also note that if an adviser did internal review to assist in this with certain U.S. regulatory relocate, it would incur the costs of determination, in particular to assess requirements, and would cause advisers regulation under the laws of most of the whether a non-U.S. affiliate manages a to move offshore or close U.S. offices to foreign jurisdictions in which it may be discretionary account for the benefit of avoid regulation.668 likely to relocate, as well as the costs of a United States person under the complying with the reporting As we explained in the Proposing rule.667 requirements applicable to exempt Release, we believe that our As noted above, because the rule is reporting advisers, unless it also interpretation recognizes that non-U.S. designed to encourage the participation qualified for the foreign private adviser activities of non-U.S. advisers are less of non-U.S. advisers in the U.S. market, exemption. We do not believe, in any likely to implicate U.S. regulatory we believe that it will have minimal case, that the adviser would relocate if interests and is in keeping with general regulatory and operational burdens on relocation would result in a material principles of international comity.669 non-U.S. advisers and their U.S. clients. decrease in the amount of assets The rule also is designed to encourage Non-U.S. advisers may rely on the rule managed because that loss would likely the participation of non-U.S. advisers in if they manage U.S. private funds with not justify the benefits of avoiding the U.S. market by applying the U.S. more than $150 million in assets at a registration, and thus we do not believe securities laws in a manner that does our rule is likely to have an adverse are now centrally held by securities depositories, not impose U.S. regulatory and effect on capital formation. which perform electronic ‘‘book-entry’’ changes in operational requirements on a non-U.S. One commenter also proposed that we 670 their records to document ownership of securities. adviser’s non-U.S. advisory business. adopt an alternative approach that This arrangement reduces transmittal costs and Non-U.S. advisers relying on rule increases efficiencies for securities settlements. See would look to the source of the generally Bank for International Settlements, The 203(m)–1 will remain subject to the assets.674 Under this alternative Depository Trust Company: Response to the Advisers Act’s antifraud provisions and approach, a non-U.S. adviser would Disclosure Framework for Securities Settlement will become subject to the requirements count the assets of private funds Systems (2002), http://www.bis.org/publ/ applicable to exempt reporting advisers. cpss20r3.pdf. An account also has no physical attributable to U.S. investors towards location even if the prime broker, custodian or other Moreover, the commenter appears to the $150 million threshold, regardless of service that holds assets on behalf of the customer suggest that an adviser that moves the location where it manages private does. Each of these approaches would be confusing offshore to avoid registering under the funds, and a U.S. adviser would exclude and extremely difficult to apply on a consistent Advisers Act would not be subject to basis. any regulation as an investment adviser, 672 667 We estimated in the Proposing Release that a See Proposing Release, supra note 26, non-U.S. adviser would need no more than 10 but we understand that most non-U.S. discussion at section V.B.2. hours of external legal advice (at $400 per hour) and advisers to private funds locate in major 673 We note that the two commenters that 10 hours of internal review by a senior compliance financial centers in jurisdictions that suggested U.S. advisers might relocate to rely on the officer (at $294 per hour) to evaluate whether the regulate investment advisers. We rule provided no data as to the likelihood that this adviser would qualify for the exemption provided would occur or the number or types of advisers who by rule 203(m)–1, for a total estimated cost of therefore believe that any competitive might relocate, and neither refuted our contention $6,940. We did not receive any comments on these consequences to U.S. advisers will be that the primary reasons for advisers to locate in a estimates. We are, however, decreasing this diminished.671 particular jurisdiction involve tax and other estimate slightly, to $6,730, to account for more business considerations. See Portfolio Manager recent salary data reflecting a $273 per hour wage As we acknowledged in the Proposing Letter; Tuttle Implementing Release Letter. for senior compliance officers. See supra note 597. Release, to avail themselves of rule 674 Portfolio Manager Letter (‘‘If you raise One commenter suggested that we presume for non- 203(m)–1, some advisers might choose significant money here you should be on the same U.S. advisers, like U.S. advisers, that all of their level playing field as the fund managers located private fund assets are managed at their principal to move their principal offices and here so that we can compete fairly.’’). See also office and place of business. Katten Foreign places of business outside of the United Merkl Letter (suggested that it ‘‘may be useful’’ to Advisers Letter. We decline to adopt this suggestion States and manage private funds at look both to assets managed from a U.S. place of for the reasons discussed above. See supra notes business and assets contributed by U.S. private 388–389 and accompanying text. In addition, the fund investors to address both investor protection 668 commenter did not convince us that the costs we Portfolio Manager Letter. See also Tuttle and systemic risk concerns). Another commenter estimate a non-U.S. adviser would incur in Implementing Release Letter (argued that suggested that we determine the ‘‘assets under determining if it has assets under management in businesses may move offshore if they become too management in the United States’’ for U.S. advisers the United States justify foregoing our approach and highly regulated in the United States). by reference to the amount of assets invested, or ‘‘in its attendant benefits. To the extent the commenter 669 See supra note 392 and accompanying text. play,’’ in the United States. Dougherty Letter. We suggests that we adopt an alternative interpretation 670 See supra note 393 and accompanying text. decline to adopt this approach because it would be to conserve our resources, we note that any 671 See also supra Section II.B.3. We also decline difficult for advisers to ascertain and monitor which interpretation that requires additional advisers to to accept a separate commenter’s suggestion to assets are invested in the United States, and this register will contribute to our workload, and permit U.S. advisers to exclude assets managed at approach thus would be confusing and extremely registration provides benefits of its own, as non-U.S. offices. See supra notes 395–396 and difficult to apply on a consistent basis. See supra discussed above. accompanying and following text. note 394 and accompanying and following text.

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assets that are not attributable to U.S. methodologies would vary based on does not have an internal capability for investors. As a result, more U.S. factors such as the nature of the asset, valuing specific illiquid assets, we advisers might be able to rely on rule the number of positions that do not have expect that it could obtain pricing or 203(m)–1 under this alternative a market value, and whether the adviser valuation services from an outside interpretation. To the extent that non- has the ability to value such assets administrator or other service provider. U.S. advisers have U.S. investors in internally or would rely on a third party Staff estimated that the cost of such a private funds that they manage at a non- for valuation services.676 Nevertheless, service would range from $1,000 to U.S. location, fewer non-U.S. advisers we continue to believe that the $120,000 annually, which could be would be eligible for the exemption. requirement to use fair value would not borne by several funds that invest in Thus, this alternative could increase result in significant costs for these similar assets or have similar costs for those non-U.S. advisers that advisers, particularly in light of our investment strategies.680 We did not would have to register but reduce costs decision to require annual, rather than receive any comments on these for those U.S. advisers that would not quarterly, valuations. We also estimates. These estimates, however, have to register. understand that private fund advisers, assumed that an adviser would be This alternative approach also could including those that may not use fair required to calculate the fair value of its adversely affect U.S. investors to the value methodologies for reporting private funds assets quarterly, as extent that it discouraged U.S. advisers purposes, perform administrative required by rule 203(m)–1 as proposed. from managing U.S. investor assets. A services, including valuing assets, We are reducing the estimated range to U.S. adviser might avoid managing internally as a matter of business $250 to $75,000 annually to reflect that assets from U.S. investors because, practice.677 rule 203(m)–1 requires advisers to under this alternative interpretation, the A number of commenters objected to calculate their private fund assets assets would be included in the requirement to determine private annually, rather than quarterly as determining whether the adviser was fund assets based on fair value, proposed.681 eligible to rely on rule 203(m)–1. This generally arguing that the requirement In addition, as discussed above, we could reduce competition for the would cause those advisers that did not have taken several steps to mitigate management of assets from U.S. use fair value methods to incur these costs.682 While many advisers will investors. The likelihood of U.S. additional costs, especially if the private calculate fair value in accordance with advisers seeking to avoid registration in funds’ assets that they manage are GAAP or another international this way might be mitigated, however, illiquid and therefore difficult to fair accounting standard,683 other advisers to the extent that the loss of managed value.678 As discussed in Section II.B.2, acting consistently and in good faith assets of U.S. investors would exceed we are sensitive to the costs this new may utilize another fair valuation the savings from avoiding registration. requirement will impose, and we standard.684 While these other standards Method of Calculating Private Fund requested comment in the Proposing may not provide the quality of Assets. Rule 203(m)–1 incorporates the Release on our estimates concerning the information in financial reporting (for valuation methodology in the costs related to fair value. Commission instructions to Form ADV, which staff estimates that such an adviser 680 These estimates are based on conversations requires advisers to use the market would incur $1,320 in internal costs to with valuation service providers. We understand value of private fund assets, or the fair conform its internal valuations to a fair that the cost of valuation for illiquid fixed income value standard.679 In the event a fund securities generally ranges from $1.00 to $5.00 per value of private fund assets where security, depending on the difficulty of valuation, market value is unavailable, when and is performed for clients on a weekly or monthly determining regulatory assets under 676 See Proposing Release, supra note 26, at n.323 basis. We understand that appraisals of privately management and to include in the and accompanying text. placed equity securities may cost from $3,000 to 677 For example, a hedge fund adviser may value $5,000 with updates to such values at much lower calculation certain types of assets fund assets for purposes of allowing new prices. For purposes of this cost benefit analysis, we advisers previously were permitted to investments in the fund or redemptions by existing are estimating the range of costs for (i) a private exclude. The revised instructions also investors, which may be permitted on a regular fund that holds 50 fixed income securities at a cost clarify that this calculation must be basis after an initial lock-up period. An adviser to of $5.00 to price and (ii) a private fund that holds private equity funds may obtain valuations of privately placed securities of 15 issuers that each done on a gross basis. portfolio companies in which the fund invests in cost $5,000 to value initially and $1,000 thereafter. We acknowledged in the Proposing connection with financing obtained by those We believe that costs for funds that hold both fixed- Release that some private fund advisers companies. Advisers to private funds also may income and privately placed equity securities value portfolio companies each time the fund would fall within the maximum of our estimated may not use fair value makes (or considers making) a follow-on investment 675 range. We note that funds that have significant methodologies. As we explained in the company. Private fund advisers could use positions in illiquid securities are likely to have the there, the costs incurred by those these valuations as a basis for complying with the in-house capacity to value those securities or advisers to use fair valuation fair valuation requirement applicable to private already subscribe to a third-party service to value fund assets. them. We note that many private funds are likely 678 See, e.g., Gunderson Dettmer Letter; Merkl to have many fewer fixed income illiquid securities 675 See supra note 634 and accompanying and Letter; O’Melveny Letter; Seward Letter; Wellington in their portfolios, some or all of which may cost following text. In addition, we estimate in the Letter. less than $5.00 per security to value. Finally, we Implementing Adopting Release, based on 679 We estimated in the Proposing Release that note that obtaining valuation services for a small registered advisers’ responses to Items 5.D, 7.B, and such an adviser would incur $1,224 in internal number of fixed income positions on an annual 9.C of Form ADV, that approximately 3% of costs to conform its internal valuations to a fair basis may result in a higher cost for each security registered advisers have at least one private fund value standard. See Proposing Release, supra note or require a subscription to the valuation service for client that is not audited, and that these advisers 26, at n.325. We received no comments on this those that do not already purchase such services. therefore may incur costs to fair value their private estimate. We are, however, increasing this estimate The staff’s estimate is based on the following fund assets. See Implementing Adopting Release, slightly, to $1,320, to account for more recent salary calculations: (50 × $5.00 × 4 = $1,000); (15 × $5,000) supra note 32, at nn.634–641 and accompanying data. This revised estimate is based upon the + (15 × $1,000 × 3) = $120,000). text. We also estimate in that release that each of following calculation: 8 hours × $165/hour = 681 The staff’s revised estimate is based on the these registered advisers that potentially would $1,320. The hourly wage is based on data for a fund following calculations: (50 × $5.00 = $250; 15 × incur costs as a result of the fair value requirement senior accountant from SIFMA’s Management & would incur costs of $37,625 on an annual basis. Professional Earnings in the Securities Industry $5,000 = $75,000). See also supra note 680. 682 Id., at n.641 and accompanying text. This is the 2010, modified by Commission staff to account for See supra notes 363–366 and accompanying middle of the range of the estimated fair value costs, an 1800-hour work-year and multiplied by 5.35 to text. which range from $250 to $75,000 annually. Id. See account for bonuses, firm size, employee benefits 683 See supra note 364 and accompanying text. also infra notes 680–681 and accompanying text. and overhead. 684 See supra note 365 and accompanying text.

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example, of private fund returns), we business, provided it complies with the assets test such a fund would be treated expect these calculations will provide exemption’s conditions. similarly for regulatory purposes as a sufficient consistency for the purposes Some commenters objected to fundamentally different fund, such as that regulatory assets under calculating regulatory assets under one that did not make extensive use of management serve in our rules, management on the basis of gross, rather leverage and had $140 million in net including rule 203(m)–1.685 than net, assets. They argued, among assets. Use of the alternative approaches other things, that gross asset The use of gross assets also need not recommended by commenters (e.g., cost measurements would be confusing,689 cause any investor confusion, as some basis or any method required by the complex,690 and inconsistent with commenters suggested.696 Although an private fund’s governing documents industry practice.691 However, nothing adviser will be required to use gross other than fair value) would not meet in the current instructions suggests that (rather than net) assets for purposes of our objective of having more meaningful liabilities should be deducted from the determining whether it is eligible for the and comparable valuation of private calculation of an adviser’s assets under private fund adviser or the foreign fund assets, and could result in a management. Indeed, since 1997, the private adviser exemptions (among significant understatement of instructions have stated that an adviser other purposes), we would not preclude appreciated assets. Moreover, these should not deduct securities purchased an adviser from holding itself out to its alternative approaches could permit on margin when calculating its assets clients as managing a net amount of advisers to circumvent the Advisers under management.692 Whether a client assets as may be its custom.697 Act’s registration requirements. has borrowed to purchase a portion of Definition of a Qualifying Private Permitting the use of any valuation the assets managed does not seem to us Fund. As discussed above, we modified standard set forth in the governing a relevant consideration in determining the definition of a ‘‘qualifying private documents of the private fund other the amount an adviser has to manage, fund’’ to include an issuer that qualifies than fair value could effectively yield to the scope of the adviser’s business, or for an exclusion from the definition of 693 the adviser the choice of the most the availability of the exemptions. ‘‘investment company,’’ as defined in favorable standard for determining its Moreover, we are concerned that the section 3 of the Investment Company registration obligation as well as the use of net assets could permit advisers Act, in addition to those provided by application of other regulatory to highly leveraged funds to avoid section 3(c)(1) or 3(c)(7) of that Act. To requirements. For these reasons and registration under the Advisers Act even the extent advisers are able to rely on those discussed in the Implementing though the activities of such advisers the exemption as a result of this Adopting Release, commenters did not may be significant and the funds they modification, investors and the persuade us that the extent of the advise may be appropriate for systemic 694 Commission will lose the benefits additional burdens the fair value risk reporting. One commenter registration would provide. This argued, in contrast, that it would be requirement would impose on some modification does, however, benefit ‘‘extremely unlikely that a net asset advisers to private funds would be advisers, as discussed above, and limit of $150,000,000 in private funds inappropriate in light of the value of a investors (and the Commission) will could be leveraged into total more meaningful and consistent still have access to the information these investments that would pose any calculation by all advisers to private advisers will be required to file as systemic risk.’’ 695 But a comprehensive funds. exempt reporting advisers. view of systemic risk requires We also do not expect that advisers’ Solely Advises Private Funds. Some information about certain funds that principals (or other employees) commenters asserted, in effect, that may not present systemic risk concerns generally will cease to invest alongside advisers should be permitted to the advisers’ clients as a result of the when viewed in isolation, but nonetheless are relevant to an combine other exemptions with rule inclusion of proprietary assets, as some 203(m)–1 so that, for example, an commenters suggested.686 If private assessment of systemic risk across the economy. Moreover, because private adviser could advise venture capital fund investors value their advisers’ co- funds with assets under management in investments as suggested by these funds are not subject to the leverage restrictions in section 18 of the excess of $150 million in addition to commenters, we expect that the other, non-venture capital private funds investors will demand them and their Investment Company Act, a private fund with less than $150 million in net assets with less than $150 million in assets advisers will structure their businesses 698 could hold assets far in excess of that under management. One commenter accordingly.687 argued that, by declining to adopt this One commenter also argued that amount as a result of its extensive use of leverage. In addition, under a net view, we are imposing unnecessary including proprietary assets would deter burdens, particularly on advisers who non-U.S. advisers that manage large 689 Dechert General Letter. See also Implementing advise both small private funds and sums of proprietary assets from Adopting Release, supra note 32, at n.80 and small business investment establishing U.S. operations and accompanying text. companies.699 But as we discuss in employing U.S. residents.688 Such an 690 MFA Letter. Section II.B.1, the approach the adviser, however, would not be 691 See, e.g., Merkl Letter; Shearman Letter. See commenter suggests runs contrary to the ineligible for the private fund adviser also supra note 351. 692 See Form ADV: Instructions for Part 1A, instr. language of section 203(m), which exemption merely because it established 5.b.(2), as in effect before it was amended by the directs us to provide an exemption ‘‘to U.S. operations. As discussed in Section Implementing Adopting Release (‘‘Do not deduct any investment adviser of private funds, II.B, a non-U.S. adviser may rely on the securities purchased on margin.’’). Instruction if each of such investment adviser acts private fund adviser exemption while 5.b.(2), as amended in the Implementing Adopting Release, provides ‘‘Do not deduct any outstanding solely as an adviser to private funds and also having one or more U.S. places of indebtedness or other accrued but unpaid liabilities.’’ See Implementing Adopting Release, 696 See, e.g., Dechert General Letter. See also 685 See supra note 366 and accompanying text. supra note 32, discussion at section II.A.3. Implementing Adopting Release, supra note 32, at 686 See, e.g., ABA Letter; Katten Foreign Advisers 693 See id. n.80 and accompanying text. Letter; Seward Letter. 694 See id., at n.82 and preceding and 697 See supra note 357. 687 See supra note 347 and accompanying text. accompanying text. 698 NASBIC/SBIA Letter; Seward Letter. 688 Katten Foreign Advisers Letter. 695 ABA Letter. 699 NASBIC/SBIA Letter.

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has assets under management in the also note that the costs of registration for As proposed, we are omitting the United States of less than advisers that do not qualify for the ‘‘special rule’’ that allowed advisers not $150,000,000.’’ Thus, we believe that private fund adviser exemption flow to count as a client any person for the costs to advisers that may have to from the Dodd-Frank Act, which whom the adviser provides investment register because they do not advise removed the private adviser exemption advisory services without solely private funds with assets under on which they currently rely. compensation.711 Finally, the rule includes two provisions that clarify that management in the United States of less C. Foreign Private Adviser Exemption than $150 million flow directly from the advisers need not double-count private Dodd-Frank Act. Section 403 of the Dodd-Frank Act funds and their investors under certain Assessing Whether the Exemption Is replaces the current private adviser circumstances.712 Available and Costs of Registration and exemption from registration under the Second, section 202(a)(30) provides Compliance. We estimate each adviser Advisers Act with a new exemption for that a ‘‘foreign private adviser’’ eligible may incur between $800 to $4,800 in any ‘‘foreign private adviser,’’ as defined for the new registration exemption legal advice to learn whether it may rely in new section 202(a)(30) of the cannot have more than 14 clients ‘‘or 706 on the exemption.700 We did not receive Advisers Act. We are adopting, investors in the United States.’’ We are any comments concerning these substantially as proposed, new rule defining ‘‘investor’’ in a private fund in estimates. We also estimate that each 202(a)(30)–1, which defines certain rule 202(a)(30)–1 as any person who adviser that registers would incur terms in section 202(a)(30) for use by would be included in determining the registration costs, which we estimate advisers seeking to avail themselves of number of beneficial owners of the would be $15,077,701 initial compliance the foreign private adviser exemption, outstanding securities of a private fund costs ranging from $10,000 to $45,000, including: (i) ‘‘Investor;’’ (ii) ’’in the under section 3(c)(1) of the Investment and ongoing annual compliance costs United States;’’ (iii) ‘‘place of business;’’ Company Act, or whether the 707 ranging from $10,000 to $50,000.702 and (iv) ‘‘assets under management.’’ outstanding securities of a private fund Some commenters suggested that these We are also including in rule are owned exclusively by qualified estimates are too low, and estimated 202(a)(30)–1 the safe harbor and many purchasers under section 3(c)(7) of that of the client counting rules that Act.713 We are also treating as investors that they would incur one-time 708 registration and compliance costs appeared in rule 203(b)(3)–1. beneficial owners of ‘‘short-term paper’’ Rule 202(a)(30)–1 clarifies several ranging from $50,000 to $600,000, issued by the private fund, who must be provisions used in the statutory followed by ongoing annual compliance qualified purchasers under section definition of ‘‘foreign private adviser.’’ costs ranging from $50,000 to 3(c)(7) but are not counted as beneficial First, the rule includes a safe harbor for $500,000.703 Although some advisers owners for purposes of section counting clients, which previously 714 may incur these costs, we do not believe 3(c)(1). appeared in rule 203(b)(3)–1, and which Third, rule 202(a)(30)–1 defines ‘‘in they are representative, as discussed we have modified to account for its use the United States’’ generally by above.704 Moreover, as discussed above, in the foreign private adviser context. incorporating the definition of a ‘‘U.S. commenters identifying themselves as Under the safe harbor, an adviser would person’’ and ‘‘United States’’ under ‘‘middle market private equity fund’’ count certain natural persons as a single Regulation S.715 In particular, we define advisers provided the highest estimated client under certain circumstances.709 ‘‘in the United States’’ in rule costs, but these commenters generally Rule 202(a)(30)–1 also includes another 202(a)(30)–1 to mean: (i) With respect to would not qualify for the private fund provision of rule 203(b)(3)–1 that any place of business, any such place adviser exemption we are required to permits an adviser to treat as a single provide under section 203(m).705 We ‘‘client’’ an entity that receives promotes, or sells interests in the legal organization investment advice based on the entity’s to the owner, or reports periodically to the owners 700 We estimate that a private fund adviser would as a group solely with respect to the performance obtain between 2 and 12 hours of external legal investment objectives and two or more 710 of or plans for the legal organization’s assets or advice (at a cost of $400 per hour) to determine entities that have identical owners. similar matters; and (3) any general partner, whether it would be eligible for the private fund managing member or other person acting as an adviser exemption. under management). See also supra note 614 and investment adviser to a limited partnership or 701 See supra note 597 and accompanying text. accompanying text. limited liability company must treat the partnership 702 See supra note 601 and accompanying text. 706 See supra notes 415–418 and accompanying or limited liability company as a client. 703 See supra notes 602–603 and accompanying text. The new exemption is codified as amended 711 See rule 203(b)(3)–1(b)(4); supra notes 425– text. section 203(b)(3). See supra Section II.C. 427 and accompanying text. 704 See supra Section V.A.2. 707 Rule 202(a)(30)–1(c). 712 See rule 202(a)(30)–1(b)(4) (an adviser is not 705 We note that the advisers that gave us these 708 See supra Section II.C. Rule 203(b)(3)–1, required to count a private fund as a client if it estimates for registration costs have assets under which we are rescinding with the Implementing counts any investor, as defined in the rule, in that management in excess of the $150 million threshold Adopting Release, provides a safe harbor for private fund as an investor in the United States in and they are not representative of advisers that determining who may be deemed a single client for that private fund); rule 202(a)(30)–1(b)(5) (an would qualify for the private fund adviser purposes of the private adviser exemption. We are adviser is not required to count a person as an exemption. See supra notes 602–603 and not, however, carrying over rules 203(b)(3)–1(b)(4), investor if the adviser counts such person as a accompanying text. We also note that (5), or (7). See supra notes 316, 420 and 425 and client in the United States). See also supra note 429. approximately 570 smaller advisers currently are accompanying text. 713 See rule 202(a)(30)–1(c)(2); supra Section registered with us. See supra note 613 and 709 Rule 202(a)(30)–1(a)(1). II.C.2. In order to avoid double-counting, the rule accompanying text. These advisers have absorbed 710 Rule 202(a)(30)–1(a)(2)(i)–(ii). In addition, rule allows an adviser to treat as a single investor any the compliance costs associated with registration, 202(a)(30)–1(b)(1) through (3) contain the following person who is an investor in two or more private notwithstanding the fact that their revenues are related ‘‘special rules:’’ (1) An adviser must count funds advised by the adviser. See rule 202(a)(30)– likely to be smaller than those of a typical adviser a shareholder, partner, limited partner, member, or 1, at note to paragraph (c)(2). that will be required to register as a result of beneficiary (each, an ‘‘owner’’) of a corporation, 714 See rule 202(a)(30)–1(c)(2)(ii); supra notes Congress’s repeal of the private adviser exemption general partnership, limited partnership, limited 453–462 and accompanying text. Consistently with (e.g., an adviser to private funds with $150 million liability company, trust, or other legal organization, section 3(c)(1) and section (3)(c)(7) of the or more of assets under management in the United as a client if the adviser provides investment Investment Company Act, the final rule, unlike the States, or a ‘‘middle market’’ private equity adviser). advisory services to the owner separate and apart proposed rule, does not treat knowledgeable See, e.g., Atlas Letter (middle market private equity from the investment advisory services provided to employees as ‘‘investors.’’ Cf. proposed rule adviser with $365 million of assets under the legal organization; (2) an adviser is not required 202(a)(30)–1(c)(1)(i). management); Cortec Letter (middle market private to count an owner as a client solely because the 715 Rule 202(a)(30)–1(c)(3). See supra Section equity adviser with less than $750 million of assets adviser, on behalf of the legal organization, offers, II.C.3.

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located in the ‘‘United States,’’ as reference to the rules we reference).721 As noted above, the definitions of defined in Regulation S; 716 (ii) with Our approach provides consistency ‘‘investor’’ and ‘‘United States’’ under respect to any client or private fund among these other rules and the new our rule rely on existing definitions, investor in the United States, any exemption. This should limit non-U.S. with slight modifications.728 Our rule person who is a ‘‘U.S. person’’ as advisers’ need to undertake additional also incorporates the safe harbor that defined in Regulation S,717 except that analysis with respect to these terms for appeared in rule 203(b)(3)–1 for under the rule, any discretionary purposes of determining the availability counting clients, except that it no longer account or similar account that is held of the foreign private adviser allows an adviser to disregard clients for for the benefit of a person ‘‘in the exemption.722 We believe that the whom the adviser provides services United States’’ by a non-U.S. dealer or consistency and clarity that results from without compensation.729 We are other professional fiduciary is a person the rule will promote efficiency for non- making these modifications ‘‘in the United States’’ if the dealer or U.S. advisers and the Commission. (collectively, the ‘‘modifications’’) in professional fiduciary is a related Commenters that expressed support for order to preclude some advisers from person of the investment adviser relying the proposed definitions confirmed that excluding certain assets or clients from on the exemption; and (iii) with respect the references to other rules will allow their calculation so as to avoid to the public, in the ‘‘United States,’’ as advisers to apply existing concepts and registration with the Commission and defined in Regulation S.718 maintain consistency with current the regulatory requirements associated Fourth, rule 202(a)(30)–1 defines interpretations.723 with registration.730 Without a ‘‘place of business’’ to have the same For example, for purposes of definition of these terms, advisers meaning as in Advisers Act rule 222– determining eligibility for the foreign would likely rely on the same 1(a).719 Finally, for purposes of rule private adviser exemption, advisers definitions we reference in rule 202(a)(30)–1, we are defining ‘‘assets must count clients substantially in the 202(a)(30)–1, but without the under management’’ by reference to same manner as they counted clients modifications. We expect, therefore, that 724 ‘‘regulatory assets under management’’ under the private adviser exemption. the rule likely will have the practical as determined under Item 5 of Form In identifying ‘‘investors,’’ advisers can effect of narrowing the scope of the ADV.720 generally rely on the determination exemption, and thus likely will result in made to assess whether the private fund more advisers registering than if it 1. Benefits meets the counting or qualification reflected no modifications from the We are defining certain terms requirements under section 3(c)(1) or current rules. included in the statutory definition of 3(c)(7) of the Investment Company The final rule does not include one of 725 ‘‘foreign private adviser’’ in order to Act. In determining whether a client, the modifications we proposed. The clarify the meaning of these terms and an investor, or a place of business is ‘‘in final rule does not treat knowledgeable reduce the potential administrative and the United States,’’ or whether it holds employees as investors, consistent with regulatory burdens for advisers that seek itself out as an investment adviser to the sections 3(c)(1) and 3(c)(7).731 As some to rely on the foreign private adviser public ‘‘in the United States,’’ an commenters noted, treating exemption. As noted above, our rule adviser generally will apply the same knowledgeable employees in the same references definitions set forth in other analysis it would otherwise apply under 726 manner for purposes of the definition of Commission rules under the Advisers Regulation S. In identifying whether investor and sections 3(c)(1) and 3(c)(7) Act, the Investment Company Act and it has a place of business in the United will simplify advisers’ compliance with States, an adviser will use the definition the Securities Act, all of which are these regulatory requirements.732 In of ‘‘place of business’’ as defined in likely to be familiar to non-U.S. advisers addition, as a result of this treatment of Advisers Act rule 222–1, which is used active in the U.S. capital markets. knowledgeable employees, more non- to determine whether a state may assert As we discussed in the Proposing U.S. advisers will be able to rely on the regulatory jurisdiction over the Release, we anticipate that by defining exemption. adviser.727 these terms we will benefit non-U.S. We believe that any increase in advisers by providing clarity with registration as compared to the number 721 See Proposing Release, supra note 26, at n.350 respect to the terms that advisers would and accompanying text. of non-U.S. advisers that might have otherwise be required to interpret (and 722 This is true for all of the definitions except for registered if we had not adopted rule which they would likely interpret with ‘‘assets under management.’’ An adviser that relies 202(a)(30)–1 will benefit investors. on the foreign private adviser exemption must Investors whose assets are, directly or calculate its assets under management according to 716 See 17 CFR 230.902(l). the instructions to Item 5 of Form ADV only for indirectly, managed by the non-U.S. 717 See 17 CFR 230.902(k). We are allowing purposes of determining the availability of the advisers that will be required to register foreign advisers to determine whether a client or exemption. As discussed above, rule 202(a)(30)–1 will benefit from the increased investor is ‘‘in the United States’’ by reference to includes a reference to Item 5 of Form ADV in order the time the person became a client or acquires to provide for consistency in the calculation of protection afforded by Federal securities issued by the private fund. See rule assets under management for various purposes registration of the adviser and 202(a)(30)–1, at note to paragraph (c)(3)(i). under the Advisers Act. See supra note 497 and application to the adviser of all of the 718 See 17 CFR 230.902(l). accompanying text. requirements of the Advisers Act. As 719 See rule 202(a)(30)–1(c)(4); rule 222–1(a) 723 See, e.g., Dechert General Letter (with respect (defining ‘‘place of business’’ of an investment to the definition of ‘‘investor’’); Dechert Foreign to register if the adviser does not have a ‘‘place of adviser as: ‘‘(1) An office at which the investment Adviser Letter and IFIC Letter (noting that the business’’ within, and has fewer than 6 client adviser regularly provides investment advisory proposed definition of ‘‘in the United States’’ has residents of, the state. services, solicits, meets with, or otherwise the benefit of relying on existing guidance that is 728 communicates with clients; and (2) Any other generally used by investment advisers); O’Melveny See supra Sections II.C.2 and II.C.3. location that is held out to the general public as a Letter (with respect to the definition of ‘‘U.S. 729 See supra Section II.C.1. location at which the investment adviser provides person’’). 730 See supra notes 453–462 and accompanying investment advisory services, solicits, meets with, 724 See supra Section II.C.1. and following text and notes 474–477 and or otherwise communicates with clients.’’). See 725 See supra note 432 and accompanying text. accompanying text. See also infra notes 744–747 for supra Section II.C.4. 726 See supra notes 471–472 and accompanying an estimate of the costs associated with registration. 720 Rule 202(a)(30)–1(c)(1); Form ADV: text. 731 See supra notes 448–452 and accompanying Instructions to Part 1A, instr. 5.b(4). See also supra 727 See supra Section II.C.4. Under section 222 of text. Section II.C.5. the Advisers Act, a state may not require an adviser 732 See Seward Letter; Shearman Letter.

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noted above, registration offers benefits or investor is ‘‘in the United States’’ by the United States.739 Two of these to the investing public, including reference to the time the person became commenters stated, for example, that in periodic examination of the adviser and a client or an investor acquires their view a non-U.S. fund could be compliance with rules requiring securities issued by the private fund considered a private fund as a result of recordkeeping, custody of client funds should also reduce advisers’ costs.736 independent actions of U.S. investors, and compliance programs.733 Advisers will make the determination such as if a non-U.S. shareholder of a 2. Costs only once and will not be required to non-U.S. fund moves to the United monitor changes in the status of each States and purchases additional As discussed in the Proposing client and private fund investor. shares.740 If these funds were ‘‘private Release, we do not believe our Moreover, if a client or an investor funds,’’ their advisers would, if seeking definitions will result in significant moved to the United States, the adviser to rely on the foreign private adviser costs for non-U.S. advisers.734 Non-U.S. would not have to choose among exemption, be required to determine the advisers that seek to avail themselves of registering with us, terminating the number of private fund investors in the the foreign private adviser exemption relationship with the client, or forcing United States and the assets under will incur costs to determine whether the investor out of the private fund. management attributable to them. they are eligible for the exemption. We Some commenters agreed that the As we explain above, if an adviser expect that these advisers will consult instruction will benefit advisers.737 reasonably believes that an investor is with outside U.S. counsel and perform Some commenters disagreed with the not ‘‘in the United States,’’ the adviser an internal review of the extent to Proposing Release’s explanation of how may treat the investor as not being ‘‘in which an advisory affiliate manages the exemption’s requirement that an the United States.’’ Moreover, we discretionary accounts owned by a U.S. adviser look through to private fund understand that non-U.S. private funds person that would be counted toward investors would apply with respect to currently count or qualify their U.S. the limitation on clients in the United certain structures, such as master-feeder investors in order to avoid regulation States and investors in the United funds and total return swaps.738 In both under the Investment Company Act.741 States. We estimate these costs will be respects, we note that the obligation to A non-U.S. adviser would need to count 735 $6,730 per adviser. look through certain transactions stems the same U.S. investors (except for Without the rule, we believe that most from section 208(d) of the Advisers Act holders of short-term paper with respect advisers would have interpreted the (section 48(a) of the Investment to a fund relying on section 3(c)(1)) in new statutory provision by reference to Company Act with respect to sections order to rely on the foreign private the same rules that rule 202(a)(30)–1 3(c)(1) and 3(c)(7)) as it applies to an adviser exemption. In this respect, references. Without our rule, some adviser’s obligations to look through to therefore, the look-through requirement advisers would have likely incurred private fund investors for purposes of of the foreign private adviser exemption additional costs because they would the foreign private adviser exemption. will generally not impose any new have sought guidance in interpreting the Thus, any costs associated with the burden on advisers to non-U.S. funds. terms used in the statutory exemption. statutory provisions that prohibit any As discussed in the Proposing By defining the statutory terms in a rule, person from doing indirectly or through Release, the modifications will result in we believe that we are providing or by another person anything that some costs for non-U.S. advisers who certainty for non-U.S. advisers and would be unlawful to do directly flow might change their business practices in limiting the time, compliance costs and from those provisions, rather than any order to rely on the exemption.742 Some legal expenses non-U.S. advisers would non-U.S. advisers may have to choose to have incurred in seeking an definitions we are adopting. Some commenters expressed concern register under the Advisers Act or to interpretation, all of which could have that the look-through requirement inhibited capital formation and reduced limit the scope of their contacts with the contained in the statutory definition of efficiency. Advisers will also be less United States in order to rely on the a ‘‘foreign private adviser’’ could likely to seek additional assistance from statutory exemption for foreign private impose significant burdens on advisers us because they can rely on relevant advisers (or the private fund adviser to non-U.S. funds, including non-U.S. 743 guidance that we have previously exemption). As noted above, we have retail funds publicly offered outside of provided with respect to the definitions 739 that rule 202(a)(30)–1 references. We See AFG letter; Dechert Foreign Adviser 736 See rule 202(a)(30)–1, at note to paragraph Letter; EFAMA Letter; Shearman Letter. also believe that non-U.S. advisers’ (c)(3)(i); supra note 476 and accompanying text. 740 Dechert Foreign Adviser Letter; EFAMA ability to rely on the definitions that the 737 See Dechert General Letter (‘‘The note Letter. See also supra note 464 and accompanying rule references and the guidance provides helpful relief at a time when advisory text. provided with respect to the referenced clients often move across international borders 741 This practice is consistent with positions our rules will reduce Commission resources while keeping an existing relationship with a staff has taken in which the staff has stated it would financial institution.’’); IFIC Letter (the proposed not recommend enforcement action in certain that would have otherwise been applied approach ‘‘is consistent with the current circumstances. See, e.g., Goodwin Procter No- to administering the foreign private interpretations on which Canadian advisers have Action Letter, supra note 294; Touche Remnant No- adviser exemption, which resources can relied for many years, and will ensure continuity Action Letter, supra note 294. See also sections be allocated to other matters. and certainty in their business operations.’’). 7(d), 3(c)(1), and 3(c)(7) of the Investment Company 738 Act. See also, e.g., Canadian Tax-Deferred Our instruction allowing non-U.S. See Dechert General Letter; EFAMA Letter. See also supra notes 442–444 and accompanying Retirement Savings Accounts Release, supra note advisers to determine whether a client text. As we discussed above, for purposes of the 294, at n.23 (‘‘The Commission and its staff have look-through provision, the adviser to a master fund interpreted section 7(d) to generally prohibit a 733 See supra text accompanying and following in a master-feeder arrangement must treat as foreign fund from making a U.S. private offering if note 575. investors the holders of the securities of any feeder that offering would cause the securities of the fund 734 See Proposing Release, supra note 26, at fund formed or operated for the purpose of to be beneficially owned by more than 100 U.S. section V.C.2. investing in the master fund rather than the feeder residents.’’). 735 See supra note 667 and accompanying text. As funds, which act as conduits. In addition, an 742 See Proposing Release, supra note 26, at n. 362 noted above, we are decreasing this estimate to adviser must count as an investor any owner of a and accompanying and following text. $6,730 to account for more recent salary data. Id. total return swap on the private fund because that 743 See, e.g., O’Melveny Letter (argued that We did not receive any comments on the costs we arrangement effectively provides the risks and because the foreign private adviser is subject to a estimated advisers would incur to perform this rewards of investing in the private fund to the swap low statutory asset threshold, it is likely ‘‘that the internal review. owner. Continued

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estimated the costs of registration to be reducing competition in the market for As discussed in the Proposing $15,077.744 In addition, we estimate that advisory services or decreasing the Release, some non-U.S. advisers to registered advisers would incur initial availability of certain investment private funds may value assets based on costs to establish a compliance opportunities for U.S. investors. If the their fair value in accordance with infrastructure, which we estimate would non-U.S. adviser chose to register, GAAP or other international accounting range from $10,000 to $45,000 and competition among registered advisers standards that require the use of fair ongoing annual costs of compliance and would increase. One commenter value, while other advisers to private examination, which we estimate would asserted that treating holders of short- funds currently may not use fair value range from $10,000 to $50,000.745 Some term paper as investors could result in methodologies.753 We noted above that commenters suggested that these a U.S. commercial lender to a fund the costs associated with fair valuation estimates are too low, and estimated being treated as an investor, leading will vary based on factors such as the that they would incur one-time non-U.S. advisers to avoid U.S. nature of the asset, the number of registration and compliance costs lenders.748 To the extent that the positions that do not have a market ranging from $50,000 to $600,000, modification included in the definition value, and whether the adviser has the followed by ongoing annual compliance of ‘‘investor’’ causes a non-U.S. adviser ability to value such assets internally or costs ranging from $50,000 to seeking to rely on the foreign private relies on a third party for valuation $500,000.746 Although some advisers adviser exemption to limit U.S. services.754 Nevertheless, we do not may incur these costs, we do not believe investors in a private fund’s short-term believe that the requirement to use fair they are representative, as discussed notes, the modification could have an value methodologies will result in above.747 Moreover, as discussed above, adverse effect on capital formation and significant costs for these advisers to commenters identifying themselves as reduce U.S. lenders as sources of credit these funds.755 Commission staff ‘‘middle market private equity fund’’ for non-U.S. funds. However, unless the estimates that such advisers will each advisers provided the highest estimated extension of credit by a fund’s broker- incur $1,320 in internal costs to costs, but these commenters generally dealer or custodian bank results in the conform its internal valuations to a fair would not qualify for the foreign private issuance of a security by the fund to its value standard.756 In the event a fund adviser exemption (e.g., because these creditor, the creditor would not be does not have an internal capability for advisers generally appear to have places considered an investor for purposes of valuing illiquid assets, we expect that it of business in the United States). the foreign private adviser will be able to obtain pricing or In any case, non-U.S. advisers will exemption.749 valuation services from an outside assess the costs of registering with the As a result of the rule’s reference to administrator or other service provider. Commission relative to relying on the the method of calculating assets under Staff estimated that the annual cost of foreign private adviser or the private management under Form ADV, non-U.S. such a service will range from $1,000 to fund adviser exemption. This advisers will use the valuation method $120,000 annually, which could be assessment will take into account many provided in the instructions to Form borne by several funds that invest in factors, which will vary from one ADV to verify compliance with the $25 similar assets or have similar adviser to another, to determine million asset threshold included in the investment strategies.757 We did not whether registration, relative to other foreign private adviser exemption.750 receive any comments on these options, is the most cost-effective Among other things, these instructions estimates. business option for the adviser to require advisers to use the market value VI. Regulatory Flexibility Certification pursue. If a non-U.S. adviser limited its of private fund assets, or the fair value activities within the United States in of private fund assets where market The Commission certified in the order to rely on the exemption, the value is unavailable, when determining Proposing Release, pursuant to section modifications might have the effect of regulatory assets under management 605(b) of the Regulatory Flexibility and to include in the calculation certain Act,758 that proposed rules 203(l)–1 and cost of enhanced regulatory compliance [resulting types of assets advisers previously were 203(m)–1 under the Advisers Act would from advisers registering or filing reports required 751 not, if adopted, have a significant of advisers relying on rule 203(m)–1] may, as a permitted to exclude. Most commercial matter, have to be borne solely by U.S. commenters addressed the components economic impact on a substantial investors, which would affect their net returns’’; the of the new method of calculation in number of small entities.759 As we commenter also stated that, alternatively, ‘‘many reference to the calculation of explained in the Proposing Release, non-U.S. advisers with less significant amounts of under Commission rules, for the U.S. assets invested in their funds may choose to ‘‘regulatory assets under management’’ restrict the participation by U.S. investors rather under Form ADV, or with respect to the purposes of the Advisers Act and the than attempt to comply with the Proposed Rules calculation of private fund assets for Regulatory Flexibility Act, an and, thereby, decrease the availability of potentially purposes of the private fund adviser investment adviser generally is a small attractive investment opportunities to U.S. 752 investors’’). We note, however, that the benefits and exemption. costs associated with the elimination of the private See ABA Letter. This result, argues the commenter, adviser exemption are attributable to the Dodd- 748 See Shearman Letter. will not be in the best interest of investors, who benefit from managers having ‘‘skin the game.’’ As Frank Act, including the costs of registration 749 See Reves v. Ernst & Young, 494 U.S. 56 discussed in Section II.B.2, if private fund investors incurred by advisers that previously relied on that (1990). See also supra note 458 and accompanying value their advisers’ co-investments as suggested by exemption but that will have to register because text. the commenter, we expect that the investors will they do not qualify for another exemption. In 750 See supra Section II.C.5. demand them and their advisers will structure their addition, the benefits and costs associated with the 751 See supra Section II.B.2.a. reporting requirements applicable to advisers businesses accordingly. 752 See Implementing Adopting Release, supra 753 relying on the private fund adviser exemption are See Proposing Release, supra note 26, at n.365 note 32, discussion at section II.A.3; supra Section associated with the separate rules that impose those and accompanying text. II.B.2.a. Among those commenters who addressed requirements. See Implementing Adopting Release, 754 See supra note 676 and accompanying text. the components specifically with respect to the supra note 32, at section II.B. 755 See supra text following note 676. foreign private adviser exemption, one noted that 744 756 See supra note 597 and accompanying text. because of the requirement to include proprietary See supra note 679. 745 See supra note 601 and accompanying text. assets in the calculation, ‘‘managers, in order to 757 See supra note 680. 746 See supra notes 602–603 and accompanying qualify for the [exemption], will have an incentive 758 5 U.S.C. 605(b). text. to reduce their personal commitments to the private 759 See Proposing Release, supra note 26, at 747 See supra Section V.A.2. funds, and manage their own assets individually.’’ section VI.

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entity if it: (i) Has assets under comments regarding this certification, this paragraph (a)(1) are the only management having a total value of less no commenters responded to this primary beneficiaries; than $25 million; (ii) did not have total request. (2)(i) A corporation, general assets of $5 million or more on the last partnership, limited partnership, VII. Statutory Authority day of its most recent fiscal year; and limited liability company, trust (other (iii) does not control, is not controlled The Commission is adopting rule than a trust referred to in paragraph by, and is not under common control 202(a)(30)–1 under the authority set (a)(1)(iv) of this section), or other legal with another investment adviser that forth in sections 403 and 406 of the organization (any of which are referred has assets under management of $25 Dodd-Frank Act, to be codified at to hereinafter as a ‘‘legal organization’’) million or more, or any person (other sections 203(b) and 211(a) of the to which you provide investment advice than a natural person) that had $5 Advisers Act, respectively (15 U.S.C. based on its investment objectives rather million or more on the last day of its 80b–3(b), 80b–11(a)). The Commission than the individual investment most recent fiscal year (‘‘small is adopting rule 203(l)–1 under the objectives of its shareholders, partners, adviser’’).760 authority set forth in sections 406 and limited partners, members, or Investment advisers solely to venture 407 of the Dodd-Frank Act, to be beneficiaries (any of which are referred capital funds and advisers solely to codified at sections 211(a) and 203(l) of to hereinafter as an ‘‘owner’’); and private funds in each case with assets the Advisers Act, respectively (15 U.S.C. (ii) Two or more legal organizations under management of less than $25 80b–11(a), 80b–3(l)). The Commission is referred to in paragraph (a)(2)(i) of this million would remain generally adopting rule 203(m)–1 under the section that have identical owners. ineligible for registration with the authority set forth in sections 406 and (b) Special rules regarding clients. For Commission under section 203A of the 408 of the Dodd-Frank Act, to be purposes of this section: Advisers Act.761 We expect that any codified at sections 211(a) and 203(m) of (1) You must count an owner as a small adviser solely to existing venture the Advisers Act, respectively (15 U.S.C. client if you provide investment capital funds that would not be 80b–11(a), 80b–3(m)). advisory services to the owner separate ineligible to register with the and apart from the investment advisory List of Subjects in 17 CFR Part 275 Commission would be able to avail itself services you provide to the legal of the exemption from registration Reporting and recordkeeping organization, provided, however, that under the grandfathering provision. If requirements; Securities. the determination that an owner is a client will not affect the applicability of an adviser solely to a new venture Text of Rules capital fund could not avail itself of the this section with regard to any other exemption because, for example, the For reasons set out in the preamble, owner; fund it advises did not meet the the Commission amends Title 17, (2) You are not required to count an definition of ‘‘venture capital fund,’’ we Chapter II of the Code of Federal owner as a client solely because you, on anticipate that the adviser could avail Regulations as follows: behalf of the legal organization, offer, itself of the exemption in section 203(m) promote, or sell interests in the legal of the Advisers Act as implemented by PART 275—RULES AND organization to the owner, or report rule 203(m)–1. Similarly, we expect that REGULATIONS, INVESTMENT periodically to the owners as a group any small adviser solely to private funds ADVISERS ACT OF 1940 solely with respect to the performance would be able to rely on the exemption of or plans for the legal organization’s ■ 1. The general authority citation for assets or similar matters; in section 203(m) of the Advisers Act as Part 275 is revised to read as follows: implemented by rule 203(m)–1. (3) A limited partnership or limited Thus, we believe that small advisers Authority: 15 U.S.C. 80b–2(a)(11)(G), 80b– liability company is a client of any solely to venture capital funds and 2(a)(11)(H), 80b–2(a)(17), 80b–3, 80b–4, 80b– general partner, managing member or small advisers to other private funds 4a, 80b–6(4), 80b–6(a), and 80b–11, unless other person acting as investment otherwise noted. will generally be ineligible to register adviser to the partnership or limited with the Commission. Those small * * * * * liability company; advisers that may not be ineligible to ■ 2. Section 275.202(a)(30)–1 is added (4) You are not required to count a register with the Commission, we to read as follows: private fund as a client if you count any believe, would be able to rely on the investor, as that term is defined in § 275.202(a)(30)–1 Foreign private paragraph (c)(2) of this section, in that venture capital fund adviser exemption advisers. under section 203(l) of the Advisers Act private fund as an investor in the United (a) Client. You may deem the or the private fund adviser exemption States in that private fund; and following to be a single client for (5) You are not required to count a under section 203(m) of that Act as purposes of section 202(a)(30) of the Act person as an investor, as that term is implemented by our rules. For these (15 U.S.C. 80b–2(a)(30)): defined in paragraph (c)(2) of this reasons, we certified in the Proposing (1) A natural person, and: section, in a private fund you advise if Release that rules 203(l)–1 and 203(m)– (i) Any minor child of the natural you count such person as a client in the 1 under the Advisers Act would not, if person; United States. adopted, have a significant economic (ii) Any relative, spouse, spousal impact on a substantial number of small Note to paragraphs (a) and (b): These equivalent, or relative of the spouse or entities. Although we requested written paragraphs are a safe harbor and are not of the spousal equivalent of the natural intended to specify the exclusive method for

760 person who has the same principal determining who may be deemed a single Rule 0–7(a) (17 CFR 275.0–7(a)). client for purposes of section 202(a)(30) of 761 residence; Section 203A of the Advisers Act (prohibiting the Act (15 U.S.C. 80b–2(a)(30)). an investment adviser that is regulated or required (iii) All accounts of which the natural to be regulated as an investment adviser in the State person and/or the persons referred to in (c) Definitions. For purposes of in which it maintains its principal office and place this paragraph (a)(1) are the only section 202(a)(30) of the Act (15 U.S.C. of business from registering with the Commission unless the adviser has $25 million or more in assets primary beneficiaries; and 80b–2(a)(30)): under management or is an adviser to a registered (iv) All trusts of which the natural (1) Assets under management means investment company). person and/or the persons referred to in the regulatory assets under management

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as determined under Item 5.F of Form a private fund under the Securities Act investment adviser of the private fund; ADV (§ 279.1 of this chapter). of 1933 (15 U.S.C. 77a). and (2) Investor means: ■ 3. Section 275.203(l)–1 is added to (3) Does not sell any securities to (i) Any person who would be read as follows: (including accepting any committed included in determining the number of capital from) any person after July 21, beneficial owners of the outstanding § 275.203(l)–1 Venture capital fund 2011. securities of a private fund under defined. (c) Definitions. For purposes of this section 3(c)(1) of the Investment (a) Venture capital fund defined. For section: Company Act of 1940 (15 U.S.C. 80a– purposes of section 203(l) of the Act (15 (1) Committed capital means any 3(c)(1)), or whether the outstanding U.S.C. 80b–3(l)), a venture capital fund commitment pursuant to which a securities of a private fund are owned is any private fund that: person is obligated to: exclusively by qualified purchasers (1) Represents to investors and (i) Acquire an interest in the private under section 3(c)(7) of that Act (15 potential investors that it pursues a fund; or U.S.C. 80a–3(c)(7)); and venture capital strategy; (ii) Make capital contributions to the (ii) Any beneficial owner of any (2) Immediately after the acquisition private fund. outstanding short-term paper, as defined of any asset, other than qualifying (2) Equity security has the same in section 2(a)(38) of the Investment investments or short-term holdings, meaning as in section 3(a)(11) of the Company Act of 1940 (15 U.S.C. 80a– holds no more than 20 percent of the Securities Exchange Act of 1934 (15 2(a)(38)), issued by the private fund. amount of the fund’s aggregate capital U.S.C. 78c(a)(11)) and § 240.3a11–1 of this chapter. Note to paragraph (c)(2): You may treat as contributions and uncalled committed capital in assets (other than short-term (3) Qualifying investment means: a single investor any person who is an (i) An equity security issued by a investor in two or more private funds you holdings) that are not qualifying qualifying portfolio company that has advise. investments, valued at cost or fair value, been acquired directly by the private consistently applied by the fund; (3) In the United States means with fund from the qualifying portfolio (3) Does not borrow, issue debt respect to: company; (i) Any client or investor, any person obligations, provide guarantees or (ii) Any equity security issued by a who is a U.S. person as defined in otherwise incur leverage, in excess of 15 qualifying portfolio company in § 230.902(k) of this chapter, except that percent of the private fund’s aggregate exchange for an equity security issued any discretionary account or similar capital contributions and uncalled by the qualifying portfolio company account that is held for the benefit of a committed capital, and any such described in paragraph (c)(3)(i) of this person in the United States by a dealer borrowing, indebtedness, guarantee or section; or or other professional fiduciary is in the leverage is for a non-renewable term of (iii) Any equity security issued by a United States if the dealer or no longer than 120 calendar days, company of which a qualifying portfolio professional fiduciary is a related except that any guarantee by the private company is a majority-owned person, as defined in § 275.206(4)– fund of a qualifying portfolio company’s subsidiary, as defined in section 2(a)(24) 2(d)(7), of the investment adviser obligations up to the amount of the of the Investment Company Act of 1940 relying on this section and is not value of the private fund’s investment in (15 U.S.C. 80a–2(a)(24)), or a organized, incorporated, or (if an the qualifying portfolio company is not predecessor, and is acquired by the individual) resident in the United subject to the 120 calendar day limit; private fund in exchange for an equity States. (4) Only issues securities the terms of security described in paragraph (c)(3)(i) which do not provide a holder with any Note to paragraph (c)(3)(i): A person who or (c)(3)(ii) of this section. is in the United States may be treated as not right, except in extraordinary (4) Qualifying portfolio company being in the United States if such person was circumstances, to withdraw, redeem or means any company that: not in the United States at the time of require the repurchase of such securities (i) At the time of any investment by becoming a client or, in the case of an but may entitle holders to receive the private fund, is not reporting or investor in a private fund, each time the distributions made to all holders pro foreign traded and does not control, is investor acquires securities issued by the rata; and not controlled by or under common fund. (5) Is not registered under section 8 of control with another company, directly (ii) Any place of business, in the the Investment Company Act of 1940 or indirectly, that is reporting or foreign United States, as that term is defined in (15 U.S.C. 80a–8), and has not elected traded; § 230.902(l) of this chapter; and to be treated as a business development (ii) Does not borrow or issue debt (iii) The public, in the United States, company pursuant to section 54 of that obligations in connection with the as that term is defined in § 230.902(l) of Act (15 U.S.C. 80a–53). private fund’s investment in such this chapter. (b) Certain pre-existing venture company and distribute to the private (4) Place of business has the same capital funds. For purposes of section fund the proceeds of such borrowing or meaning as in § 275.222–1(a). 203(l) of the Act (15 U.S.C. 80b–3(l)) issuance in exchange for the private (5) Spousal equivalent has the same and in addition to any venture capital fund’s investment; and meaning as in § 275.202(a)(11)(G)– fund as set forth in paragraph (a) of this (iii) Is not an investment company, a 1(d)(9). section, a venture capital fund also private fund, an issuer that would be an (d) Holding out. If you are relying on includes any private fund that: investment company but for the this section, you shall not be deemed to (1) Has represented to investors and exemption provided by § 270.3a–7 of be holding yourself out generally to the potential investors at the time of the this chapter, or a commodity pool. public in the United States as an offering of the private fund’s securities (5) Reporting or foreign traded means, investment adviser, within the meaning that it pursues a venture capital strategy; with respect to a company, being subject of section 202(a)(30) of the Act (15 (2) Prior to December 31, 2010, has to the reporting requirements under U.S.C. 80b–2(a)(30)), solely because you sold securities to one or more investors section 13 or 15(d) of the Securities participate in a non-public offering in that are not related persons, as defined Exchange Act of 1934 (15 U.S.C. 78m or the United States of securities issued by in § 275.206(4)–2(d)(7), of any 78o(d)), or having a security listed or

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traded on any exchange or organized office and place of business outside of 53). For purposes of this section, an market operating in a foreign the United States is exempt from the investment adviser may treat as a jurisdiction. requirement to register under section private fund an issuer that qualifies for (6) Short-term holdings means cash 203 of the Act if: an exclusion from the definition of an and cash equivalents, as defined in (1) The investment adviser has no ‘‘investment company,’’ as defined in § 270.2a51–1(b)(7)(i) of this chapter, client that is a United States person section 3 of the Investment Company U.S. Treasuries with a remaining except for one or more qualifying Act of 1940 (15 U.S.C. 80a–3), in maturity of 60 days or less, and shares private funds; and addition to those provided by section of an open-end management investment (2) All assets managed by the 3(c)(1) or 3(c)(7) of that Act (15 U.S.C. company registered under section 8 of investment adviser at a place of 80a–3(c)(1) or 15 U.S.C. 80a–3(c)(7)), the Investment Company Act of 1940 business in the United States are solely provided that the investment adviser (15 U.S.C. 80a–8) that is regulated as a attributable to private fund assets, the treats the issuer as a private fund under money market fund under § 270.2a–7 of total value of which is less than $150 the Act (15 U.S.C. 80b) and the rules this chapter. million. thereunder for all purposes. (c) Frequency of Calculations. For Note: For purposes of this section, an (6) Related person has the same investment adviser may treat as a private purposes of this section, calculate fund any issuer formed under the laws of a private fund assets annually, in meaning as in § 275.206(4)–2(d)(7). jurisdiction other than the United States that accordance with General Instruction 15 (7) United States has the same has not offered or sold its securities in the to Form ADV (§ 279.1 of this chapter). meaning as in § 230.902(l) of this United States or to U.S. persons in a manner (d) Definitions. For purposes of this chapter. inconsistent with being a private fund, section: provided that the adviser treats the issuer as (1) Assets under management means (8) United States person means any a private fund under the Act (15 U.S.C. 80b) the regulatory assets under management person that is a U.S. person as defined and the rules thereunder for all purposes. as determined under Item 5.F of Form in § 230.902(k) of this chapter, except that any discretionary account or similar ■ ADV (§ 279.1 of this chapter). 4. Section 275.203(m)–1 is added to (2) Place of business has the same account that is held for the benefit of a read as follows: meaning as in § 275.222–1(a). United States person by a dealer or § 275.203(m)–1 Private fund adviser (3) Principal office and place of other professional fiduciary is a United exemption. business of an investment adviser States person if the dealer or (a) United States investment advisers. means the executive office of the professional fiduciary is a related For purposes of section 203(m) of the investment adviser from which the person of the investment adviser relying Act (15 U.S.C. 80b–3(m)), an investment officers, partners, or managers of the on this section and is not organized, adviser with its principal office and investment adviser direct, control, and incorporated, or (if an individual) place of business in the United States is coordinate the activities of the resident in the United States. exempt from the requirement to register investment adviser. Note to paragraph (d)(8): A client will not under section 203 of the Act if the (4) Private fund assets means the be considered a United States person if the investment adviser: investment adviser’s assets under client was not a United States person at the (1) Acts solely as an investment management attributable to a qualifying time of becoming a client. adviser to one or more qualifying private fund. private funds; and (5) Qualifying private fund means any Dated: June 22, 2011. (2) Manages private fund assets of less private fund that is not registered under By the Commission. than $150 million. section 8 of the Investment Company Elizabeth M. Murphy, (b) Non-United States investment Act of 1940 (15 U.S.C. 80a–8) and has advisers. For purposes of section 203(m) not elected to be treated as a business Secretary. of the Act (15 U.S.C. 80b–3(m)), an development company pursuant to [FR Doc. 2011–16118 Filed 7–5–11; 8:45 am] investment adviser with its principal section 54 of that Act (15 U.S.C. 80a– BILLING CODE 8011–01–P

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