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Proposed Rule: Exemptions for Advisers to Venture Capital Funds

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Proposed Rule: Exemptions for Advisers to Venture Capital Funds SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 275 [Release No. IA-3111; File No. S7-37-10] RIN 3235-AK81 Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers AGENCY: Securities and Exchange Commission. ACTION: Proposed rule. SUMMARY: The Securities and Exchange Commission (the “Commission”) is proposing rules that would implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to certain privately offered investment funds that were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). As required by Title IV of the Dodd-Frank Act – the Private Fund Investment Advisers Registration Act of 2010, the new rules would define “venture capital fund” and provide for an exemption for advisers with less than $150 million in private fund assets under management in the United States. The new rules would also clarify the meaning of certain terms included in a new exemption for foreign private advisers. DATES: Comments should be received on or before [insert date 45 days after publication in Federal Register]. ADDRESSES: Comments may be submitted by any of the following methods: Electronic comments: • Use the Commission’s Internet comment form (http://www.sec.gov/rules/proposed.shtml); or • Send an e-mail to [email protected]. Please include File Number S7-37-10 on the - 2 - subject line; or • Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments. Paper comments: • Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. All submissions should refer to File Number S7-37-10. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet website (http://www.sec.gov/rules/proposed.shtml). Comments are also available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street, NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT: Tram N. Nguyen, Daniele Marchesani, or David A. Vaughan, at (202) 551-6787 or <[email protected]>, Division of Investment Management, U.S. Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-8549. SUPPLEMENTARY INFORMATION: The Commission is requesting public comment on proposed rules 203(l)-1, 203(m)-1 and 202(a)(30)-1 (17 CFR 275.203(l)-1, 275.203(m)-1 and 275.202(a)(30)-1) under the Investment Advisers Act of 1940 (15 U.S.C. 80b) (“Advisers - 3 - Act”).1 TABLE OF CONTENTS I. BACKGROUND ................................................................................................................ 3 II. DISCUSSION..................................................................................................................... 7 A. Definition of Venture Capital Fund .......................................................................10 1. Qualifying Portfolio Companies............................................................... 13 2. Management Involvement ........................................................................ 36 3. Limitation on Leverage............................................................................. 41 4. No Redemption Rights.............................................................................. 47 5. Represents Itself as a Venture Capital Fund............................................. 50 6. Is a Private Fund ....................................................................................... 51 7. Other Factors............................................................................................. 51 8. Application to Non-U.S. Advisers............................................................ 53 9. Grandfathering Provision.......................................................................... 55 B. Exemption for Investment Advisers Solely to Private Funds With Less Than $150 million in Assets Under Management...........................................................58 1. Advises Solely Private Funds ................................................................... 59 2. Private Fund Assets................................................................................... 60 3. Assets Managed in the United States........................................................ 64 4. United States Person ................................................................................. 69 5. Transition Rule.......................................................................................... 71 C. Foreign Private Advisers........................................................................................72 1. Clients ....................................................................................................... 73 2. Private Fund Investor................................................................................ 76 3. In the United States................................................................................... 81 4. Place of Business ...................................................................................... 84 5. Assets Under Management ....................................................................... 85 D. Subadvisory Relationships and Advisory Affiliates..............................................87 III. Request for Comment ....................................................................................................... 88 IV. Paperwork Reduction Act Analysis.................................................................................. 88 V. Cost-Benefit Analysis ....................................................................................................... 88 VI. Regulatory Flexibility Act Certification......................................................................... 124 VII. Statutory Authority ......................................................................................................... 126 TEXT OF PROPOSED RULES ................................................................................................. 127 I. BACKGROUND On July 21, 2010, President Obama signed into law the Dodd-Frank Act,2 which amends 1 Unless otherwise noted, all references to rules under the Advisers Act will be to Title 17, Part 275 of the Code of Federal Regulations (17 CFR 275). 2 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. - 4 - various provisions of the Advisers Act and requires or authorizes the Commission to adopt several new rules and revise existing rules.3 Unless otherwise provided for in the Dodd-Frank Act, the amendments become effective on July 21, 2011.4 The amendments include the repeal of section 203(b)(3) of the Advisers Act, which exempts any investment adviser from registration if the investment adviser (i) has had fewer than 15 clients in the preceding 12 months, (ii) does not hold itself out to the public as an investment adviser and (iii) does not act as an investment adviser to a registered investment company or a company that has elected to be a business development company (the “private adviser exemption”).5 Advisers specifically exempt under section 203(b) are not subject to reporting or recordkeeping provisions under the Advisers Act, and are not subject to examination by our staff.6 The primary purpose of Congress in repealing section 203(b)(3) was to require advisers to “private funds” to register under the Advisers Act.7 Private funds include hedge funds, private equity funds and other types of pooled investment vehicles that are excluded from the definition of “investment company” under the Investment Company Act of 19408 (“Investment Company 1376 (2010). 3 In this Release, when we refer to the “Advisers Act,” we refer to the Advisers Act as in effect on July 21, 2011. 4 Section 419 of the Dodd-Frank Act. 5 15 U.S.C. 80b-3(b)(3) as in effect before July 21, 2011. 6 See section 204(a) of the Advisers Act. See also infra note 30. 7 See S. REP. NO. 111-176, at 71-3 (2010) (“S. REP. NO. 111-176”); H. REP. NO. 111-517, at 866 (2010) (“H. REP. NO. 111-517”). H. REP. NO. 111-517 contains the conference report accompanying the version of H.R. 4173 that was debated in conference, infra note 39. 8 15 U.S.C. 80a. - 5 - Act”) by reason of sections 3(c)(1) or 3(c)(7) of such Act.9 Section 3(c)(1) is available to a fund that does not publicly offer the securities it issues10 and has 100 or fewer beneficial owners of its outstanding securities.11 A fund relying on section 3(c)(7) cannot publicly offer the securities it issues12 and generally must limit the owners of its outstanding securities to “qualified purchasers.”13 Each of these types of private funds advised by an adviser typically qualifies as a single client for purposes of the private adviser exemption.14 As a result, investment advisers could form up to 14 private funds, regardless of the total number of investors investing in the funds, 9 Section 202(a)(29) of the Advisers Act defines the term “private fund” as “an issuer
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