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[FR Doc. 2010–29956 Filed 12–9–10; 8:45 am] Securities and Exchange Commission, 1. Advises Solely Private Funds BILLING CODE C 100 F Street, NE., Washington, DC 2. Private Fund Assets 20549–1090. 3. Assets Managed in the United States 4. United States Person All submissions should refer to File 5. Transition Rule SECURITIES AND EXCHANGE Number S7–37–10. This file number COMMISSION C. Foreign Private Advisers should be included on the subject line 1. Clients 17 CFR Part 275 if e-mail is used. To help us process and 2. Private Fund Investor review your comments more efficiently, 3. In the United States [Release No. IA–3111; File No. S7–37–10] please use only one method. The 4. Place of Business 5. Assets Under Management RIN 3235–AK81 Commission will post all comments on the Commission’s Internet Web site D. Subadvisory Relationships and Advisory Affiliates Exemptions for Advisers to Venture (http://www.sec.gov/rules/ III. Request for Comment Capital Funds, Private Fund Advisers proposed.shtml). Comments are also IV. Paperwork Reduction Act Analysis With Less Than $150 Million in Assets available for Web site viewing and V. Cost-Benefit Analysis Under Management, and Foreign printing in the Commission’s Public VI. Regulatory Flexibility Act Certification Private Advisers Reference Room, 100 F Street, NE., VII. Statutory Authority Washington, DC 20549, on official Text of Proposed Rules AGENCY: Securities and Exchange business days between the hours of 10 I. Background Commission. a.m. and 3 p.m. All comments received ACTION: Proposed rule. will be posted without change; we do On July 21, 2010, President Obama signed into law the Dodd-Frank Act,2 SUMMARY: The Securities and Exchange not edit personal identifying which amends various provisions of the Commission (the ‘‘Commission’’) is information from submissions. You Advisers Act and requires or authorizes proposing rules that would implement should submit only information that the Commission to adopt several new new exemptions from the registration you wish to make available publicly. rules and revise existing rules.3 Unless requirements of the Investment Advisers FOR FURTHER INFORMATION CONTACT: otherwise provided for in the Dodd- Act of 1940 for advisers to certain Tram N. Nguyen, Daniele Marchesani, Frank Act, the amendments become privately offered investment funds that or David A. Vaughan, at (202) 551–6787 effective on July 21, 2011.4 were enacted as part of the Dodd-Frank or ([email protected]), Division of The amendments include the repeal Wall Street Reform and Consumer Investment Management, U.S. Securities of section 203(b)(3) of the Advisers Act, Protection Act (the ‘‘Dodd-Frank Act’’). and Exchange Commission, 100 F As required by Title IV of the Dodd- Street, NE., Washington, DC 20549– which exempts any investment adviser Frank Act—the Private Fund Investment 8549. from registration if the investment adviser (i) Has had fewer than 15 clients Advisers Registration Act of 2010, the SUPPLEMENTARY INFORMATION: The new rules would define ‘‘venture capital in the preceding 12 months, (ii) does not Commission is requesting public hold itself out to the public as an fund’’ and provide for an exemption for comment on proposed rules 203(l)–1, advisers with less than $150 million in investment adviser and (iii) does not act 203(m)–1 and 202(a)(30)–1 (17 CFR as an investment adviser to a registered private fund assets under management 275.203(l)–1, 275.203(m)–1 and in the United States. The new rules investment company or a company that 275.202(a)(30)–1) under the Investment has elected to be a business would also clarify the meaning of Advisers Act of 1940 (15 U.S.C. 80b) certain terms included in a new development company (the ‘‘private (‘‘Advisers Act’’).1 5 exemption for foreign private advisers. adviser exemption’’). Advisers specifically exempt under section 203(b) DATES: Comments should be received on Table of Contents are not subject to reporting or or before January 24, 2011. I. Background recordkeeping provisions under the ADDRESSES: Comments may be II. Discussion Advisers Act, and are not subject to submitted by any of the following A. Definition of Venture Capital Fund examination by our staff.6 methods: 1. Qualifying Portfolio Companies The primary purpose of Congress in Electronic Comments 2. Management Involvement repealing section 203(b)(3) was to 3. Limitation on Leverage • Use the Commission’s Internet require advisers to ‘‘private funds’’ to 4. No Redemption Rights 7 comment form (http://www.sec.gov/ 5. Represents Itself as a Venture Capital register under the Advisers Act. Private rules/proposed.shtml); or Fund 2 • Send an e-mail to rule- 6. Is a Private Fund Dodd-Frank Wall Street Reform and Consumer 7. Other Factors Protection Act, Public Law 111–203, 124 Stat. 1376 [email protected]. Please include File (2010). 8. Application to Non-U.S. Advisers Number S7–37–10 on the subject line; 3 In this Release, when we refer to the ‘‘Advisers or 9. Grandfathering Provision Act,’’ we refer to the Advisers Act as in effect on • Use the Federal eRulemaking Portal B. Exemption for Investment Advisers July 21, 2011. Solely to Private Funds With Less Than 4 (http://www.regulations.gov). Follow the Section 419 of the Dodd-Frank Act. $150 million in Assets Under 5 15 U.S.C. 80b-3(b)(3) as in effect before July 21, instructions for submitting comments. Management 2011. Paper Comments 6 See section 204(a) of the Advisers Act. See also 1 • Unless otherwise noted, all references to rules infra note 30. Send paper comments in triplicate under the Advisers Act will be to title 17, part 275 7 See S. Rep. No. 111–176, at 71–3 (2010) (‘‘S. to Elizabeth M. Murphy, Secretary, of the Code of Federal Regulations (17 CFR 275). Rep. No. 111–176’’); H. Rep. No. 111–517, at 866

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funds include hedge funds, private number of investors investing in the private funds advised; 22 and (iii) non- equity funds and other types of pooled funds, without the need to register with U.S. advisers with less than $25 million investment vehicles that are excluded us.15 This has permitted the growth of in aggregate assets under management from the definition of ‘‘investment unregistered investment advisers with from U.S. clients and private fund company’’ under the Investment large amounts of assets under investors and fewer than 15 such clients Company Act of 1940 8 (‘‘Investment management and significant numbers of and investors.23 Company Act’’) by reason of sections investors but without the Commission 3(c)(1) or 3(c)(7) of such Act.9 Section oversight that registration under the II. Discussion 3(c)(1) is available to a fund that does Advisers Act provides.16 Concern about Today we are proposing three rules not publicly offer the securities it this lack of Commission oversight led us that would implement these issues 10 and has 100 or fewer beneficial to adopt a rule in 2004 extending exemptions.24 In a separate companion owners of its outstanding securities.11 A registration to hedge fund advisers,17 release (the ‘‘Implementing Release’’),25 fund relying on section 3(c)(7) cannot which was vacated by a federal court in we are proposing rules to implement publicly offer the securities it issues 12 2006.18 In Title IV of the Dodd-Frank other amendments made to the Advisers and generally must limit the owners of Act (‘‘Title IV’’), Congress has now Act by the Dodd-Frank Act, some of its outstanding securities to ‘‘qualified generally extended Advisers Act which also concern certain advisers that purchasers.’’ 13 registration to advisers to hedge funds qualify for the exemptions discussed in Each of these types of private funds and many other private funds by this Release.26 advised by an adviser typically qualifies eliminating the current private adviser New section 203(l) of the Advisers as a single client for purposes of the exemption.19 Act provides that an investment adviser private adviser exemption.14 As a result, In addition to removing the broad that solely advises venture capital funds investment advisers could form up to 14 exemption provided by section is exempt from registration under the private funds, regardless of the total 203(b)(3), Congress created three Advisers Act and directs the exemptions from registration under the Commission to define ‘‘venture capital (2010) (‘‘H. Rep. No. 111–517’’). H. Rep. No. 111– Advisers Act.20 These new exemptions fund’’ within one year of enactment.27 517 contains the conference report accompanying apply to: (i) Advisers solely to venture We are proposing new rule 203(l)-1 to the version of H.R. 4173 that was debated in conference, infra note 39. capital funds, without regard to the provide such a definition, which we 8 15 U.S.C. 80a. number of such funds advised by the discuss below in Section II.A of this 21 9 Section 202(a)(29) of the Advisers Act defines adviser or the size of such funds; (ii) Release. the term ‘‘private fund’’ as ‘‘an issuer that would be advisers solely to private funds with New section 203(m) of the Advisers an investment company, as defined in section 3 of less than $150 million in assets under Act directs the Commission to provide the Investment Company Act of 1940 (15 U.S.C. 80a-3), but for section 3(c)(1) or 3(c)(7) of that Act.’’ management in the United States, an exemption from registration to any 10 Interests in a private fund may be offered without regard to the number or type of investment adviser that solely advises pursuant to an exemption from registration under private funds if the adviser has assets the Securities Act of 1933 (15 U.S.C. 77a) 15 See Staff Report to the united states securities (‘‘Securities Act’’). Notwithstanding these and exchange Commission, Implications of the 22 See section 408 of the Dodd-Frank Act exemptions, the persons who market interests in a Growth of Hedge Funds, at 21 (2003), http:// (directing the Commission to exempt private fund private fund may be subject to the registration www.sec.gov/news/studies/hedgefunds0903.pdf advisers with less than $150 million in aggregate requirements of section 15(a) under the Securities (discussing section 203(b)(3) of the Advisers Act as assets under management in the United States). Exchange Act of 1934 (‘‘Exchange Act’’) (15 U.S.C. in effect before July 21, 2011). 23 78o(a)). The Exchange Act generally defines a 16 See generally id. (noting that the private See section 402 of the Dodd-Frank Act ‘‘ ’’ ‘‘ ‘‘broker’’ as any person engaged in the business of adviser exemption contributed to growth in the (defining foreign private adviser as any effecting transactions in securities for the account number and size of, and investor participation in, investment adviser who—(A) Has no place of of others. Section 3(a)(4)(A) of the Exchange Act (15 hedge funds). business in the United States; (B) has, in total, fewer than 15 clients and investors in the United States U.S.C. 78c(a)(4)(A)). See also Definition of Terms in 17 See Registration Under the Advisers Act of and Specific Exemptions for Banks, Savings Certain Hedge Fund Advisers, Investment Advisers in private funds advised by the investment adviser; Associations, and Savings Banks Under Sections Act Release No. 2333 (Dec. 2, 2004) [69 FR 72054 (C) has aggregate assets under management 3(a)(4) and 3(a)(5) of the Securities Exchange Act (Dec. 10, 2004)] (‘‘Hedge Fund Adviser Registration attributable to clients in the United States and of 1934, Exchange Act Release No. 44291 (May 11, Release’’). investors in the United States in private funds advised by the investment adviser of less than 2001) [66 FR 27759 (May 18, 2001)], at n.124 18 Goldstein v. Securities and Exchange $25,000,000, or such higher amount as the (‘‘Solicitation is one of the most relevant factors in Commission, 451 F.3d 873 (D.C. Cir. 2006) determining whether a person is effecting (‘‘Goldstein’’). Commission may, by rule, deem appropriate in transactions.’’); Political Contributions by Certain accordance with the purposes of this title; and (D) 19 Section 403 of the Dodd-Frank Act amends Investment Advisers, Investment Advisers Act neither—(i) Holds itself out generally to the public existing section 203(b)(3) of the Advisers Act by Release No. 3043 (July 1, 2010) [75 FR 41018 (July in the United States as an investment adviser; nor repealing the current private adviser exemption and 14, 2010)], n.326 (‘‘Pay to Play Release’’). (ii) acts as—(I) an investment adviser to any inserting the foreign private adviser exemption. See 11 investment company registered under the See section 3(c)(1) of the Investment Company infra Section II.C. Unlike our 2004 rule, which Investment Company Act of 1940 [15 U.S.C. 80a]; Act (providing an exclusion from the definition of sought to apply only to advisers of ‘‘hedge funds,’’ or a company that has elected to be a business ‘‘investment company’’ for any ‘‘issuer whose the Dodd-Frank Act requires that, unless another development company pursuant to section 54 of the outstanding securities (other than short-term paper) exemption applies, all advisers previously eligible Investment Company Act of 1940 (15 U.S.C. 80a- are beneficially owned by not more than one for the private adviser exemption register with us 53), and has not withdrawn its election.’’). hundred persons and which is not making and does regardless of the type of private funds or other 24 not presently propose to make a public offering of clients the adviser has. The Commission provided the public with an ’’ its securities. ). 20 Title IV also created exemptions and exclusions opportunity to present its views on various 12 See supra note 10. in addition to the three discussed at length in this rulemaking and other initiatives that the Dodd- 13 See section 3(c)(7) of the Investment Company Release. See, e.g., sections 403 and 409 of the Dodd- Frank Act required the Commission to undertake. Act (providing an exclusion from the definition of Frank Act (exempting advisers to licensed small Public views relating to our rulemaking in ‘‘investment company’’ for any ‘‘issuer, the business investment companies from registration connection with the exemptions for certain advisers outstanding securities of which are owned under the Advisers Act and excluding family offices addressed in this Release are available at http:// exclusively by persons who, at the time of from the definition of ‘‘investment adviser’’ under www.sec.gov/comments/df-title-iv/exemptions/ acquisition of such securities, are qualified the Advisers Act). We proposed a rule defining exemptions.shtml. purchasers, and which is not making and does not ‘‘family office’’ in a prior release (Family Offices, 25 Rules Implementing Amendments to the at that time propose to make a public offering of Investment Advisers Act Release No. 3098 (Oct. 12, Investment Advisers Act of 1940, Investment such securities.’’). The term ‘‘qualified purchaser’’ is 2010) [75 FR 63753 (Oct. 18, 2010)]). Advisers Act Release No. 3110 (Nov. 19, 2010). defined in section 2(a)(51) of the Investment 21 See section 407 of the Dodd-Frank Act 26 See infra note 30 and accompanying and Company Act. (exempting advisers solely to ‘‘venture capital following text. 14 See rule 203(b)(3)-1(a)(2). funds,’’ as defined by the Commission). 27 See supra note 21.

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under management in the United States and investors.33 As discussed in Section would define the term venture capital of less than $150 million.28 We are II.C of this Release, in order to clarify fund consistently with what we believe proposing such an exemption in a new the application of this new exemption, Congress understood venture capital rule 203(m)–1, which we discuss below we are proposing a new rule 202(a)(30)- funds to be, and in light of other in Section II.B of this Release. Proposed 1, which would define a number of provisions of the federal securities laws rule 203(m)–1 includes provisions for terms included in the statutory that seek to achieve similar objectives.38 determining the amount of an adviser’s definition of foreign private adviser.34 We understand that Congress sought private fund assets for purposes of the These exemptions are not mandatory. to distinguish advisers to ‘‘venture exemption and when those assets are Thus, an adviser that qualifies for any capital funds’’ from the larger category deemed managed in the United States. of the exemptions could choose to of advisers to ‘‘private equity funds’’ for The new exemptions under sections register (or remain registered) with the which Congress considered, but Commission, subject to section 203A of ultimately did not provide, an 203(l) and 203(m) provide that the 39 Commission shall require advisers the Advisers Act, which generally exemption. As a general matter, relying on them to provide the prohibits from registering with the venture capital funds are long-term Commission most advisers that do not investors in early-stage or small Commission with reports and keep have at least $100 million in assets companies that are privately held, as records as the Commission determines under management.35 An adviser distinguished from other types of necessary or appropriate in the public choosing to avail itself of the private equity funds, which may invest interest or for the protection of exemptions under sections 203(l), in businesses at various stages of investors.29 These new exemptions do 203(m) or 203(b)(3), however, may be development including mature, publicly not limit our statutory authority to subject to registration by one or more held companies.40 Testimony received examine the books and records of state securities authorities.36 by Congress characterized venture advisers relying upon these capital funds as typically contributing exemptions.30 For purposes of this A. Definition of Venture Capital Fund substantial capital to early-stage Release we will refer to these advisers We are proposing a definition of companies 41 and generally not as ‘‘exempt reporting advisers.’’ In the ‘‘venture capital fund’’ for purposes of Implementing Release, we are proposing the new exemption for investment 38 See infra notes 94, 123, 125 (discussing the reporting requirements for exempt advisers that advise solely venture history of and regulatory framework applicable to reporting advisers.31 capital funds.37 Proposed rule 203(l)-1 business development companies under federal securities laws). The third exemption, set forth in 39 While the Senate voted to exempt private 33 amended section 203(b)(3) of the The exemption is not available to an adviser equity fund advisers in addition to venture capital Advisers Act, provides an exemption that ‘‘acts as (I) an investment adviser to any fund advisers, the final Dodd-Frank Act only from registration for certain foreign investment company registered under the exempts venture capital fund advisers. Compare [Investment Company Act]; or (II) a company that Restoring American Financial Stability Act of 2010, private advisers. New section 202(a)(30) has elected to be a business development company S. 3217, 111th Cong. § 408 (2010) (as passed by the of the Advisers Act defines ‘‘foreign pursuant to section 54 of [that Act] and has not Senate) with Dodd-Frank Wall Street Reform and private adviser’’ as an investment withdrawn its election.’’ Section 202(a)(30)(D)(ii). Consumer Protection Act of 2009, H.R. 4173, 111th We interpret subparagraph (II) to prevent an adviser adviser that has no place of business in Cong. (2009) (as passed by the House) (‘‘H.R. 4173’’) that advises a business development company from and Dodd-Frank Act. relying on the exemption. the United States, has fewer than 15 40 See Testimony of Trevor Loy, Flywheel 34 clients in the United States and Proposed rule 202(a)(30)-1 would define the Ventures, before the Senate Banking Subcommittee investors in the United States in private following terms: (i) ‘‘client;’’ (ii) ‘‘investor;’’ (iii) ‘‘in on Securities, Insurance and Investment Hearing, the United States;’’ (iv) ‘‘place of business;’’ and (v) funds advised by the adviser,32 and less July 15, 2009 (‘‘Loy Testimony’’), at 3; Testimony of ‘‘assets under management.’’ See discussion infra in James Chanos, Chairman, Coalition of Private than $25 million in aggregate assets section II.C of this Release. We are proposing rule Investment Companies, July 15, 2009, at 4 (‘‘Chanos under management from such clients 202(a)(30)-1 pursuant to section 211(a) of the Testimony’’) (‘‘Private investment companies play Advisers Act, which Congress amended to significant, diverse roles in the financial markets explicitly provide us with the authority to define and in the economy as a whole. For example, 28 See supra note 22. technical, trade, and other terms used in the venture capital funds are an important source of 29 See supra notes 21 and 22. Advisers Act. See section 406 of the Dodd-Frank funding for start-up companies or turnaround 30 Under section 204(a) of the Advisers Act, the Act. ventures. Other private equity funds provide growth Commission has the authority to require an 35 Section 203A(a)(1) of the Advisers Act capital to established small-sized companies, while investment adviser to maintain records and provide generally prohibits an investment adviser regulated still others pursue ‘buyout’ strategies by investing reports, as well as the authority to examine such by the state in which it maintains its principal in underperforming companies and providing them adviser’s records, unless the adviser is ‘‘specifically office and place of business from registering with with capital and/or expertise to improve results.’’); exempted’’ from the requirement to register the Commission unless it has at least $25 million Testimony of Mark Tresnowksi, General Counsel, pursuant to section 203(b) of the Advisers Act. of assets under management, and preempts certain Madison Dearborn Partners, LLC, on behalf of the Investment advisers that are exempt from state laws regulating advisers that are registered Private Equity Council, before the Senate Banking registration in reliance on section 203(l) or 203(m) with the Commission. Section 410 of the Dodd- Subcommittee on Securities, Insurance and of the Advisers Act are not ‘‘specifically exempted’’ Frank Act amended section 203A(a) to also prohibit Investment, July 15, 2009, at 2 (‘‘Tresnowski from the requirement to register pursuant to section generally from registering with the Commission an Testimony’’) (stating that private equity firms invest 203(b), and thus the Commission has authority investment adviser that has assets under in broad categories of companies, including under section 204(a) of the Advisers Act to require management between $25 million and $100 million ‘‘struggling and underperforming businesses’’ and ’’ those advisers to maintain records and provide if the adviser is required to be registered with, and promising or strong companies’’). See also Preqin, reports and has authority to examine such advisers’ if registered, would be subject to examination by, Private Equity and Alternative Asset Glossary, records. the state security authority where it maintains its http://www.preqin.com/ 31 See Implementing Release, supra note 25, at principal office and place of business. See section itemGlossary.aspx?pnl=UtoZ (defining venture section II.B. 203A(a)(2) of the Advisers Act. In each of capital as ‘‘a type of private equity investment that 32 Subparagraph (B) of section 202(a)(30) refers to subparagraphs (1) and (2) of section 203A(a), provides capital to new or growing businesses. number of ‘‘clients and investors in the United additional conditions also may apply. See Venture funds invest in start-up firms and small States in private funds,’’ while subparagraph (C) Implementing Release, supra note 25, at section businesses with perceived, long-term growth refers to the assets of ‘‘clients in the United States II.A. potential.’’). and investors in the United States in private funds’’ 36 See section 203A(b)(1) of the Advisers Act 41 Loy Testimony, supra note 40, at 3; Testimony (emphasis added). We interpret these provisions (exempting from state regulatory requirements only of Terry McGuire, General Partner, Polaris Venture consistently so that only clients in the United States advisers registered with the Commission). See also Partners, and Chairman, National Venture Capital and investors in the United States should be infra note 265 (discussing the application of section Association, before the U.S. House of included for purposes of determining eligibility for 222 of the Advisers Act). Representatives Committee on Financial Services, the exemption under subparagraph (B). 37 See proposed rule 203(l)–1. October 6, 2009, at 3 (‘‘McGuire Testimony’’) (‘‘Our

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leveraged,42 and thus not contributing to constituted a venture capital or small addition to equity securities, the venture systemic risk, a factor that appears business company,46 but acknowledged capital fund may also hold cash (and significant to Congress’ determination to that the purpose of the BDC provisions cash equivalents) and U.S. Treasuries exempt these advisers.43 In drafting the was to support ‘‘venture capital’’ activity with a remaining maturity of 60 days or proposed rule, we have sought to in capital formation for small less.51 We understand each of the incorporate this Congressional businesses.47 The BDC provisions and criteria to be characteristic of issuers of understanding of the nature of venture capital exemption reflect many portfolio securities held by venture investments of a venture capital fund, similar policy considerations, and thus capital funds.52 Moreover, collectively, and these principles guided our in drafting the definition of ‘‘venture these criteria would operate to exclude consideration of the proposed venture capital fund,’’ we have looked, in part, most other private equity funds and capital fund definition. to language Congress previously used to hedge funds from the definition. We This is not the first time that Congress describe these types of funds. describe each element of a qualifying has included special provisions to the As described in more detail below, we portfolio company below. federal securities laws for these types of propose to define a venture capital fund a. Private Companies private funds and the advisers that as a private fund that: (i) Invests in advise them. In 1980, in an effort to equity securities of private companies in We propose to define a venture promote capital raising by small order to provide operating and business capital fund as a fund that invests in businesses,44 Congress provided expansion capital (i.e., ‘‘qualifying equity securities of qualifying portfolio exemptions from various requirements portfolio companies,’’ which are companies and cash and cash in the Investment Company Act and discussed below) and at least 80 percent equivalents and U.S. Treasuries with a Advisers Act for ‘‘business development of each company’s securities owned by remaining maturity of 60 days or less.53 companies’’ (or ‘‘BDCs’’).45 Congress the fund were acquired directly from the At the time of each investment by the adopted the term BDC to avoid qualifying portfolio company; (ii) venture capital fund, the portfolio ‘‘semantical disagreements’’ over what directly, or through its investment company could not be publicly traded advisers, offers or provides significant nor could it control, be controlled by, or job is to find the most promising, innovative ideas, managerial assistance to, or controls, the be under common control with, a entrepreneurs, and companies that have the qualifying portfolio company; (iii) does publicly traded company.54 Under the potential to grow exponentially with the proposed definition, a venture capital application of our expertise and venture capital not borrow or otherwise incur leverage investment. Often these companies are formed from (other than limited short-term fund could continue to hold securities ideas and entrepreneurs that come out of university borrowing); (iv) does not offer its of a portfolio company that and government laboratories—or even someone’s investors redemption or other similar subsequently becomes public. garage.’’). See also National Venture Capital Venture capital funds provide Association Yearbook 2010, at 7–8 (noting that liquidity rights except in extraordinary venture capital is a ‘‘long-term investment’’ and the circumstances; (v) represents itself as a operating capital to companies in the ‘‘payoff [to the venture capital firm] comes after the venture capital fund to investors; and early stages of their development with company is acquired or goes public’’) (‘‘NVCA (vi) is not registered under the the goal of eventually either selling the Yearbook 2010’’); Private Equity Growth Capital company or taking it public.55 Unlike Council, Private Equity: Frequently Asked Investment Company Act and has not Questions, http://www.privateequitycouncil.org/ elected to be treated as a BDC.48 We also 51 just-the-facts/private-equity-frequently-asked- propose to grandfather an existing fund Proposed rule 203(l)–1(a)(2). questions/ (noting that venture capital funds focus 52 See infra sections II.A.1.a–II.A.1.e of this on ‘‘start-up and young companies with little or no as a venture capital fund if it satisfies Release. track record,’’ whereas buyout and growth funds certain criteria under the grandfathering 53 Proposed rule 203(l)–1(a)(2). focus on more mature businesses). provision.49 An adviser would be 54 Proposed rule 203(l)–1(c)(4)(i); proposed rule 42 Loy Testimony, supra note 40, at 3. See also eligible to rely on the exemption under 203(l)–1(c)(3) (defining a ‘‘publicly traded’’ McGuire Testimony, supra note 41, at 3–4 (‘‘most section 203(l) of the Advisers Act (the company as one that is subject to the reporting limited partnership agreements [of venture capital requirements under section 13 or 15(d) of the funds] * * * prohibit [the venture capital fund] ‘‘venture capital exemption’’) only if it Exchange Act, or has a security listed or traded on from any type of long term borrowing. * * * solely advised venture capital funds that any exchange or organized market operating in a Leverage is not part of the equation because start- met all of the elements of the proposed foreign jurisdiction). This definition is similar to ups do not typically have the ability to sustain debt definition or if it were grandfathered. rule 2a51–1 under the Investment Company Act interest payments and often do not have collateral (defining ‘‘public company,’’ for purposes of the that lenders desire. In fact most of our companies 1. Qualifying Portfolio Companies qualified purchaser standard, as ‘‘a company that are not profitable and require our equity to fund files reports pursuant to section 13 or 15(d) of the their losses through their initial growth period.’’). We propose to define a venture Securities Exchange Act of 1934’’) and rule 12g3– 43 See S. Rep. No. 111–176, supra note 7, at 74– capital fund for the purposes of the 2 under the Exchange Act (conditioning a foreign 5 (noting that venture capital funds ‘‘do not present exemption as a fund that invests in private issuer’s exemption from registering the same risks as the large private funds whose securities under section 12(g) of the Exchange Act advisers are required to register with the SEC under equity securities issued by ‘‘qualifying if, among other conditions, the ‘‘issuer is not this title [IV]. Their activities are not interconnected portfolio companies,’’ which we define required to file or furnish reports’’ pursuant to with the global financial system, and they generally generally as any company that: (i) Is not section 13(a) or section 15(d) of the Exchange Act). rely on equity funding, so that losses that may occur publicly traded; (ii) does not incur Under the proposed rule, securities of a publicly do not ripple throughout world markets but are traded company, as defined, would include borne by fund investors alone. Terry McGuire, leverage in connection with the securities of non-U.S. companies that are listed on Chairman of the National Venture Capital investment by the private fund; (iii) uses a non-U.S. market or non-U.S. exchange. Some Association, wrote in congressional testimony that the capital provided by the fund for securities that are ‘‘pink sheets’’ (i.e., generally over- ‘venture capital did not contribute to the implosion operating or business expansion the-counter securities that are quoted on an that occurred in the financial system in the last electronic quotation system operated by Pink OTC year, nor does it pose a future systemic risk to our purposes rather than to buy out other Markets) are not subject to the reporting world financial markets or retail investors.’’’). See investors; and (iv) is not itself a fund requirements under sections 13 and 15(d) of the also Loy Testimony, supra note 40, at 7 (noting the (i.e., is an operating company).50 In Exchange Act and would not be publicly traded for factors by which the venture capital industry is purposes of the proposed rule. exposed to ‘‘entrepreneurial and technological risk 55 See Chanos Testimony, supra note 40, at 4 46 See 1980 House Report, supra note 44, at 22. not systemic financial risk’’). (‘‘[V]enture capital funds are an important source of 47 44 See H. Rep. No. 96–1341, at 21–22 (1980) See id., at 21. funding for start-up companies or turnaround (‘‘1980 House Report’’). 48 Proposed rule 203(l)–1(a). ventures.’’); NVCA Yearbook 2010, supra note 41, at 45 See infra note 123 for a discussion of these 49 Proposed rule 203(l)–1(b). 7–8 (noting that venture capital is a ‘‘long-term definitions. 50 Proposed rule 203(l)–1(c)(4). Continued

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other types of private funds, venture key consideration by Congress that led For example, solely relying on the age capital funds do not trade in the public to the enactment of the venture capital of the company (e.g., first year since markets, but may sell portfolio company exemption.61 incorporation) fails to recognize that securities into the public markets once We request comment on our proposed many companies may be incorporated the portfolio company has matured.56 approach. We considered more narrow for some period of time prior to As of year-end 2009, U.S. venture definitions, such as defining a initiating business operations or remain capital funds managed approximately qualifying portfolio company as a ‘‘start- unincorporated for significant periods of $179.4 billion in assets.57 In up company’’ or ‘‘small company.’’ 62 time.66 Likewise, payment of comparison, as of year-end 2009, the There appears to be little consensus, employment taxes assumes the hiring of U.S. publicly traded equity market had however, as to what a start-up company employees, despite the fact that many a market value of approximately $13.7 is. A company may be considered a new business ventures are sole trillion,58 whereas global hedge funds ‘‘start-up’’ business depending on when proprietorships without employees.67 had approximately $1.4 trillion in assets it was formed as a legal entity,63 Such a test could also have the under management.59 As a whether it employs workers or paid unintended effect of discouraging consequence, the aggregate amount employment taxes,64 or whether it has hiring. Similarly, a bright-line revenue invested in venture capital funds is generated revenues.65 Defining a test set too low could exclude young or considerably smaller, and Congressional portfolio company based on any one of new businesses that generate significant testimony asserted that these funds may these factors may inadvertently exclude revenues more quickly than other be less connected with the public too many start-up portfolio companies. companies.68 This could have the markets and may involve less potential unintended consequence of venture for systemic risk.60 This appears to be a financial markets.’’). See also Group of Thirty, capital funds that seek to fall within the Financial Reform: A Framework for Financial Stability, January 15, 2009, at 9 (discussing the need definition investing in less promising, investment’’ and the ‘‘payoff [to the venture capital for registration of managers of ‘‘private pools of non-revenue generating, young firm] comes after the company is acquired or goes capital that employ substantial borrowed funds’’ yet companies. public.’’); George W. Fenn, Nellie Liang and recognizing the need to exempt venture capital from We also considered defining a Stephen Prowse, The Economics of the Private registration). Equity Market, December 1995, 22, n.61 and 61 See supra note 43. qualifying portfolio company as a small ‘‘ ’’ ‘‘ ’’ accompanying text ( Fenn et al. ) ( Private sales 62 See S. Rep. No. 111–176, supra note 7, at 74 company. As in the case of defining are not normally the most important type of exit (describing venture capital funds as a subset of ‘‘start-up,’’ there is no single definition strategy as compared to IPOs, yet of the 635 private investment companies, specializing in long- successful portfolio company exits by venture for what constitutes a ‘‘small term equity investments in ‘‘small or start-up ’’ 69 capitalists between 1991–1993 ‘‘merger and businesses’’). company. We are concerned that acquisition transactions accounted for 191 deals 63 There is no generally accepted definition of a and IPOs for 444 deals.’’ Furthermore, between 1983 66 ‘‘start-up’’ entity although it is generally used to According to the Kauffman Survey, in 2004, and 1994, of the 2,200 venture capital fund exits, refer to new business ventures. See, e.g., U.S. 36.0% of all start-up companies were sole 1,104 (approximately 50%) were attributed to Census Bureau, Business Dynamics Statistics, proprietorships; by 2008, 34.4% of all surviving mergers and acquisitions of venture-backed firms.). available at http://www.ces.census.gov/index.php/ companies were sole proprietorships. Overview of See also Jack S. Levin, Structuring Venture Capital, bds/bds_overview (which tracks information on the Kauffman Firm Survey, supra note 64, at 8. Private Equity and Entrepreneurial Transactions, businesses, based on the size and age of the 67 See, e.g., Ying Lowrey, Startup Business 2000 (‘‘Levin’’) at 1–2 to 1–7 (describing the various business, and assigns a ‘‘birth’’ year to a business Characteristics and Dynamics: A Data Analysis of types of venture capital and private equity beginning in the year in which it reports positive the Kauffman Firm Survey, Aug. 2009, at 6 investment business but stating that ‘‘the phrase employment of workers on the payroll); The (Working Paper) (based on a survey sample of ‘venture capital’ is sometimes used narrowly to Kauffman Foundation, Where Will the Jobs Come businesses started in 2004, reporting that 59% of all refer only to financing the start-up of a new From?, November 2009, at 5 (identifying ‘‘start-ups’’ start-up companies in 2004 had zero employees; a business’’); Anna T. Pinedo & James R. Tanenbaum, as those firms younger than one year); Anastasia Di ‘‘start-up’’ business was any business that met any Exempt and Hybrid Securities Offerings (2009), Vol. Carlo & Roger Kelly, Private Equity Market Outlook one of the five following criteria for being a start- 1 at 12–2 (‘‘Pinedo’’) (discussing the role initial 27 (European Investment Fund, Working Paper up: the payment of state unemployment taxes, the public offerings play in providing venture capital 2010/005) (defining start-ups as companies that are payment of Federal Insurance Contributions Act investors with liquidity). ‘‘in the process of being set up or may have been taxes, the existence of a legal entity, use of an 56 See Loy Testimony, supra note 40, at 5 (‘‘We in business for a short time, but have not sold their employer identification number, and use of a do not trade in the public markets.’’). See also product commercially’’). schedule C to report business income on a personal McGuire Testimony, supra note 41, at 11 64 See, e.g., The Kauffman Foundation, An tax return). (‘‘[V]enture capital funds do not typically trade in Overview of the Kauffman Firm Survey, Results 68 According to the Kauffman Survey, which the public markets and generally limit advisory from the 2004–2008 Data, May 2010, at 26 conducted a longitudinal study of ‘‘start-up’’ activities to the purchase and sale of securities of (‘‘Overview of the Kauffman Firm Survey’’) businesses that began in 2004, 46.5% of all such private operating companies in private (discussing the difficulties of compiling data on ‘‘start-up’’ companies in 2004 had zero revenues; by transactions’’); Levin, supra note 55, at 1–4 (‘‘A third new businesses; start-up businesses were generally 2008, 30.2% of the surviving companies in the distinguishing feature of venture capital/private identified based on several factors: the payment of sample reported zero revenues. In comparison, in equity investing is that the securities purchased are state unemployment taxes, the payment of Federal 2004, 15.3% of start-up companies reported generally privately held as opposed to publicly Insurance Contributions Act taxes, the existence of revenues of more than $100,000 and in 2008, 36.1% traded * * * a venture capital/private equity a legal entity, use of an employer identification of the surviving companies in the survey reported investment is normally made in a privately-held number, and use of a schedule C to report business revenues of more than $100,000. Overview of the company, and in the relatively infrequent cases income on a personal tax return). Kauffman Firm Survey, supra note 64, at 9. where the investment is into a publicly-held 65 See, e.g., NVCA Yearbook 2010, supra note 41, 69 Among countries that are members of the company, the [venture capital fund] generally holds at 61, 69, 111 (not defining ‘‘start-up’’ but classifying Organisation for Economic Co-operation and non-public securities.’’) (emphasis in original). investments in ‘‘start-up/seed’’ companies and Development, ‘‘small and medium-sized 57 NVCA Yearbook 2010, supra note 41, at 9. defining the ‘‘seed stage’’ of a company as ‘‘the state enterprises’’ (‘‘SMEs’’) are defined as non-subsidiary, 58 Bloomberg Terminal Database, WCAUUS of a company when it has just been incorporated independent firms employing fewer than the (Bloomberg United States Exchange Market and its founders are developing their product or number of employees as is set by each country. The Capitalization). service,’’ whereas an ‘‘early stage’’ company is one definition of SME may be used to determine 59 See Saijel Kishan, Hedge Funds Hold Investors that is beyond the ‘‘seed stage’’ but has not yet funding or other programs sponsored by member ‘‘Hostage’’ After Decade’s Best Year, Bloomberg generated revenues). Cf. PricewaterhouseCoopers countries. Although the European Union generally Businessweek, Jan. 20, 2010, available at http:// MoneyTree Report Definitions, https:// defines SMEs as businesses with fewer than 250 www.businessweek.com/news/2010–01–20/hedge- www.pwcmoneytree.com/MTPublic/ns/ employees, the United States sets the threshold at funds-hold-investors-hostage-after-decade-s-best- nav.jsp?page=definitions (last visited Sept. 23, fewer than 500 employees. Moreover, ‘‘small’’ firms year.html. 2010) (defining a ‘‘seed/start-up’’ company as one are generally defined as those with fewer than 50 60 See supra note 43; McGuire Testimony, supra that has a concept or product in development but employees, while micro-enterprises have at most note 41, at 6 (noting that the ‘‘venture capital not yet operational and usually has been in 10, or in some cases five, workers. In 2005, the industry’s activities are not interwoven with U.S. existence for less than 18 months). European Union adopted additional tests for small

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imposing a standardized metric such as exemption, a venture capital fund could We also request comment on our net income, the number of employees, invest in older and more mature approach to ‘‘follow-on’’ investments.74 or another single factor test could ignore companies that qualify as ‘‘operating Under our proposed rule, a qualifying the complexities of doing business in companies’’ as well as in securities portfolio company is defined to include different industries or regions. As in the issued by publicly traded companies a company that is not publicly traded case of adopting a revenue-based test, provided that the venture capital fund (or controlled by a publicly traded there is the potential that even a low obtained management rights in such company) at the time of each fund threshold for a size metric could publicly traded companies.71 Hence, investment,75 but would not exclude a inadvertently restrict venture capital although the California venture capital portfolio company that ultimately funds from funding otherwise promising exemption is for advisers to so-called becomes a successful venture capital young small companies. ‘‘venture capital companies,’’ the rule investment (typically when the Other tests also present concerns. A provides a much broader exemption that company is taken ‘‘public’’). Under this test adopted by the California would include many types of private approach, an adviser could continue to Corporations Commission and the U.S. equity and other types of private funds rely on the exemption even if the Department of Labor requires that a and thus does not appear consistent venture capital fund’s portfolio venture capital company hold at least 50 with our understanding of the intended ultimately consisted entirely of publicly percent of its assets in ‘‘operating scope of section 203(l).72 We request traded securities, a result that could be companies,’’ which are defined as comment on any of these approaches or viewed as inconsistent with section companies primarily engaged in the alternative ones that we have not 203(l) of the Advisers Act. We believe production or sale of a product or discussed.73 that our proposed approach would give services other than the investment of advisers to venture capital funds capital.70 Under the California subsidiaries, in the production or sale (including sufficient flexibility to exercise their any research or development) of a product or business judgment on the appropriate businesses, defining small business (i.e., 10–49 service other than the management or investment of time to dispose of portfolio company employees) as those with no more than Ö10 million capital but shall not include an individual or sole ’’ investments—which may occur at a in annual revenue and no more than Ö10 million proprietorship. Id. tit. 10, § 260.204.9(b)(7). ‘‘ ’’ ‘‘ in assets as evidenced on their annual balance Management rights is defined as the right, time when the company is privately sheet. See, e.g., Organisation for Economic Co- obtained contractually or through ownership of held or publicly held.76 Moreover, operation and Development, Glossary of Statistical securities . . . to substantially participate in, to substantially influence the conduct of, or to provide under the federal securities laws, a Terms, http://stats.oecd.org/glossary/ person that is deemed to be an affiliate detail.asp?ID=3123. (or offer to provide) significant guidance and counsel concerning, the management, operations or Under one regulatory framework in the United of a publicly traded company may be business objectives of the operating company in States, a business may be considered ‘‘small’’ limited in its ability to dispose of which the venture capital investment is made.’’ Id. depending on the specified number of employees or 77 tit. 10, § 260.204.9(b)(6). Management rights may be publicly traded securities. Would our the net worth or net income of such business. held by the adviser, the fund or an affiliated person proposed approach to follow-on Separate tests are specified for a business based on of the adviser, and may be obtained either through various factors, such as the size of the industry, its investments accommodate the way one person or through two or more persons acting geographical concentration, and the number of venture capital funds typically invest? together. Id. market participants. See, e.g., Small Business ‘‘ Are there circumstances in which a Administration, SBA Size Standards Methodology The U.S. Department of Labor regulations ( VCOC ’’ venture capital fund would provide (Apr. 2009) at 8, http://www.sba.gov/idc/groups/ exemption ) are similar to the California VC ‘‘ public/documents/sba_homepage/ exemption. The regulations define operating follow-on investments in a company ’’ ‘‘ size_standards_methodology.pdf (noting that the company to mean an entity that is primarily that has become public? Should the rule Small Business Administration (‘‘SBA’’) decided to engaged, directly or through a majority owned subsidiary or subsidiaries, in the production or sale specifically provide that a venture apply the net worth and net income measures to its capital fund includes a fund that invests Small Business Investment Company (‘‘SBIC’’) of a product or service other than the investment financing program because investment companies of capital. The term ‘operating company’ includes a limited percentage of its capital in typically evaluate businesses using these measures an entity that is not described in the preceding publicly traded securities under certain sentence, but that is a ‘venture capital operating when determining whether or not to invest). For circumstances (e.g., a follow-on example, under the SBIC program administered by company’ described in paragraph (d) or a ‘real the SBA, SBA loans may be made to SBICs that estate operating company’ described in paragraph investment in a company in which the ’’ invest in companies that are ‘‘small’’ (usually (e). 29 CFR 2510.3–101(c)(1). The regulations fund’s previous investments were made defined as having a net worth of $18 million or less define a venture capital operating company when the company was private)? If so, (‘‘VCOC’’) as any entity that, as of the date of the and an average after-tax net income for the prior what is the appropriate percentage two years of no more than $6 million, although first investment (or other relevant time), has at least there are specific tests depending on the industry 50% of its assets (other than short-term investments threshold (e.g., 5, 10 or 20 percent)? of the company that may be based on net income, pending long-term commitment or distribution to We request comment on whether our net worth or number of employees). The size investors), valued at cost, invested in venture definition should exclude any venture capital investments. 29 CFR 2510.3–101(d). A requirement is codified at 13 CFR 121.301(c)(2). See capital fund that holds any publicly SBA, Investment Program Summary, http:// venture capital investment is defined as ‘‘an www.sba.gov/financialassistance/borrowers/vc/ investment in an operating company (other than a traded securities or a specified sbainvp/index.html. venture capital operating company) as to which the percentage of publicly traded portfolio investor has or obtains management rights’’ that are 70 Under section 260.204.9 of the California Code company securities. What percentage ‘‘contractual rights * * * to substantially of Regulations (the ‘‘California VC exemption’’), an participate in, or substantially influence the adviser is exempt from the requirement to register letters in response to our request for public views if it provides investment advice only to ‘‘venture conduct of, the management of the operating ’’ on rulemaking and other initiatives under the capital companies,’’ which are generally defined as company. 29 CFR 2510.3–101(d)(3). 71 See Cal. Code Reg. tit. 10, § 260.204.9. Dodd-Frank Act. See generally supra note 24. entities that, on at least one annual occasion 74 (commencing with the first annual period following 72 The California VC exemption does not limit See, e.g., Loy Testimony, supra note 40, at 3 the initial capitalization), have at least 50% of their permitted investments to companies that are start- (discussing the role of follow-on investments); assets (other than short-term investments pending up or privately held companies, which were cited NVCA Yearbook 2010, supra note 41, at 34 long-term commitment or distribution to investors), as characteristic of venture capital investing in (statistics comparing initial investments versus valued at cost, in ‘‘venture capital investments.’’ A testimony to Congress. See McGuire Testimony, follow-on investments made by venture capital venture capital investment is defined as an supra note 41; Loy Testimony, supra note 40. funds at Figure 3.15). acquisition of securities in an operating company as 73 See Letter of Keith P. Bishop (July 28, 2009) 75 See proposed rule 203(l)–1(c)(4)(i). to which the adviser has or obtains management (recommending elements of the California VC 76 See supra note 55. rights. See Cal. Code Regs. tit. 10, § 260.204.9(a), exemption). Cf. Letter of P. James (August 21, 2010) 77 See, e.g., rule 144 under the Securities Act (17 (b)(3), (b)(4) (2010). An ‘‘operating company’’ is (expressing the view that the provision of CFR 230.144) (prohibiting the resale of certain defined to mean any entity ‘‘primarily engaged, management services does not distinguish venture restricted and control securities by ‘‘affiliates’’ directly or through a majority owned subsidiary or capital from private equity). We received these unless certain conditions are met).

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would be appropriate? What percentage companies in anticipation of a future and includes common stock as well as would give venture capital funds round of venture capital investment.83 preferred stock, warrants and other sufficient flexibility to dispose of their Such financings may take the form of securities convertible into common publicly traded securities? Would 30 or investment in instruments that are stock in addition to limited partnership 40 percent of the value of a venture ultimately convertible into a portfolio interests.86 This definition would capital fund’s assets be appropriate? 78 company’s common or preferred stock include various securities in which Should the rule specify that publicly at a subsequent investment stage and venture capital funds typically invest traded securities may only be held for thus would meet the definition of and would provide venture capital a limited period of time, such as one- ‘‘equity security.’’ 84 Should our funds with flexibility to determine year, or that a venture capital fund’s definition include any fund that extends which equity securities in the portfolio entire portfolio may not consist only of bridge financing that does not meet the company capital structure are publicly traded securities except for a definition of ‘‘equity security’’ on a appropriate for the fund.87 We request limited period of time, such as one-year short-term limited basis to a qualifying comment on the use of this definition. or other period? portfolio company? Should our Should we consider a more limited definition be limited to those funds that definition of equity security? Do venture b. Equity Securities, Cash and Cash make bridge loans to a portfolio capital funds typically invest in other Equivalents and Short-Term U.S. company that are convertible into equity types of equity securities that are not Treasuries. funding only in the next round of covered by the proposed definition? We propose to define venture capital venture capital investing? Under our Under the proposed rule, we define a fund for purposes of the exemption as proposed definition, debt investments venture capital fund for purposes of the a fund that invests in equity securities or loans with respect to qualifying exemption as a fund that holds cash and of qualifying portfolio companies, cash portfolio companies that did not meet cash equivalents or short-term U.S. and cash equivalents and U.S. the definition of ‘‘equity security’’ could Treasuries, in recognition of the manner Treasuries with a remaining maturity of not be made by a fund seeking to qualify in which venture capital funds 60 days or less.79 Under our proposed as a venture capital fund. Should we operate.88 A venture capital fund may definition, a fund would not qualify as modify the proposed rule so that such hold cash funded by its investors until a venture capital fund for purposes of investments and loans could be made the cash is allocated to an investment the exemption if it invested in debt subject to a limit? If so, what would be opportunity; subsequently, upon instruments (unless they met the an appropriate limit (e.g., 5 or 10 liquidation of the investment, the definition of ‘‘equity security’’) of a percent) and how should the limit be venture capital fund will receive cash as portfolio company or otherwise lent determined (e.g., as a percentage of the a return on its investment, which is then money to a portfolio company, strategies fund’s capital commitments)? distributed to the fund’s that are not the typical form of venture We propose to use the definition of investors.89 Thus, pending receipt of all capital investing.80 Congress received equity security in section 3(a)(11) of the testimony that, unlike other types of Securities Exchange Act of 1934 rules and regulations as it may prescribe in the public interest or for the protection of investors, to private funds, venture capital funds (‘‘Exchange Act’’) and rule 3a11–1 85 treat as an equity security.’’); rule 3a11–1 under the ‘‘invest cash in return for an equity share thereunder. This definition is broad, Exchange Act (17 CFR 240.3a11–1) (defining of the company’s stock.’’ 81 As a ‘‘equity security’’ to include ‘‘any stock or similar 83 consequence, venture capital funds See, e.g., Darian M. Ibrahim, Debt as Venture security, certificate of interest or participation in Capital, 4 U. Ill. L. Rev. 1169, 1173, 1206 (2010) any profit sharing agreement, preorganization avoid using financial leverage, and (‘‘VCs sometimes [provide] bridge loans to their certificate or subscription, transferable share, voting leverage appears to have raised systemic portfolio companies * * * [A] bridge loan * * * is trust certificate or certificate of deposit for an equity risk concerns for Congress.82 Should our [essentially] about ‘funding to subsequent rounds of security, limited partnership interest, interest in a equity’ rather than relying on the underlying start- joint venture, or certificate of interest in a business definition of venture capital fund up’s ability to repay the loan through cash flows.’’); trust; any security future on any such security; or include funds that invest in debt, or Alan Olsen, Venture Capital Financing: Structure any security convertible, with or without certain types of debt, issued by and Pricing, VirtualStreet (July 25, 2010), available consideration into such a security, or carrying any qualifying portfolio companies, or make at http://www20.csueastbay.edu/news/2010/07/ warrant or right to subscribe to or purchase such alan-olsen-venture-capital.html (‘‘Bridge financing a security; or any such warrant or right; or any put, certain types of loans to qualifying is designed as temporary financing in cases where call, straddle, or other option or privilege of buying portfolio companies? We understand the company has obtained a commitment for such a security from or selling such a security to that some venture capital funds may financing at a future date, which funds will be used another without being bound to do so.’’). extend ‘‘bridge’’ financing to portfolio to retire the debt.’’); Thomas Flynn, Venture Capital: 86 See rule 3a11–1 under the Exchange Act (17 Current Trends and Lessons Learned, Ventures and CFR 240.3a11–1) (defining ‘‘equity security’’ to Intellectual Property Letter (2003), available at include any ‘‘limited partnership interest’’). 78 Cf. note 94 (discussing limits applicable to http://www.shipmangoodwin.com/publications/ 87 Our proposed use of the definition of equity BDCs). Detail.aspx?pub=194 (‘‘The bridge financing, security under the Exchange Act acknowledges that 79 Proposed rule 203(l)–1(a)(2). intended to take the cash strapped company either venture capital funds typically invest in common 80 See Loy Testimony, supra note 40, at 2, 4; to the next full round of venture investment or stock and other equity instruments that may be Pinedo, supra note 55, Vol. 1 at 12–2; Levin, supra alternatively to a liquidity event or wind-up, has convertible into equity common stock. See supra note 55, at 1–5 (noting that venture capital funds become a familiar fixture in the life cycle of a note 80. Our proposed definition does not focus on ‘‘common stock or common equivalent venture-backed company.’’). otherwise specify the types of equity instruments securities, with any purchase of subordinated 84 Provided such financings were structured to that a venture capital fund could hold in deference debentures and/or preferred stock generally satisfy the definition of equity security, we would to the business judgment of venture capital designed merely to fill a hole in the financing or view such transactions to satisfy the definition of investors. to provide [the venture capitalist] with some qualifying portfolio company under proposed rule 88 Proposed rule 203(l)–1(a)(2)(ii). priority over management in liquidation or return 203(l)–1(c)(4)(ii). 89 ‘‘[T]he capital supplied to a venture capital of capital’’). See also Jesse M. Fried and Mira Ganor, 85 See 15 U.S.C. 78c(a)(11) (defining ‘‘equity fund consists entirely of equity commitments Agency Costs of Venture Capitalist Control in security’’ as ‘‘any stock or similar security; or any provided as cash from investors in installments on Startups, 81 N.Y.U. Law Journal 967, 970 (2006) security future on any such security; or any security an as-needed basis. * * * The ‘capital calls’ for (venture capital funds investing in U.S. start-ups convertible, with or without consideration, into investments generally happen in cycles over the full ‘‘almost always receive convertible preferred such a security, or carrying any warrant or right to life of the fund on an ‘as needed’ basis as stock’’); Fenn et al., supra note 55, at 32. subscribe to or purchase such a security; or any investments are identified by the general partners 81 McGuire Testimony, supra note 41, at 4; Loy such warrant or right; or any other security which and then as further rounds of investment are made Testimony, supra note 40, at 2. the Commission shall deem to be of similar nature into the portfolio companies.’’ Loy Testimony, 82 See infra section II.A.3 of this Release. and consider necessary or appropriate, by such supra note 40, at 2; Paul A. Gompers & Josh Lerner,

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capital commitments from investors or Should the rule only specify that cash definition of a venture capital fund.97 pending distribution of such proceeds to be held in anticipation of investments, As discussed in greater detail below, we investors, a venture capital fund could or in connection with the payment of believe that Congress did not intend the hold cash and cash equivalents and expenses or liquidations from venture capital fund definition to apply short-term U.S. Treasuries.90 We define underlying portfolio companies? Are to these other types of private equity ‘‘cash and cash equivalents’’ by reference there other types of cash instruments in funds.98 This definition of qualifying to rule 2a51–1(b)(7)(i) under the which venture capital funds typically portfolio company would only exclude Investment Company Act.91 Rule 2a51– invest and/or that should be reflected in companies that borrow in connection 1, however, is used to determine the proposed rule? with a venture capital fund’s whether an owner of an investment We do not propose to define venture investment, but would not exclude company excluded by reason of section capital fund for purposes of the companies that borrow in the ordinary 3(c)(7) of the Investment Company Act exemption as one that invests solely in course of their business (e.g., to finance meets the definition of a qualified U.S. companies. In contrast, the BDC inventory or capital equipment, manage purchaser by examining whether such provisions in the Investment Company cash flows, and meet payroll). We owner holds sufficient ‘‘investments’’ Act generally limit the exemption to would generally view any financing or (generally securities and other assets U.S. companies and require that loan (unless it met the definition of held for investment purposes).92 We do permitted investments generally be equity security) to a portfolio company not propose to define a venture capital made in U.S. companies.94 However, as that was provided by, or was a fund’s cash holdings by reference to we discuss below, there is no indication condition of a contractual obligation whether the cash is held ‘‘for investment in the legislative record that Congress with, a fund or its adviser as part of the purposes’’ or to the net cash surrender intended the venture capital exemption fund’s investments as being a type of value of an insurance policy. would be available only to U.S. advisers financing that is ‘‘in connection with’’ Furthermore, since rule 2a51–1 does not or to advisers that invest fund assets the fund’s investment, although we explicitly include short-term U.S. solely in U.S. companies.95 Should our recognize that other types of financings Treasuries, which we believe would be proposed definition similarly define a may also be ‘‘in connection with’’ a an appropriate form of cash equivalent venture capital fund as a fund formed fund’s investment. Should we provide for a venture capital fund to hold under the laws of the United States guidance on other types of financing pending investment in a portfolio and/or that invests exclusively or transactions as being ‘‘in connection company or distribution to investors, primarily in U.S. portfolio companies or with’’ a fund’s investment in a our rule would include short-term U.S. a sub-set of such companies (e.g., U.S. qualifying portfolio company? If so, Treasuries with a remaining maturity of companies operating in non-financial what types of financing transactions 60 days or less among the investments sectors)? Are venture capital funds that should such guidance address? We a venture capital fund could hold.93 invest in non-U.S. portfolio companies propose this element of the qualifying Should we specify a shorter or longer more or less likely to have financial portfolio company definition because of period of remaining maturity for U.S. relationships that may pose systemic the focus on leverage in the Dodd-Frank Treasuries? risk issues, a rationale that was Act as a potential contributor to We request comment on whether the presented and appeared significant to systemic risk as discussed by the Senate 99 proposed rule’s provision for cash Congress in exempting advisers to Committee report, and the testimony holdings is too broad or too narrow. venture capital funds? 97 A leveraged buyout fund is a private equity The Venture Capital Cycle, at 459 (MIT Press 2004) c. Portfolio Company Leverage fund that will ‘‘borrow significant amounts from (‘‘Gompers & Lerner’’) (‘‘Venture capitalists can banks to finance their deals—increasing the debt-to- liquidate their position in the company by selling Proposed rule 203(l)–1 would define equity ratio of the acquired companies.’’ U.S. Govt. shares on the open market and then paying those a qualifying portfolio company for Accountability Office, Private Equity: Recent proceeds to investors in cash.’’). Growth in Leveraged Buyouts Exposed Risks that purposes of the exemption as one that Warrant Continued Attention (2008) (‘‘GAO Private 90 Proposed rule 203(l)–1(a)(2)(ii). does not borrow, issue debt obligations Equity Report’’), at 1. A leverage buyout fund in 91 Rule 2a51–1(b)(7) under the Investment or otherwise incur leverage in 2005 typically financed a deal with 34% equity and Company Act provides that cash and cash 66% debt. Id. at 13. See also Fenn et al., supra note equivalents include foreign currencies ‘‘held for connection with the venture capital 96 55, at 23 (companies that have been taken private investment purposes’’ and ‘‘(i) [b]ank deposits, fund’s investments. As a consequence, in an LBO transaction generally ‘‘spend less on certificates of deposit, bankers acceptances and certain types of funds that use leverage research and development, relative to assets, and similar bank instruments held for investment or finance their investments in portfolio have a greater proportion of fixed assets; their debt- purposes; and (ii) [t]he net cash surrender value of companies or the buyout of existing to-assets ratios are high, above 60%, and are two to an insurance policy.’’ 17 CFR 270.2a51–1(b)(7). four times those of venture-backed firms.’’ 92 See generally sections 2(a)(51) and 3(c)(7) of the investors with borrowed money (e.g., Moreover, compared to venture capital backed Investment Company Act; 17 CFR 270.2a51(b) and leveraged buyout funds, which are a companies, LBO-private equity backed companies (c). different subset of private equity funds) that are taken public typically use proceeds from an 93 We have treated debt securities with maturities would not meet the proposed rule’s IPO to reduce debt whereas new venture capital of 60 days or less differently than debt securities backed firms tend to use proceeds to fund growth.); with longer maturities under our rules. In Tresnowski Testimony, supra note 40, at 2 particular, we have recognized that the potential for 94 See sections 2(a)(46) and 2(a)(48) of the (indicating that portfolio companies in which fluctuation in those shorter-term securities’ market Investment Company Act. Under section 55 of the private equity funds invest typically have 60% debt value has decreased sufficiently that, under certain Investment Company Act, a BDC is prohibited from and 40% equity). conditions, we allow certain open-end investment acquiring any assets, except for permitted assets, 98 See infra discussion in section II.A.1.d of this companies to value them using amortized cost unless, at the time the acquisition is made, Release. value rather than market value. See Valuation of permitted assets ‘‘represent at least 70 per centum 99 See S. Rep. No. 111–176, supra note 7, at 74 Debt Instruments by Money Market Funds and of the value of [the BDC’s] total assets.’’ Permitted (‘‘The Committee believes that venture capital Certain Other Open-End Investment Companies, assets for this purpose generally mean securities of funds, a subset of private investment funds Investment Company Act Release No. 9786 (May an ‘‘eligible portfolio company,’’ which is defined in specializing in long-term equity investment in small 31, 1977) [42 FR 28999 (June 7, 1977)]. We believe section 2(a)(46) of the Investment Company Act. or start-up businesses, do not present the same risks that the same consideration warrants treating U.S. 95 See infra section II.A.8 of this Release. as the large private funds whose advisers are Treasury securities with a remaining maturity of 60 96 Proposed rule 203(l)–1(c)(4)(ii) (setting forth required to register with the SEC under this title.’’); days or less as more akin to cash equivalents than this requirement as a condition for the portfolio id. at 75 (concluding that private funds that use Treasuries with longer maturities for purposes of company to qualify as a ‘‘qualifying portfolio limited or no leverage at the fund level engage in the definition of venture capital fund. company’’). Continued

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before Congress that stressed the lack of fund’s investment in the company In contrast, private equity funds that leverage in venture capital investing.100 (which could be an indirect buyout).103 are identified as buyout funds typically Should we use a test other than whether One of the distinguishing features of provide capital to an operating company the loan is ‘‘in connection with’’ the venture capital funds is that, unlike in exchange for majority or complete fund’s investments? For example, many hedge funds and private equity ownership of the company,108 generally should the test be whether the portfolio funds, they invest capital directly in achieved through the buyout of existing company currently intends to borrow at portfolio companies for the purpose of shareholders or other security holders the time of the fund’s investment? funding the expansion and development and financed with debt incurred by the Should the test depend only on how the of the company’s business rather than portfolio company,109 and compared to portfolio company uses the proceeds of buying out existing security holders, venture capital funds, hold the borrowing, such as by excluding otherwise purchasing securities from investment for shorter periods of companies that use proceeds to buyout other shareholders, or leveraging the time.110 As a result of the use of the investors or return capital to a fund? capital investment with debt capital provided and the incurrence of Venture capital has been described as financing.104 Testimony received by this debt, following the buyout fund investing in companies that cannot Congress and our research suggest that investment, the operating company may borrow from the usual lending venture capital funds provide capital to carry debt several times its equity and sources.101 Should we define a many types of businesses at different may devote significant levels of its cash qualifying portfolio company as a stages of development,105 generally with flow and corporate earnings to repaying company that does not incur certain the goal of financing the expansion of the debt financing, rather than investing 106 specified types of borrowing or other the company and helping it progress in capital improvement or business forms of leverage? Would such a to the next stage of its development operations.111 definition narrow the current range of through successive tranches of portfolio companies in which venture investment (i.e., ‘‘follow-on’’ companies that do not reach their agreed upon capital funds typically invest? investments) if the company reaches milestones.’’). agreed-upon milestones.107 108 GAO Private Equity Report, supra note 97, at d. Capital Used for Operating and 8 (‘‘A private equity-sponsored LBO generally is Business Purposes 103 Proposed rule 203(l)–1(c)(4)(iii). defined as an investment by a private equity fund in a public or private company (or division of a 104 See Loy Testimony, supra note 40, at 2 company) for majority or complete ownership.’’). Under proposed rule 203(l)–1, a (‘‘Although venture capital funds may occasionally 109 venture capital fund is defined as a fund borrow on a short-term basis immediately preceding See Annalisa Barrett et al., Prepared by the the time when the cash installments are due, they Corporate Library Inc., under contract for the IRRC that holds equity securities of qualifying Institute, What is the Impact of Private Equity portfolio companies, and at least 80 do not use debt to make investments in excess of the partner’s capital commitments or ‘lever up’ the Buyout Fund Ownership on IPO Companies’ percent of each company’s equity fund in a manner that would expose the fund to Corporate Governance?, at 7 (June 2009) (‘‘Barrett et securities owned by the venture capital losses in excess of the committed capital or that al.’’) (‘‘In general, VC firms provide funding to would result in losses to counter parties requiring companies in early stages of their development, and fund were acquired directly from each the money they provide is used as working capital such qualifying portfolio company.102 a rescue infusion from the government.’’). See also infra notes 109–111; Mark Heesen & Jennifer C. for the firm. Buyout firms, in contrast, work with This element reflects the distinction Dowling, National Venture Capital Association, mature companies, and the funds they provide are between venture capital funds that Venture Capital & Adviser Registration, materials used to compensate the firm’s existing owners.’’); provide capital to portfolio companies submitted in connection with the Commission’s Ieke van den Burg and Poul Nyrup Rasmussen, Government-Business Forum on Small Business Hedge Funds and Private Equity: A Critical for operating and business purposes (in Capital Formation (‘‘Heesen’’) (summarizing the Analysis (2007), at 16–17 (‘‘van den Burg’’); exchange for an equity investment) and differences between venture capital funds and Sahlman, supra note 106, at 517. See also Tax leveraged buyout funds, which acquire buyout and hedge funds), available at http:// Legislation: CRS Report, Taxation of Hedge Fund www.sec.gov/info/smallbus/ and Private Equity Managers, Tax Law and Estate controlling equity interests in operating Planning Course Handbook Series, Practicing Law companies through the ‘‘buy out’’ of 2010gbforumstatements.htm. 105 See, e.g., McGuire Testimony, supra note 41, Institute (Nov. 2, 2007) at 2 (noting that in a existing security holders. Hence, in at 1; NVCA Yearbook 2010, supra note 41; leveraged buyout ‘‘private equity investors use the addition to the definitional element that PricewaterhouseCoopers/National Venture Capital proceeds of debt issued by the target company to a venture capital fund is one that does Association MoneyTree Report, Q4 2009/Full-year acquire all the outstanding shares of a public 2009 Report (providing data on venture capital company, which then becomes private’’). not redeem or repurchase securities investments in portfolio companies); Schell, supra 110 Unlike venture capital funds, which generally from other shareholders (i.e., a note 101, at § 1.03[1]; Gompers & Lerner, supra note invest in portfolio companies for 10 years or more, ‘‘buyout’’), a related criterion in the rule 89, at 178, 180 table 8.2 (displaying percentage of private equity funds that use leveraged buyouts specifies that a qualifying portfolio annual venture capital investments by stage of invest in their portfolio companies for shorter development and classifying ‘‘early stage’’ as seed, periods of time. See Loy Testimony, supra note 40, company is one that does not distribute start-up, or early stage and ‘‘late stage’’ as expansion, at 3 (citing venture capital fund investments company assets to other security holders second, third, or bridge financing). periods in portfolio companies of five to 10 years in connection with the venture capital 106 See McGuire Testimony, supra note 41, at 1; or longer); van den Burg, at 19 (noting that LBO Loy Testimony, supra note 40, at 3 (‘‘Once the investors generally retain their investment in a venture fund is formed, our job is to find the most listed company for 2 to 4 years or even less after activities that do not pose risks to the wider markets promising, innovative ideas, entrepreneurs, and the company goes public). See also Paul A. through credit or counterparty relationships). companies that have the potential to grow Gompers, The Rise and Fall of Venture Capital, 100 See Loy Testimony, supra note 40, at 6 (noting exponentially with the application of our expertise Business And Economic History, vol. 23, no. 2, that ‘‘many venture capital funds significantly limit and venture capital investment.’’). See also William Winter 1994, at 17 (‘‘Gompers’’) (stating that ‘‘an borrowing’’). See also McGuire Testimony, supra A. Sahlman, The Structure and Governance of LBO investment is significantly shorter than that of note 41, at 7 (‘‘Not only are our partnerships run Venture-Capital Organizations, Journal of Financial a comparable venture capital investment. Assets are without debt but our portfolio companies are Economics 27 (1990), at 473, 503 (‘‘Sahlman’’) sold off almost immediately to meet debt burden, usually run without debt as well.’’). (noting venture capitalists typically invest more and many companies go public again (in a reverse 101 See Loy Testimony, supra note 40, at 3. See than once during the life of a company, with the LBO) in a very short period of time’’). also James Schell, Private Equity Funds: Business expectation that each capital investment will be 111 See Barrett et al., supra note 109. See also Structure and Operations (2010), at § 1.03[1] sufficient to take the company to the next stage of Fenn et al., supra note 55, at 23 (when comparing (‘‘Schell’’) (‘‘Venture Capital Funds provide development, at which point the company will venture capital backed companies that are taken investment capital to business enterprises early in require additional capital to make further progress). public to LBO-private equity backed companies that their development cycle at a time when access to 107 See Sahlman, at 503; Loy Testimony, supra are taken public, the common use of proceeds from conventional financing sources is non-existent or note 40, at 3 (‘‘[W]e continue to invest additional an IPO are used by LBO-private equity backed extremely limited.’’). capital into those companies that are performing companies to reduce debt whereas new firms use 102 Proposed rule 203(l)–1(a)(2)(i). well; we cease follow-on investments into proceeds to fund growth).

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We believe that these differences (i.e., acquired directly from the company, in unnecessary burdens on the company’s the use of buyouts and associated order to give venture capital funds operation or business? Rather than leverage) distinguish venture capital relying on the exemption some define a venture capital fund by funds from buyout private equity funds flexibility to acquire securities from a reference to the manner in which it for which Congress did not provide an portfolio company founder or ‘‘angel’’ acquires equity securities (or the exemption.112 Under our proposed rule, investor who may seek liquidity from manner in which qualifying portfolio an exempt adviser relying on section his or her initial investment.116 We companies may indirectly facilitate a 203(1) of the Advisers Act would not be adopted this 80 percent threshold buyout), should the proposed rule eligible for the exemption if it advised because we understand that many instead define the manner in which these types of private equity funds that venture capital funds currently are proceeds from a venture capital in effect acquire a majority of the equity managed in a manner that seeks to rely investment may be used? For example, securities of portfolio companies on provisions of the tax code providing should the rule specify that proceeds of directly from other security holders.113 favorable tax treatment for directly borrowings or other financings not be Correspondingly, we also propose to acquired equity securities of issuers that used to finance the acquisition of equity define a qualifying portfolio company satisfy certain conditions.117 Thus, securities by a venture capital fund or for purposes of the exemption as one using this threshold in our definition otherwise distribute company assets to that does not redeem or repurchase may not result in substantial changes to equity owners? Would defining outstanding securities in connection either investment strategies employed, qualifying portfolio company in this with a venture capital fund’s or the compliance programs currently manner facilitate compliance or would investment.114 Because at least 80 used, by venture capital advisers. Is our this approach make it easier for a percent of each portfolio company’s assumption that venture capital funds company to achieve a ‘‘buyout’’ and equity securities in which the fund do not generally acquire portfolio thereby circumvent the intended scope invests must be acquired directly from company securities directly from of the exemption, given the fungibility the portfolio company, a venture capital existing shareholders correct? Is 80 of cash and the privately negotiated fund relying on the exemption could percent the appropriate threshold? nature of typical venture capital purchase the remainder of the securities Should the threshold be set lower? transactions? We do not intend that a directly from existing shareholders (i.e., Should direct acquisitions of equity venture capital fund would not meet the a ‘‘buyout’’). Under our proposed securities be increased to 90 percent or proposed definition if it acquired equity definition, however, a company that 100 percent in order to more effectively securities from a portfolio company in achieves an indirect buyout of its prevent advisers to funds engaged in connection with a capital reorganization security holders, such as through the activities that are not characteristic of intended to simplify the company’s complete recapitalization or venture capital funds from relying on capital structure without changing the restructuring of the portfolio company the exemption? existing beneficial owners’ rights, capital structure would not be a In contrast to leveraged buyout fund priority, or economic terms. Are there qualifying portfolio company.115 The 80 financing, venture capital received by a other capital reorganizations that would percent test is not intended to preclude portfolio company is devoted to be consistent with the intent of our conversions of directly acquired developing the company’s business proposed rule but that would prevent a securities into other equity securities. rather than repurchasing the securities venture capital fund from satisfying the Similarly, we would not view a capital of other shareholders or making proposed definition? reorganization intended merely to payments to fund debt financing e. Operating Companies simplify a qualifying portfolio through the portfolio company. We company’s capital structure and request comment on this criterion. Does Proposed rule 203(l)–1 would define outstanding securities without any the definition’s focus on a portfolio the term qualifying portfolio company change in the existing beneficial company’s use of capital received from for the purposes of the exemption to owners’ rights, priority, or economic a venture capital fund impose any exclude any private fund or other terms as breaching the 80 percent pooled investment vehicle.118 There is condition. 116 See NVCA Yearbook 2010, supra note 41, at no indication that Congress intended We propose to define a venture 57 (defining ‘‘angel’’ as ‘‘a wealthy individual that the venture capital exemption to apply invests in companies in relatively early stages of to funds of funds. Without this capital fund by reference to ownership development’’). See also Fenn et al., supra note 55, of equity securities of a qualifying at 2 (defining angel capital as ‘‘investments in small, definition, a venture capital fund could portfolio company, wherein at least 80 closely held companies by wealthy individuals, circumvent the intended scope of the percent of the securities owned were many of whom have experience operating similar exemption by investing in other pooled companies [and] * * * may have substantial investment vehicles that are not ownership stakes and may be active in advising the 112 See supra notes 39, 42, 43, 99 and company, but they generally are not as active as themselves subject to the definitional accompanying text. professional managers in monitoring the company criteria under our proposed rule. For 113 Proposed rule 203(l)–1(a)(2)(i). and rarely exercise control.’’). example, a venture capital fund could 114 Proposed rule 203(l)–1(c)(4)(iii). 117 See Int. Rev. Code § 1202(e)(1)(A) (26 U.S.C. circumvent the intent of the proposed 115 For example, concurrently with the issuance 1202) (‘‘IRC 1202’’) (which permits partial exclusion rule by incurring off-balance sheet of new securities to the venture capital fund, a from income tax gain on directly acquired equity portfolio company could redeem existing securities of certain issuers that, among other leverage or indirectly investing in shareholders and use proceeds from the venture things, devote at least 80% of their assets to the companies that may be publicly traded. capital fund investment to pay such shareholders conduct of their business as specified in IRC 1202). Our proposed exclusion would be redemption proceeds. Similarly, existing Under our proposed rule, at least 80% of the similar to the approach of other shareholders may receive new securities that are portfolio company securities owned by a venture ‘‘ ’’ subordinated to the securities issued to the venture capital fund must be acquired directly from the definitions of venture capital capital fund in exchange for tendering their portfolio company, which in turn cannot redeem or discussed above, which limit outstanding securities, partially funded with repurchase existing security holders in connection investments received from the venture capital fund. with such venture capital fund investment. Thus 118 Proposed rule 203(l)–1(c)(4)(iv). For this In each of these examples, the fund becomes a we presume that venture capital funding proceeds purpose, pooled investment vehicles include majority owner of the company by ‘‘buying out’’ the (or at least 80% of such proceeds) will be used for investment companies, investment companies existing owners with investment capital initially operating and business expansion purposes, which relying on rule 3a–7 under the Investment Company provided by the fund. is similar to the requirements under IRC 1202. Act and commodity pools.

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investments to operating companies and generally takes the form of active and financially troubled businesses.124 thus would exclude investments in involvement in the business, operations Because Congress modeled the other private funds or securitized asset or management of the portfolio definition of BDC under the Advisers vehicles.119 We request comment on company, or less active forms of control and Investment Company Acts on the this definitional element. Under the of the portfolio company, such as capital formation activities of venture proposed definition, a venture capital through board representation or similar capital funds, both definitions under fund would not invest in another voting rights.122 We also acknowledge such Acts incorporate the requirement private fund, a commodity pool or other that the nature of managerial assistance to make available significant managerial ‘‘investment companies.’’ Should the may evolve over time as the needs of assistance to portfolio companies.125 proposed definition specifically identify qualifying portfolio companies change, Congress did not use the existing BDC other types of pooled investment and hence the proposed rule does not definitions when determining the scope vehicles (e.g., real estate funds or specify that managerial assistance has a of the venture capital exemption,126 and structured investment vehicles) in fixed character. the primary policy considerations that which a fund seeking to satisfy the We have modeled the proposed led to the adoption of the BDC proposed definition could not invest? approach to managerial assistance in exemptions differed from those under part on existing provisions under the 1. Management Involvement the Dodd-Frank Act. However, we Advisers Act and the Investment believe these provisions are instructive To qualify as a venture capital fund Company Act dealing with BDCs, which because they reflect many of the same under our proposed definition, the fund were added over the years to ease the characteristics of venture capital and or its investment adviser would: (i) regulatory burdens on venture capital private equity fund activity presented in 123 Have an arrangement under which it and other private equity investments. testimony before Congress in connection offers to provide significant guidance In 1980, when Congress first introduced with the Dodd-Frank Act.127 Although and counsel concerning the BDCs into the Advisers Act and Congress viewed BDC activities as management, operations or business Investment Company Act, it typical of ‘‘venture capital’’ investing,128 objectives and policies of the portfolio acknowledged that the purpose of the the BDC provisions are complex. Hence, ‘‘ company (and, if accepted, actually BDC provisions was to support venture we are proposing a modified version of provides the guidance and counsel) or capital’’ activity in capital formation for ‘‘ 120 the definition of making available (ii) control the portfolio company. small business, and described BDCs as significant managerial assistance’’ in Because a key distinguishing principally investing in and providing order to simplify the language and to managerial assistance to small, growing characteristic of venture capital reduce the potential for confusion that investing is the assistance beyond the might arise in interpreting the meaning retention of stock and debt investments by a money mere provision of capital, we propose of the term. that advisers seeking to rely on the rule manager.’’) (emphasis in original); Sahlman, supra note 106, at 508 (noting that venture capitalists have a significant level of involvement typically play a role in the operation of the 124 See 1980 House Report, supra note 44, at 21. company, help to establish tactics and strategy, in developing a fund’s portfolio 125 See section 202(a)(22) of the Advisers Act; 121 work with suppliers and customers, and often companies. Managerial assistance section 2(a)(48)(B) of the Investment Company Act. assume more direct control by changing Generally, a BDC under the Advisers Act is any management and sometimes taking over day-to-day 119 company that meets the definition of BDC under the See California VC exemption, supra notes 70– operations themselves). See also Fenn et al., supra Investment Company Act, except that certain 72; see also VCOC exemption under 29 CFR 2510.3– note 55, at 32–33 for a discussion of various control requirements were modified for ‘‘private’’ BDCs 101(d), supra note 70. mechanisms available to venture capital and private 120 under the Advisers Act. See also Prohibition of Proposed rule 203(l)–1(a)(3). Under section equity funds, including preferred stock ownership, 202(a)(12) of the Advisers Act, ‘‘control’’ is defined representation on the board and various contractual Fraud by Advisers to Certain Pooled Investment to mean ‘‘the power to exercise a controlling covenants. Vehicles; Accredited Investors in Certain Private Investment Vehicles, Investment Advisers Act influence over the management or policies of a 122 See generally supra note 121. See also Alan T. Release No. 2576 (Dec. 27, 2006) [72 FR 400 (Jan. company, unless such power is solely the result of Frankel, et al., Venture Capital: Financial and Tax 4, 2007)] (‘‘Accredited Natural Person Release’’), at an official position with such company.’’ Considerations, The CPA Journal (Aug. 2003) at 1 n.69 (discussing the difference between the term 121 See McGuire Testimony, supra note 41, at 1 (noting that the ‘‘VC will also monitor the portfolio BDC under the Investment Company Act and the (‘‘[W]e build companies by actively partnering with company after the investment has been made. Advisers Act). In 1996, as part of NSMIA, Congress each entrepreneur and management team to help Oftentimes, the VC will serve as a board member sought to encourage greater investment in small propel their ideas into market leading businesses. or financial and strategic advisor to the portfolio businesses by giving BDCs more flexibility, and We do this by providing a small amount of capital company.’’). therefore expanded the class of eligible portfolio and a large amount of operating expertise and 123 The term ‘‘business development company’’ companies in which BDCs could invest without strategic counsel over a long period of time. While was first introduced into the Investment Company being required to provide ‘‘managerial assistance.’’ providing capital is the first order of business, it is Act and the Advisers Act in 1980 as part of the See S. Rep. No. 104–293, at 13 (1996). the least time consuming of all our activities. We Small Business Investment Incentive Act of 1980 126 also recruit and attract employees at all levels [for (‘‘Small Business Act’’), and was amended as part We have looked to the BDC definition to the portfolio company]. We identify and structure of the National Securities Markets Improvement Act define a venture capital fund before. In 2006, we strategic partnerships. We raise additional equity to of 1996, Public Law 104–290, 110 Stat. 3416 (1996) proposed to impose a qualification standard for all help the [portfolio] company make it to the next (‘‘NSMIA’’). Congress introduced an alternative investors of private investment funds, excluding milestone. And, we’re available 24/7 to support regulatory framework applicable to BDCs, which venture capital funds, which we proposed to define great teams, solve problems, identify opportunities was designed to remove ‘‘unnecessary by reference to section 202(a)(22) of the Advisers and detect ‘land mines.’ * * * We provide access disincentives’’ for BDCs to provide capital to small Act. See Accredited Natural Person Release, supra to [our] expertise and network at all stages of a businesses, while also preserving protection for note 125 (proposing to define the term ‘‘accredited [portfolio] company’s development and across all investors and preventing fraud and abuse. See 1980 natural person’’ as any natural person who satisfies strategic areas of the business.’’). See also Levin, House Report, supra note 44, at 21–22. the requirements in Regulation D as an accredited supra note 55, at 1–3 (noting that the ‘‘first feature In the Small Business Act, Congress modeled the investor and who also owns investments of at least distinguishing venture capital/private equity definition of a BDC under section 202(a)(22) of the $2.5 million). We sought additional comment on investing is the VC professional’s active Advisers Act on the capital formation activities of this proposal in a subsequent release but a rule has involvement in identifying the investment, venture capital funds. Congress recognized that the not been adopted. See Revisions of Limited Offering negotiating and structuring the transaction, and principal activity of a BDC is to invest in and Exemptions in Regulation D, Securities Act Release monitoring the portfolio company after the provide managerial assistance to small, growing and No. 8828 (Aug. 3, 2007) [72 FR 45116 (Aug. 10, investment has been made. Often, the VC financially troubled companies. See 1980 House 2007)]. professional will serve as a board member and/or Report, supra note 44, at 21. See also infra note 129 127 See generally Loy Testimony, supra note 40; financial advisor to the portfolio company. Hence, (definition of ‘‘making available significant McGuire Testimony, supra note 41. venture capital/private equity investing is managerial assistance’’ by a BDC under section 128 See 1980 House Report, supra note 44, at 21– significantly different from passive selection and 2(a)(47) of the Investment Company Act). 2.

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We request comment on the approach not all, of the assistance to the portfolio provide managerial assistance to all of a to managerial assistance in the company. Is that understanding correct? fund’s portfolio companies result in definition of venture capital fund. As Under proposed rule 203(l)–1, venture potential demands on a fund or its we have noted above, Congressional capital funds that invest as a group adviser that could not be satisfied if all testimony asserted that a key would only satisfy the definition if each or a significant subset of a fund’s characteristic of venture capital funds is venture capital fund (or its adviser) portfolio companies accepted the offer? the provision of managerial assistance. offered (and, if accepted, provided) Alternatively, does the proposed Is this true in the industry generally? managerial assistance or exercised definition provide a venture capital We request comment on the description control.130 Should the rule specify how fund (including those that invest as a of managerial assistance in proposed managerial assistance or control is to be group) with sufficient flexibility to rule 203(l)–1. Is this description easier determined in the case of venture determine the scope of any managerial to understand and apply than the capital funds that invest as a group if assistance or control it may seek to offer definition in section 2(a)(47) of the only one fund (or its adviser) provides (or provide) to a portfolio company? Investment Company Act? 129 As under the assistance? Should the rule specify 2. Limitation on Leverage the definition of BDC in the Advisers the extent to which each fund (or its and Investment Company Acts, the adviser) must offer or provide Under proposed rule 203(l)–1, the proposed definition specifies the fund managerial assistance or adopt the definition of a venture capital fund for or its adviser need only offer assistance. approach of other regulatory definitions purposes of the exemption would be Should the rule specify that the fund or of ‘‘venture capital’’ funds, which limited to a private fund that does not its adviser actually provide assistance? impose strict numerical investment or borrow, issue debt obligations, provide If so, what if a portfolio company that ownership tests for determining guarantees or otherwise incur leverage, initially accepts the offer of assistance whether a venture capital fund exercises in excess of 15 percent of the fund’s later refuses any actual or further supervision or influence over the capital contributions and uncalled assistance? We understand that when operation or business of the operating committed capital, and any such venture capital funds invest as a group, company? 131 Does the fact that the borrowing, indebtedness, guarantee or there may be an understanding among assistance need only be offered render leverage is for a non-renewable term of the funds and the portfolio company the condition so readily met that the no longer than 120 calendar days.133 that while all fund advisers may be criterion should be removed from the Under the proposed definition, a fund available to provide managerial rule? Should our rule provide guidance could borrow and still be a venture assistance if necessary, one adviser is on what constitutes ‘‘control’’ under our capital fund provided it did not borrow generally expected to provide most, if proposed definition? For example, or otherwise use leverage in excess of instructions to Form ADV provide a the specified threshold. 129 Section 2(a)(47) of the Investment Company presumption of control if a person has By specifying that loans be non- Act states: the power to vote 25 percent or more of renewable, we would avoid the ‘‘‘Making available significant managerial a corporation’s voting securities, or a transformation of short-term debt into assistance’ by a business development company long-term debt without full repayment means— person acts as manager of a limited 132 (A) Any arrangement whereby a business liability company. Should the to the lender. Should the rule specify development company, through its directors, proposed rule rely on similar or other borrowing or financing terms or officers, employees, or general partners, offers to different presumptions? conditions that would nevertheless provide, and, if accepted, does so provide, Our proposed rule provides that when avoid this type of transformation? Do significant guidance and counsel concerning the management, operations, or business objectives and a fund controls the qualifying portfolio venture capital funds use lines of credit policies of a portfolio company; company, an offer to provide managerial repeatedly but pay the outstanding (B) the exercise by a business development assistance is not required. As in the case amounts in full before drawing down company of a controlling influence over the of ‘‘managerial assistance’’ as defined in additional credit? Should loans of this management or policies of a portfolio company by nature be included in the definition? the business development company acting the BDC provisions, the proposed rule individually or as part of a group acting together presumes that when a fund acquires Under our proposed definition, it would which controls such portfolio company; or control, it is likely to be exercised. be possible for a venture capital fund to (C) with respect to a small business investment Should the rule specify that in all cases issue commercial paper on a short-term company licensed by the Small Business basis to potential investors because the Administration to operate under the Small Business managerial assistance includes both the Investment Act of 1958, the making of loans to a offer of assistance as well as the exercise proposed definition does not specify portfolio company. of control? We request comment on which types of instruments a venture For purposes of subparagraph (A), the whether venture capital funds (or their capital fund issues. Should the requirement that a business development company advisers) typically have the personnel to proposed rule specifically exclude make available significant managerial assistance commercial paper from debt issuances shall be deemed to be satisfied with respect to any provide significant managerial particular portfolio company where the business assistance to all of their portfolio to avoid the potential that a venture development company purchases securities of such companies or only a subset. Would the capital fund could convert short-term portfolio company in conjunction with one or more requirement to offer and potentially debt into long-term debt by continuing other persons acting together, and at least one of the to roll over its commercial paper persons in the group makes available significant 134 managerial assistance to such portfolio company, 130 According to one study, funds focusing on issuances? This criterion regarding except that such requirement will not be deemed later-stage companies and middle-market buyout to be satisfied if the business development investing tend to invest alongside other funds, 133 Proposed rule 203(l)–1(a)(4). Similarly, our company, in all cases, makes available significant whereas venture capital funds focusing on early proposed rule would exclude from the definition of managerial assistance solely in the manner stage companies tend to invest individually in ‘‘qualifying portfolio company’’ a company that described in this sentence.’’ portfolio companies. See Fenn et al., supra note 55, borrowed in connection with the venture capital In contrast to section 2(a)(47) of the Investment at 31. fund’s investments in the company. Proposed rule Company Act, our proposed definitional approach 131 See supra note 70 and accompanying text 203(l)–1(c)(4)(ii). See supra section II.A.1 of this to managerial assistance does not specifically define (discussing the California VC exemption and the Release. managerial assistance by referring to a fund’s VCOC exemption). 134 We note that because commercial paper directors, officers, employees, or general partners or 132 See Amendments to Form ADV, Investment issuers often refinance the repayment of maturing address how managerial assistance is determined Advisers Act Release No. 3060 (July 28, 2010) [75 commercial paper with newly issued commercial for funds that invest as a group. FR 49234 (Aug. 12, 2010)] (‘‘Form ADV Release’’). Continued

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leverage at the venture capital fund lack of financial leverage in venture borrowing or other forms of leverage level is in addition to the conditions capital funds as a basis for exempting encourage venture capital funds to incur relating to a qualifying portfolio advisers to venture capital funds 137 in other investment risks different from company’s debt issuances in connection contrast to other types of private funds those typically associated with venture with the venture capital fund’s such as hedge funds, which may engage capital investing today? To the extent investment.135 Under this condition, a in trading strategies that may contribute that venture capital funds use short- venture capital fund seeking to satisfy to systemic risk and affect the public term leverage or borrowing, 90 days has the definitional criteria could not avoid securities markets.138 For this reason, been cited as typical.142 Would a 120- the borrowing element at the portfolio our proposed rule is designed to address day period, as specified in our proposed company level by incurring such concerns that financial leverage may rule, create other investment risks for leverage at the venture capital fund contribute to systemic risk by excluding venture capital funds? Our proposed level. funds that incur more than a limited rule refers specifically to borrowing but Congress cited the implementation of amount of leverage from the definition also is designed to give venture capital trading strategies that use financial of venture capital fund.139 funds the flexibility to issue debt (which leverage by certain private funds as We also understand that venture is also a form of borrowing) for short- creating a potential for systemic risk.136 capital funds generally do not rely on term purposes. Should the rule refer In testimony before Congress, the short-term financing,140 which has been specifically to additional forms of venture capital industry identified the identified as another potential systemic borrowing not already identified? Do risk factor.141 Should we increase or any or many venture capital funds paper, they may face roll-over risk, i.e., the risk that reduce the 15 percent threshold for borrow in excess of 120 days? Should investors may not be willing to refinance maturing short-term borrowing? If so, what is the commercial paper. These risks became particularly the 15 percent limit not apply when a apparent for issuers of asset-backed commercial appropriate threshold (e.g., 20, 10, or 5 fund borrows in order to invest in a paper beginning in August 2007. At that time, percent)? Or should we define a venture qualifying portfolio company and is structured investment vehicles (‘‘SIVs’’), which are capital fund as a private fund that does repaid with capital called from the off-balance sheet funding vehicles sponsored by not borrow at all or otherwise incur any financial institutions, issued commercial paper to fund’s investors? Would the 120-day finance the acquisition of long-term assets, financial leverage? Would even the limit alone achieve a similar result? including residential mortgages. As a result of limited ability to engage in short-term Our proposed rule specifies that the problems in the residential home mortgage market, 15 percent calculation must be short-term investors began to avoid asset-backed 137 See McGuire Testimony, supra note 41, at 7 commercial paper tied to residential mortgages, (‘‘Venture capital firms do not use long term determined based on the fund’s regardless of whether the securities had substantial leverage, rely on short term funding, or create third aggregate capital contributions and exposure to sub-prime mortgages. Unable to roll party or counterparty risk * * * [F]rom previous uncalled capital commitments. Unlike over their commercial paper, SIVs suffered severe testimony submitted by the buy-out industry, the most registered investment companies liquidity problems and significant losses. See typical capital structure of the companies acquired Money Market Fund Reform, Investment Company by a buyout fund is approximately 60% debt and or hedge funds, venture capital funds Act Release No. 28807 (June 30, 2009) [74 FR 32688 40% equity. In contrast, borrowing at the venture rely on investors funding their capital (July 8, 2009)] (‘‘Money Market Fund Reform capital fund level, if done at all, typically is only commitments from time to time in order Release’’) at nn.37–39 and preceding and used for short-term capital needs (pending to acquire portfolio companies.143 A accompanying text; Marcin Dacperczyk and Philipp drawdown of capital from its partners) and does not Schnabl, When Safe Proved Risky: Commercial exceed 90 days. Not only are our partnerships run capital commitment is a contractual Paper During the Financial Crisis of 2007–2009 without debt but our portfolio companies are obligation to acquire an interest in, or (Nov. 2009). usually run without debt as well.’’); Loy Testimony, provide the total commitment amount 135 See proposed rule 203(l)–1(c)(4)(ii); supra supra note 40, at 2 (‘‘Although venture capital funds over time to, a fund, when called by the section II.A.1.c of this Release. Because private may occasionally borrow on a short-term basis equity funds often engage in leveraged buy-out immediately preceding the time when the cash fund. Accordingly, advisers to venture transactions in which the portfolio company, rather installments are due, they do not use debt to make capital funds manage the fund in than the fund, incurs debt, our proposed definition investments in excess of the partner’s capital anticipation of all investors fully would exclude leveraged buy-out funds. commitments or ‘lever up’ the fund in a manner 136 funding their commitments when due See, e.g., section 115 of the Dodd-Frank Act that would expose the fund to losses in excess of (enumerating prudential standards for addressing the committed capital or that would result in losses and typically have the right to penalize systemic risks, including risk-based capital to counter parties requiring a rescue infusion from investors for failure to do so.144 Venture requirements, leverage limits, liquidity the government.’’). requirements, resolution plan and credit exposure 138 See S. Rep. No. 111–176, supra note 7, at 74– 142 See McGuire Testimony, supra note 41, at 7. report requirements, concentration limits, a 75. 143 Schell, supra note 101, at § 1.03[8] (‘‘The contingent capital requirement, enhanced public 139 disclosures, short-term debt limits, and overall risk In proposing an exemption for advisers to typical Venture Capital Fund calls for Capital management requirements). See also G20 Working private equity funds, which would have required Contributions from time to time as needed for Group 1, Enhancing Sound Regulation and the Commission to define the term private equity investments.’’); id. at § 2.05[2] (stating that ‘‘[venture Strengthening Transparency, at iii–iv (March 25, fund, the Senate Banking Committee noted the capital funds] begin operation with Capital 2009) (‘‘G20 Working Group Report’’), at iii (noting difficulties in distinguishing some private equity Commitments but no meaningful assets. Over a contribution to ‘‘market turmoil’’ when ‘‘the funds from hedge funds and expected the specific period of time, the Capital Commitments financial system developed new structures and Commission to exclude from the exemption private are called by the General Partner and used to created new instruments, some with embedded equity funds that raise significant potential acquire Portfolio Investments.’’). leverage.’’ Further, ‘‘[w]hile the build-up of leverage systemic risk concerns. S. Rep. No. 111–176, supra 144 See Loy Testimony, supra note 40, at 5 and the underpricing of credit risk were recognized note 7, at 75. See also G20 Working Group Report, (‘‘[Limited partners] make their investment in a in advance of the turmoil, their extent was under- supra note 136, at 7 (noting that unregulated venture fund with the full knowledge that they appreciated and there was no coordinated approach entities such as hedge funds may contribute to generally cannot withdraw their money or change to assess the implications of these systemic risks systemic risks through their trading activities). their commitment to provide funds. Essentially they ***’’); International Monetary Fund, Lessons of 140 See Loy Testimony, supra note 40, at 7 agree to ‘‘lock-up’’ their money for the life of the the Global Crisis for Macroeconomic Policy, (‘‘[V]enture capital firms do not generally rely on fund.’’). See also Stephanie Breslow & Phyllis February 19, 2009, at 6 (noting how ‘‘[l]everage short-term funding. In fact, quite the opposite is Schwartz, Private Equity Funds, Formation and * * * increases lender exposure by magnifying the true.’’); Schell, supra note 101, at § 1.03[6] (‘‘Venture Operation 2010 (‘‘Breslow & Schwartz’’), at § 2:5.6 impact of a price adjustment on borrowers’ balance Capital Funds rarely have the ability to borrow (discussing the various remedies that may be sheets and, thus on banks’ losses and capital.’’). See money, other than short-term loans to cover imposed in the event an investor fails to fund its generally Department of Treasury, Financial Partnership Expenses or to ‘bridge’ Capital contractual capital commitment, including, but not Regulatory Reform, A New Foundation: Rebuilding Contributions.’’); Heesen, supra note 104, at 17. limited to, ‘‘the ability to draw additional capital Financial Supervision and Regulation, June 2009, 141 See, e.g., Financial Crisis Inquiry Commission, from non-defaulting investors;’’ ‘‘the right to force a available at http://www.financialstability.gov/docs/ Preliminary Staff Report, Shadow Banking and the sale of the defaulting partner’s interests at a price regs/FinalReport_web.pdf. Financial Crisis (May 4, 2010). determined by the general partner;’’ and ‘‘the right

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capital funds are subject to investment borrowings in excess of 10 to 15 percent requirements.151 These events may be restrictions, and calculate fees payable of the fund’s total capital contributions ‘‘foreseeable’’ because they are to an adviser, as a percentage of the total and uncalled capital commitments.147 circumstances that are known to occur capital commitments of investors, We believe that imposing a maximum at (e.g., changes in law, corporate events regardless of whether or not the capital the upper range of borrowings typically such as mergers) but are unexpected in commitment is ultimately funded by an used by venture capitals may their timing or scope. Thus, withdrawal investor.145 Venture capital fund accommodate existing practices of the or exclusion rights might be triggered by advisers typically report and market vast majority of industry participants. a change in the tax law after an investor themselves to investors on the basis of invests in the fund, or the enactment of aggregate capital commitment amounts 3. No Redemption Rights laws that may prohibit an investor’s raised for prior or existing funds.146 participation in the fund’s investment in These factors would lead to the Proposed rule 203(l)-1 would define a particular countries or industries.152 conclusion that, in contrast to other venture capital fund as a fund that The trigger events for these rights are types of private funds, such as hedge issues securities that do not provide typically beyond the control of the funds, which trade on a more frequent investors redemption rights except in adviser and fund investor (e.g., tax and basis, a venture capital fund would view ‘‘extraordinary circumstances’’ but that regulatory changes). the fund’s total capital commitments as do entitle investors generally to receive For these purposes, for example, a the primary metric for managing the pro rata distributions.148 Unlike hedge fund that permits quarterly or other fund’s assets and for determining funds, venture capital funds do not periodic withdrawals would be compliance with investment guidelines. typically permit investors to redeem considered to have granted investors Hence, we believe that calculating the their interests during the life of the redemption rights in the ordinary course leverage threshold to include uncalled fund,149 but rather distribute assets even if those rights may be subject to an capital commitments is appropriate, generally as investments mature.150 initial lock-up or suspension or given that capital commitments are Although venture capital funds restrictions on redemption. Is the phrase already used by venture capital funds typically return capital and profits to ‘‘extraordinary circumstances’’ themselves to measure investment investors only through pro rata sufficiently clear to distinguish the guideline compliance. distributions, such funds may also investor liquidity terms of venture The proposed 15 percent threshold provide extraordinary rights for an capital funds, as they operate today, would be determined based on the investor to withdraw from the fund from hedge funds? Congressional venture capital fund’s aggregate capital under foreseeable but unexpected commitments. In practice, this means circumstances or rights to be excluded 151 See Hedge Fund Adviser Registration Release, that a venture capital fund relying on supra note 17, at n.240 and accompanying text from particular investments due to (‘‘Many partnership agreements provide the investor the exemption could leverage an regulatory or other legal the opportunity to redeem part or all of its investment transaction up to 100 investment, for example, in the event continuing to hold the investment became impractical or illegal, percent when acquiring equity 147 securities of a particular portfolio See Loy Testimony, supra note 40, at 6 in the event of an owner’s death or total disability, (‘‘[M]any venture capital funds significantly limit in the event key personnel at the fund adviser die, company as long as the investment borrowing such that all outstanding capital become incapacitated, or cease to be involved in the amount does not exceed 15 percent of borrowed by the fund, together with guarantees of management of the fund for an extended period of the fund’s total capital commitments, portfolio company indebtedness, does not exceed time, in the event of a merger or reorganization of albeit on a short-term basis that did not the lesser of (i) 10–15% of total limited partner the fund, or in order to avoid a materially adverse commitments to the fund and (ii) undrawn limited tax or regulatory outcome. Similarly, some exceed 120 days. Should the 15 percent partner commitments.’’). investment pools may offer redemption rights that calculation be determined with respect 148 Proposed rule 203(l)–1(a)(5) (limiting venture can be exercised only in order to keep the pool’s to the total investment amount for each capital funds to funds that ‘‘[o]nly issue[] securities assets from being considered ‘plan assets’ under portfolio company? Would this standard the terms of which do not provide a holder with ERISA [Employee Retirement Income Security Act be easier to apply? any right, except in extraordinary circumstances, to of 1974].’’). See, e.g., Breslow & Schwartz, supra withdraw, redeem or require the repurchase of such note 144, at § 2:14.1 (‘‘Private equity funds generally Our proposed rule defines a venture securities but may entitle holders to receive provide for mandatory withdrawal of a limited capital fund by reference to a maximum distributions made to all holders pro rata’’). partner [i.e., investor] only in the case where the of 15 percent of borrowings based on 149 See Schell, supra note 101, at § 1.03[7] continued participation by a limited partner in a our understanding that venture capital (venture capital fund ‘‘redemptions and fund would give rise to a regulatory or legal withdrawals are rarely allowed, except in the case violation by the investor or the fund (or the general funds typically would not incur of legal compulsion’’); Breslow & Schwartz, supra partner [i.e., adviser] and its affiliates). Even then, note 144, at § 2:14.2 (‘‘the right to withdraw from it is often possible to address the regulatory issue to take any other action permitted at law or in the fund is typically provided only as a last resort’’). by excusing the investor from particular equity’’). 150 Loy Testimony, supra note 40, at 2–3 (‘‘As investments while leaving them otherwise in the 145 See, e.g., Breslow & Schwartz, supra note 144, portfolio company investments are sold in the later fund.’’). at § 2:5.7 (noting that a cap of 10% to 25% of years of the [venture capital] fund—when the 152 See, e.g., Breslow & Schwartz, supra note 144, remaining capital commitments is a common company has grown so that it can access the public at § 2:14.2 (‘‘The most common reason for allowing limitation on follow-on investments). See also markets through an initial public offering (an IPO) withdrawals from private equity funds arises in the Schell, supra note 101, at § 1.01 (noting that capital or when it is an attractive target to be bought—the case of an ERISA violation where there is a contributions made by the investors are used to liquidity from these ‘exits’ is distributed back to the substantial likelihood that the assets of the fund ‘‘make investments * * * in a manner consistent limited partners. The timing of these distributions would be treated as ‘plan assets’ of any ERISA with the investment strategy or guidelines is subject to the discretion of the general partner, partner for purposes of Title I of ERISA or section established for the Fund.’’); id. at § 1.03 and limited partners may not otherwise withdraw 4975 of the Code.’’). See also Schell, supra note 101, (‘‘Management fees in a Venture Capital Fund are capital during the life of the venture [capital] at § 9.04[3] (‘‘Exclusion provisions allow the usually an annual amount equal to a fixed fund.’’). Id. at 5 (Investors ‘‘make their investment General Partner to exclude a Limited Partner from percentage of total Capital Commitments.’’); see also in a venture [capital] fund with the full knowledge participation in any or all investments if a violation Dow Jones, Private Equity Partnership Terms and that they generally cannot withdraw their money or of law or another material adverse effect would Conditions, 2007 edition (‘‘Dow Jones Report’’) at change their commitment to provide funds. otherwise occur.’’); id. at Appendix D–31 (attaching 15. Essentially they agree to ‘lock-up’ their money for model limited partnership agreement providing 146 See, e.g., NVCA Yearbook 2010, supra note 41, the life of the fund, generally 10 or more years as ‘‘The General Partner at any time may cancel the at 16; John Jannarone, Private Equity’s Cash I stated earlier.’’). See also Dow Jones Report, supra obligations of all Partners to make Capital Problem, Wall St. J., June 23, 2010, http:// note 145, at 60 (noting that an investor in a private Contributions for Portfolio Instruments if * * * online.wsj.com/article/SB10001424052748704853 equity or venture capital fund typically does not changes in applicable law * * * make such 404575323073059041024.html#printMode. have the right to transfer its interest). cancellation necessary or advisable. * * * ’’).

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testimony cited an investor’s inability to funds that do not significantly differ capital funds from other types of private withdraw from a venture capital fund as from the common understanding of equity or private funds.162 For example, a key characteristic of venture capital what a venture capital fund is,157 and testimony presented to Congress funds and a factor for reducing their that are actually offered to investors as indicated that venture capital funds potential for systemic risk.153 Although venture capital funds, should qualify for typically have capital contributions a fund prohibiting redemptions would the exemption. Thus, an adviser to a from their advisers, generally up to five be a venture capital fund for purposes venture capital fund that is otherwise percent of the fund’s total capital of the exemption, the rule does not relying on the exemption could not commitments.163 Congress also received specify a minimum period of time for an identify the fund as a hedge fund or testimony that venture capital funds are investor to remain in the fund. Should multi-strategy fund (i.e., venture capital generally not open to retail investors,164 the rule define when withdrawals by is one of several strategies used to have long investment periods, generally investors would be ‘‘extraordinary?’’ manage the fund) or include the fund in of at least ten years,165 and contribute to Should the rule specify minimum a hedge fund database or hedge fund the U.S. economy by creating jobs, investment periods for investors? Could index. fostering competition and facilitating venture capital funds provide investors We request comment on a venture innovation.166 with ‘‘extraordinary’’ rights to redeem capital fund’s representations regarding Are any of these characteristics that could effectively result in itself as a criterion under the proposed appropriate to include as elements in redemption rights in the ordinary definition. Is our criterion inconsistent the definition? If so, which elements course? 154 Should we address this with current practice? Does the should be included and what would be potential for circumvention of the proposed criterion regarding venture appropriate thresholds for application? definition by establishing a maximum capital fund representations adequately Do venture capital advisers typically amount that may be redeemed during address our concern that advisers invest in the funds they manage? any period of time (e.g., 10 percent of should not be eligible for the exemption Should we modify the proposed rule to an investor’s total capital if they advise funds that otherwise meet include as a condition that advisers commitments)? Would such a limit the definitional criteria in the rule but relying on the exemption under section constrain investors in a way so as to engage in activities that do not 203(l) would invest in the venture prevent them from complying with constitute venture capital investing? capital fund at a specified minimum other legal or regulatory requirements? 5. Is a Private Fund threshold? If so, what is an appropriate investment threshold—less than one 4. Represents Itself as a Venture Capital We propose to define a venture Fund percent, one percent, three percent, five capital fund for the purposes of the percent, or somewhere in between? Proposed rule 203(l)–1 would limit exemption as a private fund, which is 158 Should the proposed rule be modified to the definition of venture capital fund for defined in the Advisers Act, and specify that venture capital funds have the purposes of the exemption to a exclude from the proposed definition a minimum term, for example, of 10 private fund that represents itself as funds that are registered investment being a venture capital fund to its companies (e.g., mutual funds) or have 162 See, e.g., Heesen, supra note 104 (generally investors and potential investors.155 A elected to be regulated as BDCs.159 describing characteristics that distinguish venture private fund could satisfy this There is no indication that Congress capital funds from hedge funds and buyout funds). definitional element by, for example, intended this exemption to apply to 163 See Loy Testimony, supra note 40, at 2 describing its investment strategy as advisers to these publicly available (‘‘[g]enerally, 95 to 99 percent of capital for the venture fund is provided by * * * investors * * * 160 venture capital investing or as a fund funds, referring to venture capital and we supply the rest of the capital for the fund that is managed in compliance with the funds as a ‘‘subset of private investment from our own personal assets’’); McGuire elements of our proposed rule. Without funds.’’ 161 We request comment on this Testimony, supra note 41, at 3. Industry data this element, a fund that did not engage requirement and whether it confirm that such investments are typical in the venture capital industry. See, e.g., Dow Jones in typical venture capital activities appropriately reflects the expectation of Report, supra note 145, at 23–24 (showing that, in could be treated as a venture capital Congress. a survey of 110 North American general partners, fund simply because it met the other at least 83% contributed at least 1% of venture elements specified in our proposed rule 6. Other Factors capital fund capital). We note that certain investors We request comment on whether the perceive an investment in the fund as aligning the (because for example it only invests in interest of investors and advisers. See Institutional short term Treasuries, controls portfolio proposed rule should include other Limited Partners Association Private Equity companies, does not borrow, does not elements that were described in Principles, September 9, 2009, at 3 (recommending offer investors redemption rights, and is testimony as characteristic of venture that the ‘‘general partner should have a substantial capital funds or that distinguish venture equity interest in the fund to maintain a strong not a registered investment alignment of interest with the limited partners, and 156 company). We believe that only a high percentage of the amount should be in cash 157 See Gompers, supra note 110, at 6–7. as opposed to being contributed through the waiver 153 See supra notes 149–150 and accompanying 158 See section 202(a)(29) of the Advisers Act. of the management fee.’’); Mercer Investment text. 159 Proposed rule 203(l)–1(a)(6). Consulting, Inc., Key Terms and Conditions for 154 For example, a private fund’s governing 160 Legislative history does not indicate that Private Equity Investing, 1996 at 13 (‘‘Many limited documents may provide that investors do not have Congress addressed this matter, nor does testimony partners view the 1% standard as an inadequate any right to redeem without the consent of the before Congress suggest that this was contemplated. sharing of risk * * * .’’). general partner. In practice, if the general partner See, e.g., McGuire Testimony, supra note 41, at 3 164 See McGuire Testimony, supra note 41, at 3 typically permits investors to redeem or transfer (noting that venture capital funds are not directly (‘‘Venture capital funds are not sold directly to retail their otherwise non-redeemable, non-transferable accessible by individual investors); Loy Testimony, investors like mutual funds.’’); Loy Testimony, interests on a periodic basis, then the fund would supra note 40, at 2 (‘‘Generally * * * capital for the supra note 40, at 2 (‘‘Generally, 95 to 99 percent of not be considered to have issued securities that ‘‘do venture fund is provided by qualified institutional capital for the venture fund is provided by qualified not provide a holder with any right, except in investors such as pension funds, universities and institutional investors such as pension funds, extraordinary circumstances, to withdraw.’’ endowments, private foundations, and to a lesser universities and endowments, private foundations, 155 Proposed rule 203(l)–1(a)(1). extent, high net worth individuals.’’). See generally and to a lesser extent, high net worth individuals.’’). 156 We also note that a fund that represents to supra note 158 (definition of ‘‘private fund’’). 165 See Loy Testimony, supra note 40, at 2; investors that it is one type of fund while pursuing 161 See S. Rep. No. 111–176, supra note 7, at 74 McGuire Testimony, supra note 41, at 3. a different type of fund strategy may raise concerns (describing venture capital funds as a subset of 166 See Loy Testimony, supra note 40, at 4; under rule 206(4)–8 of the Advisers Act. ‘‘private investment funds’’). McGuire Testimony, supra note 41, at 5.

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years? Should the proposed rule be residents of the United States.172 A non- fund that does not make such a U.S. modified to specify that a venture U.S. adviser may rely on the venture offering would not be a private fund and capital fund is one that does not have capital exemption if all of its clients, therefore could not qualify as a venture retail investors? If so, how should ‘‘retail whether U.S. or non-U.S., are venture capital fund, even if operated as a investor’’ be defined? Should ‘‘retail capital funds. In effecting the new venture capital fund in a manner that investor’’ exclude persons who are not venture capital exemption, should we would otherwise meet the criteria under ‘‘qualified clients’’ for purposes of the specifically provide that a non-U.S. our proposed definition. If we adopt the Advisers Act?167 adviser may avail itself of the exemption approach we are proposing today, even if it advises clients other than should we allow an adviser to treat such 7. Application to Non-U.S. Advisers venture capital funds, provided such a non-U.S. fund as a private fund and, to the extent that the fund meets all of Neither the statutory text of section clients are non-United States persons, the other conditions of our proposed 203(l) nor the legislative reports gives an under the definition we propose for definition, as a venture capital fund for indication of whether Congress purposes of the other exemptions 173 purposes of the exemption? If so, under intended the exemption to be available discussed below? If we take this approach, should the non-U.S. adviser what conditions? For example, should a to advisers that operate principally non-U.S. fund be a private fund under outside of the United States but that be able to rely on the venture capital exemption if it advises these other the proposed rule if the non-U.S. fund invest in U.S. companies or solicit U.S. would be deemed a private fund upon investors.168 Testimony before Congress clients from within the United States? If a non-U.S. adviser must advise conducting a private offering in the presented by members of the U.S. solely venture capital funds (even those United States in reliance on sections venture capital industry discussed the advisers that principally operate outside 3(c)(1) or 3(c)(7)? industry’s role primarily in the U.S. of the United States) our proposed economy including its lack of 8. Grandfathering Provision definition may have the result of interconnection with the U.S. financial subjecting non-U.S. advisers to United We propose to include in the markets and ‘‘interdependence’’ with the ‘‘ ’’ States regulatory oversight because they definition of venture capital fund any world financial system.169 Nevertheless, advise funds offered only outside the private fund that: (i) Represented to we expect that venture capital funds United States. Under our proposed rule, investors and potential investors at the with advisers operating principally only a private fund as defined under time the fund offered its securities that outside of the United States may seek to section 202(a)(29) may be a venture it is a venture capital fund; (ii) has sold access the U.S. capital markets by securities to one or more investors prior capital fund.174 A non-U.S. fund that to December 31, 2010; and (iii) does not investing in U.S. companies or soliciting uses U.S. jurisdictional means in the sell any securities to, including U.S. investors; investors in the United offering of the securities it issues and accepting any additional capital States may also have an interest in relies on sections 3(c)(1) or 3(c)(7) commitments from, any person after venture capital opportunities outside of would be a private fund.175 A non-U.S. the United States. We request comment July 21, 2011 (the ‘‘grandfathering ’’ 176 on whether the proposed rule should 172 See rule 203(b)(3)–1(a)(2). See also ABA provision ). The grandfathering specify that an adviser with its principal Subcommittee on Private Investment Companies, provision thus would include any fund office and place of business outside of SEC Staff No-Action Letter (Aug. 10, 2006) (‘‘ABA that has accepted capital commitments the United States (a ‘‘non-U.S. adviser’’) Letter’’). In the ABA Letter, Commission staff by the specified dates even if none of expressed the view that the substantive provisions 177 is eligible to rely on the exemption even of the Advisers Act do not apply to offshore the commitments has been called. As if it advises funds that do not meet our advisers with respect to such advisers’ dealings a result, any investment adviser that proposed definition of venture capital with offshore funds and other offshore clients to the solely advises private funds that meet fund. extent described in prior staff no-action letters and the definitions in either proposed rule the Hedge Fund Adviser Registration Release, supra 203(l)–1(a) or (b) would be exempt from A non-U.S. adviser currently may rely note 17. The staff took the position, however, that registration. on the private adviser exemption, if it an offshore adviser registered with the Commission under the Advisers Act must comply with the We believe that most funds previously meets the conditions of current section Advisers Act and the Commission’s rules sold as venture capital funds likely 203(b)(3) of the Advisers Act, including thereunder with respect to any U.S. clients (and any would satisfy all or most of the 170 prospective U.S. clients) it may have. advising no more than 14 clients. We conditions in the proposed rule. have permitted such an adviser to count 173 See proposed rule 203(m)–1(e)(8); proposed only clients that are residents of the rule 202(a)(30)–1(c)(2)(i). 174 See proposed rule 203(l)–1(a). FR 14648 (Mar. 26, 1999)], at nn.10, 20, 23; 171 United States, and for this purpose 175 An issuer that is organized under the laws of Statement of the Commission Regarding Use of permitted the adviser to treat a private the United States or of a state is a private fund if Internet Web Sites to Offer Securities, Solicit fund incorporated outside of the United it is excluded from the definition of an investment Securities Transactions or Advertise Investment Services Offshore, Securities Act Release No. 7516 States as a non-resident of the United company for most purposes under the Investment Company Act pursuant to sections 3(c)(1) or 3(c)(7). (Mar. 23, 1998) [63 FR 14806 (Mar. 27, 1998)], at States, even if some or all of the Section 7(d) of the Investment Company Act n.41. See also Dechert LLP, SEC Staff No-Action investors in the private fund are prohibits a non-U.S. fund from using U.S. Letter (Aug. 24, 2009) at n.8; Goodwin, Procter & jurisdictional means to make a public offering, Hoar LLP, SEC Staff No-Action Letter (Feb. 28, absent an order permitting registration. A non-U.S. 1997) (‘‘Goodwin Procter Letter’’); Touche Remnant 167 Rule 205–3 generally defines a qualified client fund may conduct a private U.S. offering without & Co., SEC Staff No-Action Letter (Aug. 27, 1984). as any person who has at least $750,000 under violating section 7(d) only if the fund complies with 176 Proposed rule 203(l)–1(b). management with an adviser immediately after either section 3(c)(1) or 3(c)(7) with respect to its 177 See also Electronic Filing and Revision of entering into the contract or who has a net worth U.S. investors (or some other available exemption Form D, Securities Act Release No. 8891(Feb. 6, of more than $1,500,000 at the time the contract is or exclusion). Consistent with this view, a non-U.S. 2008) [73 FR 10592 (Feb. 27, 2008)], at section VIII, entered into. fund is a private fund if it makes use of U.S. Form D, General Instructions—When to File (noting 168 See section 203(l) of the Advisers Act; H. Rep. jurisdictional means to, directly or indirectly, offer that a Form D is required to be filed within 15 days No. 111–517, supra note 7, at 867; S. Rep. No. 111– or sell any security of which it is the issuer and of the first sale of securities which would include 176, supra note 7, at 74–75. relies on either section 3(c)(1) or 3(c)(7). See Hedge ‘‘the date on which the first investor is irrevocably 169 See Loy Testimony, supra note 40, at 4–5; Fund Adviser Registration Release, supra note 17, contractually committed to invest’’), n.159 (‘‘a McGuire Testimony, supra note 41, at 5–6. at n.226; Offer and Sale of Securities to Canadian mandatory capital commitment call would not 170 See supra note 5 and accompanying text. Tax-Deferred Retirement Savings Accounts, constitute a new offering, but would be made under 171 See rule 203(b)(3)–1(b)(5). Securities Act Release No. 7656 (Mar. 19, 1999) [64 the original offering’’).

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Nevertheless, we recognize that equity securities,180 or provide 1. Advises Solely Private Funds investment advisers currently seeking to significant managerial assistance to the Proposed rule 203(m)–1 would, like sponsor new funds before the adoption portfolio companies in which the fund section 203(m) of the Advisers Act, limit 181 of the final version of proposed rule invests? Should the grandfathering an adviser relying on the exemption to 203(l)–1 will continue to face provision be modified to exclude other advising ‘‘private funds’’ as that term is uncertainty regarding the precise terms types of funds, such as funds of venture defined in that Act.185 An adviser that of the definition and hence uncertainty capital funds or publicly available acquires a different type of client would regarding their eligibility for the new venture capital funds? 182 We have to register under the Advisers Act exemption. Thus, our proposed rule understand that venture capital funds unless another exemption is available. presumes that a fund that has may be in the planning and initial An adviser could advise an unlimited commenced its offering (i.e., has offering stage for a considerable period number of private funds, provided the initially sold securities by December of time.183 Should funds that have their aggregate value of the adviser’s private 2010) and that also concludes its first sale of securities within a period of fund assets is less than $150 million. offering by the effective date of Title IV time such as 180 days after the final rule In the case of an adviser with a of the Dodd-Frank Act (i.e., July 21, is adopted be able to rely on the principal office and place of business 2011) is unlikely to have been proposed grandfathering provision? outside of the United States (a ‘‘non-U.S. structured to circumvent the intended Does our grandfathering provision adviser’’), we propose to provide the scope of the exemption. Moreover, unnecessarily encourage the formation exemption as long as all of the adviser’s requiring existing venture capital funds of new funds before December 31, 2010, clients that are United States persons to modify their investment conditions or and therefore should the grandfathering are qualifying private funds.186 As a characteristics, liquidate portfolio provision only apply to funds in consequence, a non-U.S. adviser could company holdings or alter the rights of existence on the date of this proposal or enter the U.S. market and take investors in the funds in order to satisfy some other time before December 31, advantage of the exemption without the proposed definition of a venture 2010? Would the dates specified in the regard to the type or number of its non- capital fund would likely be impossible grandfathering provision significantly U.S. clients. Under this approach, a in many cases and yield unintended shorten the fundraising periods for non-U.S. adviser would not lose the consequences for the funds and their venture capital funds? Should we private fund adviser exemption as a investors. specify a date later than December 31, result of its business activities outside Thus, we propose that an investment 2010 or earlier than July 21, 2011? Do the United States. Recognizing that non- adviser may treat any existing private venture capital fund advisers need more U.S. activities of non-U.S. advisers are fund as a venture capital fund for time or flexibility to determine less likely to implicate U.S. regulatory purposes of section 203(l) of the eligibility for the grandfathering interests and in consideration of general Advisers Act if the fund meets the provision? Alternatively, would exempt principles of international comity, our elements of the grandfathering advisers consider registering with the rules have taken a similar approach by provision. The current private adviser Commission in order to retain flexibility permitting a non-U.S. adviser to count exemption does not require an adviser to raise capital for new venture capital only clients that are U.S. persons when to identify or characterize itself as any funds without regard to the determining whether it has 14 or fewer type of adviser (or impose limits on grandfathering provision? clients, and is thus eligible for the advising any type of funds). 187 B. Exemption for Investment Advisers private adviser exemption. Accordingly, we believe that advisers We request comment on our proposed Solely to Private Funds With Less Than have not had an incentive to mis- application of the statute to non-U.S. $150 Million in Assets Under characterize existing venture capital advisers. Should we, alternatively, Management funds that have already been marketed interpret section 203(m) as denying the to investors. As we note above, a fund Section 203(m) of the Advisers Act private fund adviser exemption to a that ‘‘represents’’ itself to investors as a directs the Commission to exempt from non-U.S. adviser that has other types of venture capital fund is typically one registration any investment adviser clients outside of the United States? that discloses it pursues a venture solely to private funds that has less than This interpretation would have the capital investing strategy and identifies $150 million in assets under effect of treating non-U.S. and U.S. itself as such. We do not expect funds management in the United States.184 We advisers equally with respect to the identifying themselves as ‘‘private are proposing a new rule 203(m)–1 that types of clients they may have, but equity’’ or ‘‘hedge’’ would be able to rely would provide the exemption and could also have the result of requiring on this exemption. address several interpretive questions many non-U.S. advisers to register We request comment on this because of the scope and nature of their grandfathering provision. Should we raised by section 203(m). We will refer ‘‘ non-U.S. advisory business, an outcome include other conditions in addition to to this exemption as the private fund adviser exemption.’’ which the ‘‘assets under management in the fund representing itself as a venture the United States’’ limitation in section capital fund? For example, should a 203(m) suggests was not a consideration fund seeking to be grandfathered also 180 See proposed rule 203(l)–1(a)(1); supra discussion in section II.A.1.b of this Release. relevant to the scope of the exemption. provide that its investors do not have 181 See proposed rule 203(l)–1(a)(3); supra any redemption rights except in discussion in section II.A.2 of this Release. 185 See proposed rule 203(m)–1(a) and (b). A extraordinary circumstances,178 not 182 See supra discussion in sections II.A.1.e and ‘‘private fund’’ includes a private fund that invests incur leverage except on a short-term II.A.6 of this Release. in other private funds. basis,179 limit the securities that it 183 See Breslow & Schwartz, supra note 144, at 186 Proposed rule 203(m)–1(b)(1). acquires from portfolio companies to § 2:4.1 (private equity fundraising may take six to 187 Rule 203(b)(3)–1(b)(5) (‘‘If you have your 12 months following the initial closing, depending principal office and place of business outside the upon whether the adviser has an existing investor United States, you are not required to count clients 178 See proposed rule 203(l)–1(a)(5); supra base or a successful performance record). that are not United States residents, but if your discussion in section II.A.4 of this Release. 184 Section 408 of the Dodd-Frank Act, which is principal office and place of business is in the 179 See proposed rule 203(l)–1(a)(4); supra codified in section 203(m) of the Advisers Act. See United States, you must count all clients.’’). See discussion in section II.A.3 of this Release. supra note 22. infra note 207.

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Under such an approach, moreover, the in anticipation of all investors fully Some private funds do not use fair value exemption would be unavailable to a paying in these capital commitments methodologies, which may be more non-U.S. adviser unless all of the non- during the life of the fund, and fees difficult to apply when the fund holds U.S. funds it manages are offered to payable to the adviser are calculated as illiquid or other types of assets that are investors in the United States (and a percentage of total capital not traded on organized markets.197 therefore meet the definition of ‘‘private commitments.193 Many of these types of Would the proposed approach result in fund’’).188 If we adopt this alternative private funds are managed following advisers valuing their private fund approach, should the exemption apply investment guidelines and restrictions assets in a generally uniform manner to a non-U.S. adviser even if not all of that are determined as a percentage of and in comparability of the valuations? the non-U.S. funds it manages are overall capital commitments, rather We are not proposing to require advisers offered in the United States? than as a percentage of current net asset to determine fair value in accordance 194 with GAAP. Should we adopt such a 2. Private Fund Assets value. We request comment on whether the method for calculating the requirement? If not, should we specify Under proposed rule 203(m)–1, an relevant assets under management that advisers may only determine the adviser would have to aggregate the should deviate from the method in the fair value of private fund assets in value of all assets of private funds it proposed amendments to Form ADV accordance with a body of accounting manages in the United States to instructions by, for example, excluding principles used in preparing financial determine if the adviser remains below proprietary assets, assets managed statements? We understand that GAAP 189 the $150 million threshold. Proposed without compensation, or uncalled does not require some funds to fair rule 203(m)–1 would require advisers to capital commitments. value certain investments. Should we calculate the value of private fund assets Under proposed rule 203(m)–1, each provide for an exception from the by reference to Form ADV, under which adviser would have to determine the proposed fair valuation requirement we propose to provide a uniform amount of its private fund assets with respect to any of those method of calculating assets under quarterly, based on the fair value of the investments? management for regulatory purposes 195 Should we adopt a different approach 190 assets at the end of the quarter. We under the Advisers Act. In the case propose that advisers use the fair value altogether and allow advisers to use a of a sub-adviser, it would have to count of private fund assets in order to ensure method other than fair value? Are there only that portion of the private fund other methods that would not 191 that, for purposes of this exemption, assets for which it has responsibility. advisers value private fund assets on a understate the value of fund assets? In addition to assets appearing on a meaningful and consistent basis. Use of Should the rule permit advisers to rely private fund’s balance sheet, advisers the cost basis (i.e., the value at which exclusively on the method set forth in would include any uncalled capital the assets were originally acquired), for a fund’s governing documents, or the commitments, which are contractual example, could under certain method used to report the value of obligations of an investor to acquire an circumstances understate significantly assets to investors or to calculate fees (or interest in, or provide the total the value of appreciated assets, and thus other compensation) for investment commitment amount over time to, a result in advisers availing themselves of advisory services? What method should private fund, when called by the the exemption. Use of the fair valuation apply if a fund uses different methods fund.192 Advisers to private funds that method by all advisers, moreover, for different purposes? Should we use capital commitments seek would result in more consistent asset modify the proposed rule to require that investments early in the life of the fund calculations and reporting across the the valuation be derived from audited financial statements or subject to review 188 See supra note 174–175 and accompanying industry and, therefore, in a more coherent application of the Advisers paragraph. financial reports. These reports are prepared under 189 Proposed rule 203(m)–1(c). Act’s regulatory requirements and of our generally accepted accounting principles, or GAAP, 190 See proposed rules 203(m)–1(a)(2); 203(m)– staff’s risk assessment program. and audited under the standards established for all 1(b)(2); 203(m)–1(e)(1) (defining ‘‘assets under We understand that many, but not all, investment companies, including the largest mutual management’’ to mean ‘‘regulatory assets under private funds value assets based on their fund complexes.’’); Comment Letter of Managed management’’ in proposed item 5.F of Form ADV, Funds Association (July 28, 2009), at 3 (a Part 1A); 203(m)–1(e)(4) (defining ‘‘private fund fair value in accordance with U.S. ‘‘substantial proportion of hedge fund managers, assets’’ to mean the assets under management generally accepted accounting whether or not they are registered with the attributable to a qualifying private fund). This principles (‘‘GAAP’’) or other Commission, provide independently audited uniform method of calculation would be used to international accounting standards.196 financial statements of the [hedge] fund to determine whether an adviser qualifies to register investors.’’). These comment letters were submitted with the Commission rather than the states, as well in connection with the Commission’s proposed as to determine eligibility for the private fund 193 See supra notes 143–145. amendments to the custody rule, Custody of Funds adviser exemption and the foreign private adviser 194 Id. or Securities of Clients by Investment Advisers, exemption discussed in this Release. Under the 195 See proposed rule 203(m)–1(c); supra note Investment Advisers Act Release No. 2876 (May 20, proposed Form ADV instructions, advisers would 190; proposed Form ADV: Instructions for Part 1A, 2009) [74 FR 25354 (May 27, 2009)], and are include in their ‘‘regulatory assets under instr. 5.b(4). As discussed in the Implementing available on the Commission’s Internet Web site at management’’ any proprietary assets, assets Release, we are proposing to require advisers to http://www.sec.gov/comments/s7–09–09/ managed without receiving compensation, and value private fund assets using fair value when s70909.shtml. assets of non-U.S. clients, all of which an adviser calculating their assets under management for 197 Those assets include, for example, ‘‘distressed may currently exclude, as well as, in the case of several purposes under the Advisers Act. See debt’’ (such as securities of companies or private funds, uncalled capital commitments. Implementing Release, supra note 25, at section government entities that are either already in Moreover, the adviser could not deduct liabilities, II.A.3. A fund’s governing documents may provide default, under bankruptcy protection, or in distress such as accrued fees and expenses or the amount for a specific process for calculating fair value (e.g., and heading toward such a condition) or certain of any borrowing. See Implementing Release, supra that the general partner, rather than the board of types of emerging market securities that are not note 25, at section II.A.3 (discussing the rationale directors, determines the fair value of the fund’s readily marketable. See Gerald T. Lins et al., Hedge underlying the proposed new instructions for assets). An adviser would be able to rely on such Funds and Other Private Funds: Reg and Comp calculating assets under management under Form a process also for purposes of calculating its assets § 5:22 (2009) (‘‘At any given time, some portion of ADV). under management. a hedge fund’s portfolio holdings may be illiquid 191 See proposed Form ADV: Instructions for Part 196 See, e.g., Comment Letter of National Venture and/or difficult to value. This is particularly the 1A, instr. 5.b(2). Capital Association (July 28, 2009), at 2 (the ‘‘vast case for certain types of hedge funds, such as those 192 See proposed Form ADV: Instructions for Part majority of venture capital funds provide their LPs focusing on distressed securities, activist investing, 1A, instr. 5.b(1). [i.e., investors] quarterly and audited annual etc.’’).

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by auditors or another independent Rule 203(m)–1 would deem all of the interpretation of the statute would treat third party? assets managed by an adviser to be U.S. advisers the same as non-U.S. As discussed above, we are proposing managed ‘‘in the United States’’ if the advisers, but would seem to ignore the that funds value assets no less adviser’s ‘‘principal office and place of fact that day-to-day management of frequently than quarterly, although such business’’ is in the United States. We some assets of the private fund does in values are not subject to quarterly would look to an adviser’s principal fact take place ‘‘in the United States,’’ reporting to us.198 As a consequence, office and place of business as the even though that management is short-term market value fluctuations location where the adviser controls, or ultimately controlled from outside of would not affect the availability of the has ultimate responsibility for, the the United States. Moreover, it would exemption between the ends of calendar management of private fund assets, and permit an adviser engaging in quarters. We request comment on our therefore as the place where all the substantial advisory activities in the proposed quarterly calculation. Should advisers’ assets are managed, although United States to escape our regulatory compliance with the $150 million day-to-day management of certain assets oversight merely because the adviser’s threshold be determined more or less may also take place at another location. principal office and place of business is frequently than quarterly? For purposes This approach is similar to the way we outside the United States. This of reporting on proposed amendments have identified the location of the consequence seems at odds not only on Form ADV, registered investment adviser for regulatory purposes under with section 203(m), but also with the advisers (and exempt reporting advisers) our current rules,202 which define an ‘‘foreign private adviser’’ exemption would be required to report their adviser’s principal office and place of discussed below in which Congress regulatory assets under management business as the location where it specifically set forth circumstances annually.199 Should the availability of ‘‘directs, controls and coordinates’’ its under which a non-U.S. adviser may be the exemption under proposed rule global advisory activities, regardless of exempt provided it does not have any 203(m)–1 be conditioned on annual the location where some of the advisory place of business in the United States, valuation rather than quarterly activities might occur.203 For most among other conditions.205 valuation? advisers, this approach would avoid We request comment on our proposed difficult attribution determinations that approach, which is similar to the way 3. Assets Managed in the United States would be required if assets are managed we have administered the current Under proposed rule 203(m)–1, all of by teams located in multiple private adviser exemption in section the private fund assets of an adviser jurisdictions, or if portfolio managers 203(b)(3) of the Advisers Act with with a principal office and place of located in one jurisdiction rely heavily respect to non-U.S. advisers. Under that business in the United States would be on research or other advisory services exemption (as discussed above), an considered to be ‘‘assets under performed by employees located in adviser with a principal office and place management in the United States,’’ even another jurisdiction. of business outside of the United States if the adviser has offices outside of the We considered but decided not to need only count clients that are United States.200 A non-U.S. adviser, propose an approach that would residents of the United States towards however, would need only count private presume that a non-U.S. adviser to the 14 client limit.206 As with other fund assets it manages from a place of private funds offered in the United Commission rules that adopt a territorial business in the United States toward the States would have no assets managed approach, the private adviser exemption $150 million asset limit under the from a location in the United States if is available to a non-U.S. adviser exemption.201 its principal office and place of business (regardless of its non-U.S. advisory is not ‘‘in the United States.’’204 Such an activities) in recognition of the fact that 198 The proposed frequency of the calculation is non-U.S. activities of non-U.S. advisers consistent with section 2(a)(41)(A) of the Insurance and Government Sponsored Enterprises, are less likely to implicate U.S. Investment Company Act, which specifies the May 7, 2009, at 3. These commenters propose an regulatory interests and in consideration valuation of the assets of an issuer for purposes of approach that looks to the location where the determining whether it meets the definition of primary business is conducted, which is similar to of general principles of international investment company under section 3 of that Act. our territorial approach. comity.207 This approach to the 199 See proposed rules 204–1(a) and 204–4(a) and 202 See rule 203A–3(c); rule 222–1. Both rules exemption is designed to encourage the proposed General Instruction 3 to Form ADV. See define ‘‘principal place of business’’ of an participation of non-U.S. advisers in the Implementing Release, supra note 25, at section investment adviser as the executive office of the II.B.3. See also Form ADV Release, supra note 132, investment adviser from which the officers, at 15 (‘‘Advisers must update the amount of their partners or managers of the investment adviser count towards the $150 million asset threshold assets under management annually (as part of their direct, control and coordinate the activities of the under the exemption. See proposed rule 203(m)– annual updating amendment) and make interim investment adviser. 1(b)(2). See also supra note 203 for the definition amendments only for material changes in assets 203 See proposed rule 203(m)–1(e)(3) (defining of ‘‘place of business’’ under proposed rule 203(m)– under management when they are filing an ‘other ‘‘principal office and place of business’’ as the 1(e)(2). than annual amendment’ for a separate reason.’’). adviser’s executive office from which the officers, 205 See section II.C of this Release. 200 Proposed rule 203(m)–1(a). The proposed rule partners, or managers of the adviser direct, control, 206 Rule 203(b)(3)–1(b)(5) (adviser with principal also would define the United States to have the and coordinate the adviser’s activities); proposed office and place of business outside of the United same meaning as in rule 902(l) of Regulation S rule 203(m)–1(e)(2) (defining ‘‘place of business,’’ by States not required to count clients that are not under the Securities Act, which is ‘‘the United reference to proposed rule 222–1(a), as (i) an office United States residents, but adviser with principal States of America, its territories and possessions, where the investment adviser regularly provides office and place of business is in the United States any State of the United States, and the District of investment advisory services, solicits, meets with, must count all clients). Our staff has taken the Columbia.’’ Proposed rule 203(m)–1(e)(7). or otherwise communicates with clients, and (ii) position that under the existing private adviser 201 Proposed rule 203(m)–1(b). Any assets any other location that it holds out to the general exemption, a non-U.S. adviser need not count its managed from a U.S. place of business for clients public as a place where those activities take place). non-U.S. clients, including an offshore fund, even other than private funds would make the exemption 204 Under our proposed rule, assets under if there are U.S. investors in the fund. See ABA unavailable. We understand that others have management for purposes of the exemption are Letter, supra note 172, at 2 and discussion infra supported a jurisdictional approach to regulation, those assets for which the adviser provides section II.C.1 of this Release. which focuses on the primary market in which an ‘‘continuous and regular supervisory or 207 See, e.g., Regulation S (adopting a territorial adviser conducts its business. See, e.g., G20 management services.’’ See proposed rule 203(m)– approach to offers and sales of securities); rule 15a– Working Group Report, supra note 136, at 16; 1(e)(1); proposed Form ADV: Instructions for Part 6 under the Exchange Act (17 CFR 240.15a–6) Testimony of W. Todd Groome, Chairman, The 1A, instr. 5.b(3). For a non-U.S. adviser, the assets (providing an exemption from U.S. registration for Alternative Investment Management Association, for which the adviser provides such services from non-U.S. broker-dealers who limit their activities before the House Subcommittee on Capital Markets, a place of business in the United States would and satisfy certain conditions).

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U.S. market by applying the U.S. the location where it manages the managers to private funds and their securities laws in a manner that does private funds. We note that this counsel must today be familiar with the not impose U.S. regulatory and approach could have the result that definition of ‘‘U.S. person’’ under operational requirements on an fewer non-U.S. advisers would be Regulation S in order to comply with adviser’s non-U.S. advisory business.208 eligible for the exemption if there are other provisions of the federal securities Should we adopt a different approach significant assets of U.S. investors in laws.217 We ask comment on the that more broadly applies the those funds that the advisers manage proposed use of the Regulation S availability of the private fund adviser from a non-U.S. location. This approach definition of U.S. person. Should we use exemption to U.S. advisers? We could could also mean that a U.S. adviser a different definition of United States treat U.S. and non-U.S. advisers alike, in managing assets from, for example, an person? We have previously suggested which case a U.S. adviser could exclude office in New York City, could manage that advisers may rely on an alternative assets it manages through non-U.S. substantially in excess of $150 million to Regulation S for certain types of offices. Under the proposed rule, would in assets of one or more private funds clients.218 Would that approach be less some or most advisers with non-U.S. as long as the investors in those funds prone to abuse or circumvention or branch offices re-organize those offices were not U.S persons. provide greater clarity? as subsidiaries in order to avoid Do commenters view either of these Proposed rule 203(m)–1 contains a attributing assets managed to the non- alternatives, separately or in special rule for discretionary accounts U.S. office? We understand that U.S. combination with our proposed maintained outside of the United States advisers that manage private fund assets approach, as more closely reflecting the for the benefit of United States in a non-U.S. country typically do so intent of Congress in using the term persons.219 Under the proposed rule, an through one or more separate ‘‘assets under management in the United adviser must treat a discretionary or subsidiaries organized in such non-U.S. States’’ and our regulatory interests? other fiduciary account as a United jurisdictions.209 If so, the proposed rule Would either alternative approach be States person if the account is held for may have a limited effect on multi- easier for advisers to comply with than the benefit of a United States person by national advisory firms, which for tax or the one we are proposing to adopt? a non-U.S. fiduciary who is a related business reasons keep their non-U.S. Would it be easier for investors to person of the adviser. An adviser could advisory activities separate from their understand the rationale for why an not rely on the exemption if it U.S. advisory activities. Is this adviser is eligible for the exemption established discretionary accounts for understanding correct? Such U.S. under the proposed approach or either the benefit of U.S. clients with an advisers would not generally have to of the alternative approaches? offshore affiliate that would then count the assets managed by the non- delegate the actual management of the U.S. affiliates under the proposed 4. United States Person account back to the adviser.220 We rule.210 Should our rule determine Under proposed rule 203(m)–1(b), a request comment on this special rule. ‘‘private fund assets’’ on an aggregated non-U.S. adviser could not rely on the Does our proposed rule adequately basis if, for example, U.S. and non-U.S. exemption if it advised any client that affiliates share advisory duties for a is a United States person other than a 217 For instance, our staff has generally taken the private fund, or if one affiliate provides 211 interpretive position that an investor that is not a private fund. We propose to define a U.S. person under Regulation S is not a U.S. person subadvisory services to another affiliate? ‘‘United States person’’ generally by when determining whether a non-U.S. private fund Alternatively, should we interpret incorporating the definition of a ‘‘U.S. meets the counting or qualification requirements ‘‘assets under management in the United person’’ in our Regulation S.212 that apply to U.S. beneficial owners or owners of States’’ by reference to the source of the a private fund under sections 3(c)(1) or 3(c)(7) of the Regulation S looks generally to the Investment Company Act. We understand that assets (i.e., U.S. private fund investors)? residence of an individual to determine many U.S. and non-U.S. advisers currently follow Under this approach, a non-U.S. adviser whether the individual is a United our staff’s guidance and rely on this definition would count the assets of private funds 213 when determining whether a pooled investment States person, and also addresses the vehicle qualifies as a private fund. See Goodwin attributable to U.S. investors towards circumstances under which a legal the $150 million threshold, regardless of Procter Letter, supra note 175; ABA Letter, supra person, such as a trust, partnership or a note 172. Advisers apply the Regulation S corporation, is a United States definition of ‘‘U.S. person’’ also for other purposes. 208 See generally Division of Investment person.214 Regulation S generally treats See infra note 259. Management, SEC, Protecting Investors: A Half 218 In connection with adopting rule 203(b)(3)–2 Century of Investment Company Regulation, May legal partnerships and corporations as under the Advisers Act, we previously noted that 1992, at 223–227 (recognizing that non-U.S. Unites States persons if they are commenters had suggested that we incorporate the advisers that registered with the Commission were organized or incorporated in the United definition of U.S. person from Regulation S. arguably subject to all of the substantive provisions Pending our reconsideration of the use of the of the Advisers Act with respect to their U.S. and States, and trusts by reference to the Regulation S definition, we indicated at the time 215 non-U.S. clients, which could result in inconsistent residence of the trustee. It treats that we would not object if advisers identified U.S. regulatory requirements or practices imposed by the discretionary accounts generally as persons by looking: ‘‘(i) In the case of individuals regulations of their local jurisdiction and the U.S. United States persons if the fiduciary is to their residence, (ii) in the case of corporations securities laws; in response, advisers could form 216 and other business entities to their principal office separate and independent subsidiaries but this a resident of the United States. and place of business, (iii) in the case of personal could result in U.S. clients having access to a We are proposing to incorporate trusts and estates to the rules set out in Regulation limited number of advisory personnel and reduced Regulation S because it would provide S, and (iv) in the case of discretionary or non- access by the U.S. subsidiary to information or a well-developed body of law that discretionary accounts managed by another research by non-U.S. affiliates). investment adviser to the location of the person for 209 See, e.g., James D. Rosener, Legal would, in our view, appropriately whose benefit the account is held.’’ See Hedge Fund Considerations for Establishing Operations in the address many of the questions that will Adviser Registration Release, supra note 17, at United States, Pepper Hamilton LLP, June 25, 2002, arise under rule 203(m)–1. Moreover, n.201. We reconsidered the use of Regulation S and http://www.pepperlaw.com/ concluded it is appropriate as modified in our publications_article.aspx?ArticleKey=186 (creating proposed rule. 211 Proposed rule 203(m)–1(b)(1). separate subsidiaries offers benefits, including the 219 Proposed rule 203(m)–1(e)(8). 212 Proposed rule 203(m)–1(e)(8). ability to offset profits from one subsidiary against 220 213 Under Regulation S, a discretionary account losses in another); see also Edward F. Greene, et al., 17 CFR 230.902(k)(1)(i). maintained by a non-U.S. fiduciary (such as an U.S. Regulation of the International Securities and 214 See, e.g., 17 CFR 230.902(k)(1) and (2). investment adviser) is not a ‘‘U.S. person’’ even if Derivatives Markets, § 11.02[2]. 215 17 CFR 230.902(k)(1)(ii) and (iv). the account is owned by a U.S. person. See rule 210 See infra note 270. 216 17 CFR 230.902(k)(1)(vii). 902(k)(1)(vii); rule 902(k)(2)(i).

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address the concern that an adviser exemption is codified as amended addition, we propose to define other could avoid the limitation of the section 203(b)(3). terms used in the definition of ‘‘foreign exemption through non-U.S. Under section 202(a)(30), a foreign private adviser’’ in section 202(a)(30), discretionary accounts? private adviser is any investment including: (i) ‘‘investor;’’ (ii) ’’in the adviser that: (i) Has no place of business United States;’’ (iii) ‘‘place of business;’’ 5. Transition Rule in the United States; (ii) has, in total, and (iv) ‘‘assets under management.’’ 229 We propose to include in proposed fewer than 15 clients in the United 1. Clients rule 203(m)–1 a provision giving an States and investors in the United States adviser one calendar quarter (three in private funds advised by the For purposes of the definition of months) to register with the investment adviser; (iii) has aggregate ‘‘foreign private adviser,’’ proposed rule Commission after becoming ineligible to assets under management attributable to 202(a)(30)–1 would include the safe rely on the exemption due to an clients in the United States and harbor for counting clients currently in increase in the value of its private fund investors in the United States in private rule 203(b)(3)–1, as modified to account assets.221 Because qualification for the funds advised by the investment adviser for its use in the foreign private adviser exemption depends on remaining below of less than $25 million; 225 and (iv) context and to eliminate a provision the $150 million threshold on a does not hold itself out generally to the allowing advisers not to count those quarterly basis, an adviser could exceed public in the United States as an clients from which they receive no the limit based on market fluctuations investment adviser.226 Section compensation. We note, however, that without any new investments from 202(a)(30) provides the Commission the foreign private adviser exemption existing or new investors. This three with authority to increase the $25 provides a much more limited month period would enable the adviser million threshold ‘‘in accordance with exemption in this regard than our to take steps to register and otherwise the purposes of this title.’’ 227 current rule 203(b)(3)–1 because section come into compliance with the We are proposing a new rule, 202(a)(30) requires an adviser to also requirements of the Advisers Act 202(a)(30)–1, which would define count the number of ‘‘investors’’ of an applicable to registered investment certain terms in section 202(a)(30) for issuer that is a ‘‘private fund’’ (a term advisers, including the adoption and use by advisers seeking to avail that is defined in section 202(a)(29)) 230 implementation of compliance policies themselves of the foreign private adviser managed by the adviser. and procedures.222 It would be available exemption. Because eligibility for the Specifically, proposed rule only to an adviser that has complied new foreign private adviser exemption, 202(a)(30)–1, like current rule 203(b)(3)– with all applicable Commission like the current private adviser 1, would allow an adviser to treat as a reporting requirements.223 We are not exemption, is determined, in part, by single client a natural person and: (i) required to provide the safe harbor, and the number of clients an adviser has, we That person’s minor children (whether or not they share the natural person’s we do not believe it would be propose to include in rule 202(a)(30)–1 principal residence); (ii) any relative, appropriate for an adviser to rely on it the safe harbor rules and many of the spouse, or relative of the spouse of the if the adviser has failed to comply with client counting rules that appear in rule 228 natural person who has the same its reporting requirements. We request 203(b)(3)–1, as currently in effect. In principal residence; (iii) all accounts of comment on this transition period. Is which the natural person and/or the the calendar quarter period sufficient? codified at section 202(a)(30) of the Advisers Act). See supra note 23 and accompanying text. person’s minor child or relative, spouse, Should the transition period be longer, 225 Subparagraph (B) of section 202(a)(30) refers or relative of the spouse who has the such as two calendar quarters, or to the number of ‘‘clients and investors in the same principal residence are the only shorter, such as 30 days? If the adviser United States in private funds,’’ while subparagraph primary beneficiaries; and (iv) all trusts determines to expand its advisory (C) refers to assets of ‘‘clients in the United States and investors in the United States in private funds’’ of which the natural person and/or the business to manage assets other than (emphasis added). We interpret these provisions person’s minor child or relative, spouse, private funds (e.g., separate accounts), consistently so that only clients in the United States or relative of the spouse who has the should the transition period also be and investors in the United States should be same principal residence are the only available? Should a transition period be counted for purposes of subparagraph (B). 226 In addition, the exemption is not available to primary beneficiaries.231 Proposed rule available at all? an adviser that ‘‘acts as (I) an investment adviser to 202(a)(30)–1 would also retain other any investment company registered under the provisions of rule 203(b)(3)–1 that C. Foreign Private Advisers [Investment Company Act]; or (II) a company that Section 403 of the Dodd-Frank Act has elected to be a business development company permit an adviser to treat as a single pursuant to section 54 of [that Act] and has not ‘‘client’’ (i) a corporation, general replaces the current private adviser withdrawn its election.’’ Section 202(a)(30)(D)(ii). exemption from registration under the partnership, limited partnership, We interpret subparagraph (II) to prevent an adviser limited liability company, trust, or other Advisers Act with a new exemption for that advises a business development company from a ‘‘foreign private adviser,’’ as defined in relying on the exemption. legal organization to which the adviser 227 provides investment advice based on new section 202(a)(30).224 The new Section 202(a)(30)(C). 228 Rule 203(b)(3)–1, as currently in effect, the organization’s investment objectives, provides a safe harbor for determining who may be 221 and (ii) two or more legal organizations Proposed rule 203(m)–1(d). In effect, an deemed a single client for purposes of the private adviser would register by the end of the calendar adviser exemption. We would not, however, carry quarter following the quarter-end date at which over from rule 203(b)(3)-1 a provision that discussed below, we are proposing to include private fund assets equaled or exceeded $150 distinguishes between advisers whose principal another, similar, provision in rule 202(a)(30)–1, million. If, however, on the succeeding calendar places of business are inside or outside of the which would apply to both clients and investors for quarter end date, private fund assets have declined United States. Under the definition of ‘‘foreign purposes of the foreign private adviser exemption. below $150 million, then registration would not be private adviser,’’ an adviser may not have any place See infra note 257 and accompanying text. required. of business in the United States. See section 402 of 229 Proposed rule 202(a)(30)–1(c). 222 See rule 206(4)–7. the Dodd-Frank Act (defining ‘‘foreign private 230 See supra note 9. 223 See proposed rule 203(m)–1(d); see also, e.g., adviser’’); rule 203(b)(3)–1(b)(5). We would also not 231 Proposed rule 202(a)(30)–1(a)(1). If a client proposed rule 204–4 under the Advisers Act include rule 203(b)(3)–1(b)(7), which specifies that relationship involving multiple persons does not (discussed in the Implementing Release, supra note a client who is an owner of a private fund is a fall within the rule, the question of whether the 25, at section II.B). resident where the client resides at the time of the relationship may appropriately be treated as a 224 Section 402 of the Dodd-Frank Act (providing client’s investment in the fund. The provision was single ‘‘client’’ must be determined on the basis of a definition of ‘‘foreign private adviser,’’ to be vacated by Goldstein. See supra note 18. As the facts and circumstances involved.

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that have identical shareholders, We are proposing to include the Act.238 In order to avoid double- partners, limited partners, members, or current rule 203(b)(3)–1 safe harbor for counting, an adviser would be able to beneficiaries.232 counting clients in proposed rule treat as a single investor any person who We would not include the ‘‘special 202(a)(30)–1 because we believe that is an investor in two or more private rule’’ providing advisers with the option application of this provision (as we funds advised by the investment of not counting as a client any person propose to modify it) will operate to adviser.239 for whom the adviser provides effect the purposes of the foreign private The term ‘‘investor’’ is not currently investment advisory services without adviser exemption. Congress replaced defined under the Advisers Act or the compensation.233 As noted above, we the private adviser exemption with the rules under the Advisers Act. Defining propose to require advisers to include foreign private adviser exemption, both the term as proposed would ensure the assets of such clients in their of which require advisers to count consistent application of the statutory ‘‘regulatory assets under clients. As Congress was aware of rule provision and prevent, for example, management,’’ 234 and we propose the 203(b)(3)–1’s counting guidelines when non-U.S. advisers from circumventing same approach with respect to counting it incorporated a limitation on the the limitations in section 203(b)(3) by clients.235 number of ‘‘clients’’ in the definition of using nominee accounts that would Finally, we propose to add a ‘‘foreign private adviser,’’ we believe it aggregate investors into a single nominal provision that would avoid double- would be consistent with Congress’s investor for purposes of the counting counting private funds and their amendment to preserve generally the requirement of section 202(a)(30). Under 236 investors by advisers. This provision method for counting clients, together section 203(b)(3), an adviser relying on would specify that an adviser need not with the requirement to count clients. the foreign private adviser exemption count a private fund as a client if the We request comment generally on our may only have advisory relationships adviser counted any investor, as defined approach to counting ‘‘clients’’ in with private funds with a limited in the rule, in that private fund as an proposed rule 202(a)(30)–1 and on each number of U.S. investors. Advisers investor in that private fund for of the specific proposed provisions. Is it should not be able to avoid this purposes of determining the availability limitation by setting up intermediate 237 appropriate to derive the definition of of the exemption. ‘‘client’’ in proposed rule 202(a)(30)–1 accounts through which investors may from rule 203(b)(3)–1’s definition? Are access a private fund and not be 232 Proposed rule 202(a)(30)–1(a)(2). In addition, proposed rule 202(a)(30)–1(b)(1) through (3) would there alternative approaches we should counted for purposes of the exemption. retain the following related ‘‘special rules’’: (1) An consider instead? Is including the Defining investors by reference to adviser must count a shareholder, partner, limited ‘‘special rules’’ in proposed rule 202(a) sections 3(c)(1) and 3(c)(7) of the partner, member, or beneficiary (each, an ‘‘owner’’) (30)–1 appropriate? Are there any that Investment Company Act may best of a corporation, general partnership, limited partnership, limited liability company, trust, or are not appropriate in this context and achieve these purposes. Funds and their other legal organization, as a client if the adviser should not be included in the proposed advisers must determine who is a provides investment advisory services to the owner rule? In particular, should we have beneficial owner for purposes of section separate and apart from the legal organization; (2) an adviser is not required to count an owner as a maintained the special rule allowing an 3(c)(1) or whether an owner is a client solely because the adviser, on behalf of the adviser not to count as a client any qualified purchaser for purposes of legal organization, offers, promotes, or sells person for whom the adviser provides section 3(c)(7).240 Typically, a interests in the legal organization to the owner, or investment advisory services without prospective investor in a private fund reports periodically to the owners as a group solely with respect to the performance of or plans for the compensation, even though such person must complete a subscription agreement legal organization’s assets or similar matters; and (3) may be treated as a client for other that includes representations or any general partner, managing member or other purposes (e.g., reporting on Form ADV)? confirmations that it is qualified to person acting as an investment adviser to a limited invest in the fund and whether it is a partnership or limited liability company must treat Should we modify the proposed rule the partnership or limited liability company as a that allows an adviser not to count a U.S. person. This information is client. private fund as a client if it counts any designed to allow the adviser (on behalf 233 See rule 203(b)(3)–1(b)(4). investor in that private fund by also of the fund) to make the above 234 In the Implementing Release, we are proposing providing that an adviser may avoid determination. Therefore, an adviser to adopt a uniform method for calculating assets under management for purposes of registration counting as a client any person it counts seeking to rely on the foreign private pursuant to which an adviser would count assets as an investor? Finally, are there any adviser exemption will have ready that are managed without compensation. In this further modifications to the definition access to this information. Release, we propose to apply the proposed method that we should make? More important, defining the term of calculation to the foreign private adviser ‘‘investor’’ by reference to sections exemption and the private fund adviser exemption. 2. Private Fund Investor See infra section II.C.5 of this Release; 3(c)(1) and 3(c)(7) appears to Implementing Release, supra note 25, at section Section 202(a)(30) provides that a appropriately limit the ability of a non- II.A.3. ‘‘foreign private adviser’’ eligible for the U.S. adviser to avoid application of the 235 As discussed in the Implementing Release, our proposed changes to the method of calculating new registration exemption cannot have registration provisions of the Advisers assets under management would remove the option more than 14 clients ‘‘or investors in the Act. For example, under the proposed of excluding certain assets from an adviser’s United States in private funds’’ advised rule, holders of both equity and debt calculation in order to avoid registration with the by the adviser. We propose to define securities would be counted as Commission and regulatory requirements associated with registration. See Implementing Release, supra ‘‘investor’’ in a private fund in rule note 25, nn.44–50 and accompanying and following 202(a)(30)–1 as any person who would 238 See proposed rule 202(a)(30)–1(c)(1); supra text. Allowing an adviser not to count as clients be included in determining the number notes 8–13 and accompanying text. Under the persons in the United States that do not compensate of beneficial owners of the outstanding proposed rule, knowledgeable employees with the adviser would similarly allow certain advisers respect to the private fund (and certain persons to avoid registration through reliance on the foreign securities of a private fund under related to them) and beneficial owners of short-term private adviser exemption despite the fact that the section 3(c)(1) of the Investment paper issued by the private fund would also count adviser provides advisory services to such persons. Company Act, or whether the as investors. See infra note 246 and accompanying 236 See proposed rule 202(a)(30)–1(b)(4). outstanding securities of a private fund text. 237 239 See proposed rule 202(a)(30)–1(c)(1), at note to See proposed rule 202(a)(30)–1(b)(4); are owned exclusively by qualified 202(a)(30)–1(c)(1). See also infra section II.C.2 of paragraph (c)(1). this Release (discussing the definition of investor). purchasers under section 3(c)(7) of that 240 See supra notes 11 and 13.

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investors.241 Advisers, moreover, would even though the record owner would employees as investors under the same have to ‘‘look though’’ nominee and remain the nominal owner of private approach we take with our proposal that similar arrangements to the underlying fund securities, the associated risks of advisers count in their calculation of holders of private fund-issued securities an investment in the securities would assets under management assets they to determine whether they have fewer have been transferred to the third party manage without being compensated, than 15 clients and private fund who has made the determination to which often include assets of investors in the United States.242 invest in the private fund indirectly knowledgeable employees.250 Under our Under the proposed rule, an adviser through the record owner. In such a proposed rule, holders of short-term would determine the number of case, the third party would be counted paper, like other debt holders, would investors in a private fund based on as a beneficial owner under section also be counted as investors because a facts and circumstances and in light of 3(c)(1), or be required to be a qualified private fund’s losses directly affect these the applicable prohibition not to do purchaser under section 3(c)(7).245 holders’ interest in the fund just as they indirectly, or through or by any other Accordingly, the third party would be affect the interest of other debt holders person, what is unlawful to do counted as an investor in the private in the fund.251 directly.243 In the following fund for purposes of the foreign private We request comment on our circumstances, for example, an adviser adviser exemption. definition of ‘‘investor.’’ Does the term relying on the exemption would have to We are also proposing to treat as require further definition? Does our count as an investor a person who is not investors beneficial owners (i) who are definition of ‘‘investor’’ appropriately the nominal owner of a private fund’s ‘‘knowledgeable employees’’ with reflect Congress’s intent in providing an securities. First, the adviser to a master respect to the private fund, and certain exemption for foreign private advisers? fund in a master-feeder arrangement other persons related to such employees Under our proposal, advisers would not would have to treat as investors the (we refer to these, collectively, as be able to consolidate investors for holders of the securities of any feeder ‘‘knowledgeable employees’’); 246 and (ii) counting purposes in the same manner 247 fund formed or operated for the purpose of ‘‘short-term paper’’ issued by the they would be able to consolidate 248 of investing in the master fund rather private fund, even though these clients under certain circumstances. than the feeder funds, which act as persons are not counted as beneficial Should we consider extending to conduits.244 Second, an adviser would owners for purposes of section 3(c)(1), investors the ‘‘special rules’’ for counting need to count as an investor any holder and knowledgeable employees are not clients under proposed rule 202(a)(30)– of an instrument, such as a total return required to be qualified purchasers 1? Would this lead to either under- 249 swap, that effectively transfers the risk under section 3(c)(7). We are counting or over-counting of investors? of investing in the private fund from the proposing to count knowledgeable Is it appropriate to count as a single record owner of the private fund’s investor a person that invests in two or 245 As noted above, we have recognized that in more private funds advised by the securities. The record owner of private certain circumstances it is appropriate to ‘‘look fund securities could enter into a total adviser? Is it appropriate to treat as through’’ an investor (i.e., attribute ownership of a investors beneficial owners who are return swap transaction to transfer to a private fund to another person who is the ultimate ‘‘ ’’ third party any profits or losses that the owner). See, e.g., NSMIA Release, supra note 244 knowledgeable employees with record owner could incur as a result of (‘‘The Commission understands that there are other respect to the private fund, and of short- forms of holding investments that may raise term paper issued by the fund? its investment in the private fund. Thus, interpretative issues concerning whether a Prospective Qualified Purchaser ‘owns’ an 3. In the United States 241 Sections 3(c)(1) and 3(c)(7) of the Investment investment. For instance, when an entity that holds Company Act refer to beneficial owners and investments is the ‘alter ego’ of a Prospective Section 202(a)(30)’s definition of owners, respectively, of ‘‘securities’’ (which is Qualified Purchaser (as in the case of an entity that ‘‘foreign private adviser’’ employs the broadly defined in section 2(a)(36) of that Act to is wholly owned by a Prospective Qualified term ‘‘in the United States’’ in several include debt and equity). Purchaser who makes all the decisions with respect contexts including: (i) Limiting the 242 to such investments), it would be appropriate to Proposed rule 202(a)(30)–1(c)(1). See generally number of—and assets under sections 3(c)(1) and 3(c)(7) of the Investment attribute the investments held by such entity to the Company Act. Prospective Qualified Purchaser.’’). management attributable to—an 243 See section 208(d) of the Advisers Act. 246 See proposed rule 202(a)(30)–1(c)(1)(A) adviser’s ‘‘clients’’ ‘‘in the United States’’ 244 A ‘‘master-feeder fund’’ is an arrangement in (referencing rule 3c–5 under the Investment and ‘‘investors’’ ‘‘in the United States’’ in which one or more funds with identical investment Company Act (17 CFR 270.3c–5(b)), which excludes from the determinations under sections 3(c)(1) and private funds advised by the adviser; (ii) objectives (‘‘feeder funds’’) invest all of their assets exempting only those advisers without in a single fund (‘‘master fund’’) with the same 3(c)(7) of that Act any securities beneficially owned investment objective and strategies. We have taken by knowledgeable employees of a private fund; a the same approach within our rules that expressly company owned exclusively by knowledgeable 250 See supra note 190. As discussed above, our require a private fund to ‘‘look-through’’ any employees; and any person who acquires securities proposed changes to the method of calculating investor that is formed for the specific purpose of originally acquired by a knowledgeable employee assets under management would preclude some investing in a private fund. See rule 2a51–3(a) through certain transfers of interests, such as a gift advisers from excluding certain assets from their under the Investment Company Act (17 CFR or a bequest). calculation in order to avoid registration with the 270.2a51–3(a)) (a company is not a qualified 247 See proposed rule 202(a)(30)–1(c)(1)(B) Commission and regulatory requirements associated purchaser if it is ‘‘formed for the specific purpose (referencing the definition of ‘‘short-term paper’’ with registration. Allowing an adviser not to count of acquiring the securities’’ of an investment contained in section 2(a)(38) of the Investment as investors persons that do not compensate the company that is relying on section 3(c)(7) of the Company Act, which defines ‘‘short-term paper’’ to adviser, such as knowledgeable employees, would Investment Company Act, unless each of the mean ‘‘any note, draft, bill of exchange, or banker’s similarly allow certain advisers to avoid registration company’s beneficial owners is also a qualified acceptance payable on demand or having a maturity by relying on the foreign private adviser exemption. purchaser). See also Privately Offered Investment at the time of issuance of not exceeding nine 251 Various types of investment vehicles make Companies, Investment Company Act Release No. months, exclusive of days of grace, or any renewal significant use of short-term paper for financing 22597 (Apr. 3, 1997) [62 FR 17512 (Apr. 9, 1997)] thereof payable on demand or having a maturity purposes so holders of this type of security are, in (‘‘NSMIA Release’’) (explaining that rule 2a51–3(a) likewise limited; and such other classes of practice, exposed to the investment results of the would limit the possibility that ‘‘a company will be securities, of a commercial rather than an security’s issuer. See Money Market Fund Reform able to do indirectly what it is prohibited from investment character, as the Commission may Release, supra note 134, at nn. 37–39 and preceding doing directly [by organizing] * * * a ‘qualified designate by rules and regulations.’’) and accompanying text (discussing how money purchaser’ entity for the purpose of making an 248 See proposed rule 202(a)(30)–1(c)(1). market funds were exposed to substantial losses investment in a particular Section 3(c)(7) Fund 249 See section 3(c)(1) of the Investment Company during 2007 as a result of exposure to debt available to investors that themselves did not meet Act; rule 3c–5(b) under the Investment Company securities issued by structured investment the definition of ‘qualified purchaser.’ ’’). Act. vehicles).

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a place of business ‘‘in the United registering with us or terminating the to ‘‘clients’’ and ‘‘investors in a private States’’; and (iii) exempting only those relationship with any client that moved fund?’’ Is it appropriate as it relates to advisers that do not hold themselves out to the United States, or redeeming the the ‘‘public?’’ Is it necessary to define ‘‘in to the public ‘‘in the United States’’ as interest in the private fund of any the United States’’ for purposes of the an investment adviser.252 We are investor that moved to the United definition of ‘‘foreign private adviser’’ in proposing to define ‘‘in the United States. new section 202(a)(30)? Is our States’’ to provide clarification of the We believe that the use of Regulation understanding of non-U.S. advisers’ term for all of the above purposes as S is appropriate for purposes of the application of the Regulation S well as provide specific instruction as to foreign private adviser exemption definition correct? Since private funds the relevant time for making the related because Regulation S provides more already rely on the Regulation S determination. specific rules when applied to various definition of U.S. person to determine Proposed rule 202(a)(30)–1 defines ‘‘in types of legal structures.258 Advisers, which investors must qualify to invest ’’ the United States generally by moreover, already apply the Regulation in the fund, would adopting a different incorporating the definition of a ‘‘U.S. S definition of U.S. person with respect definition increase regulatory burdens person’’ and ‘‘United States’’ under to both clients and investors for other associated with determining eligibility Regulation S.253 In particular, we would purposes and therefore are familiar with for the proposed exemption? 262 Are define ‘‘in the United States’’ in 259 the definition. The proposed there alternatives that would better proposed rule 202(a)(30)–1(c)(2) to references to Regulation S with respect mean: (i) With respect to any place of reflect the intent of Congress in creating to a place of business ‘‘in the United a new category of ‘‘foreign private business located in the ‘‘United States,’’ States’’ and the public in the ‘‘United as that term is defined in Regulation advisers’’ and providing them with an States’’ would also allow us to maintain exemption from registration? Is our S; 254 (ii) with respect to any client or consistency across our rules. private fund investor in the United proposed note regarding the relevant Similar to our approach in proposed time for determining whether a person States, any person that is a ‘‘U.S. person’’ rule 203(m)–1(e)(8),260 we treat as 255 is ‘‘in the United States’’ appropriate? If as defined in Regulation S, except persons ‘‘in the United States’’ for not, how should we modify it? that any discretionary account or similar purposes of the foreign private adviser, account that is held for the benefit of a certain persons that would not be 4. Place of Business person ‘‘in the United States’’ by a non- considered ‘‘U.S. persons’’ under U.S. dealer or other professional Regulation S. We are proposing to treat Proposed rule 203(a)(30)–1, by fiduciary is deemed ‘‘in the United as a U.S. person discretionary accounts reference to proposed rule 222–1,263 States’’ if the dealer or professional owned by a U.S. person and managed by defines ‘‘place of business’’ to mean any fiduciary is a related person of the a non-U.S. affiliate of the adviser in office where the investment adviser investment adviser relying on the order to discourage non-U.S. advisers regularly provides advisory services, exemption; and (iii) with respect to the from creating such discretionary solicits, meets with, or otherwise public in the ‘‘United States,’’ as that communicates with clients, and any 256 accounts with the goal of circumventing term is defined in Regulation S. In the exemption’s limitation with respect location held out to the public as a place addition, we are proposing to add a note to persons in the United States.261 where the adviser conducts any such to paragraph (c)(2)(i) specifying that for We request comment on the definition activities.264 We believe this definition purposes of that definition, a person of ‘‘in the United States’’ in proposed appropriately identifies a location that is ‘‘in the United States’’ may be rule 202(a)(30)–1(c)(2). Is our definition where an adviser is doing business for treated as not being ‘‘in the United appropriate as it relates to a ‘‘place of purposes of section 202(a)(30) of the States’’ if such person was not ‘‘in the business?’’ Is it appropriate as it relates Advisers Act and thus provides a basis United States’’ at the time of becoming for an adviser to determine whether it a client or, in the case of an investor in 258 See supra notes 214–216 and accompanying can rely on the exemption in section a private fund, at the time the investor text. See also Letter of Paul, Hastings, Janofsky & 203(b)(3) of the Advisers Act for foreign acquires the securities issued by the Walker LLP (Oct. 29, 2010) (‘‘Paul Hastings Letter’’) private advisers. Because both the fund.257 We believe that without this (addressing the foreign private adviser exemption in Commission and the state securities note this rule might be burdensome response to our request for public views, and recommending that we rely on a modified authorities use this definition to identify because an adviser would have to Regulation S definition of ‘‘U.S. person’’ for an unregistered foreign adviser’s place monitor the location of clients and purposes of defining ‘‘in the United States’’ with respect to clients and investors). See generally of business for purposes of determining investors on an ongoing basis, and 265 might have to choose between supra note 24. regulatory jurisdiction, it appears to 259 Many non-U.S. advisers identify whether a be logical as well as efficient to use the client is a ‘‘U.S. person’’ under Regulation S in order 252 rule 222–1(a) definition of ‘‘place of See section 402 of the Dodd-Frank Act. to determine whether such client may invest in 253 Proposed rule 202(a)(30)–1(c)(2). As discussed certain private funds and certain private placement above, we are also proposing to reference offerings exempt from registration under the 262 See supra note 217 and accompanying and Regulation S’s definition of a ‘‘U.S. person’’ for Securities Act. With respect to ‘‘investors,’’ our staff following text. purposes of the definition of ‘‘United States person’’ has generally taken the interpretive position that an 263 Rule 222–1(a) (defining ‘‘place of business’’ of in rule 203(m)–1. See sections II.B.3 and II.B.4 of investor that does not meet that definition is not a an investment adviser as: ‘‘(1) An office at which this Release (discussing proposed rules 203(m)– U.S. person when determining whether a non-U.S. the investment adviser regularly provides 1(e)(7) through (8)). private fund meets the section 3(c)(1) and 3(c)(7) investment advisory services, solicits, meets with, 254 See 17 CFR 230.902(l). counting or qualification requirements. See supra or otherwise communicates with clients; and (2) 255 See 17 CFR 230.902(k). note 217. Many non-U.S. advisers, moreover, Any other location that is held out to the general 256 See 17 CFR 230.902(l). currently determine whether a private fund investor public as a location at which the investment adviser 257 Proposed rule 202(a)(30)–1, at note to is a ‘‘U.S. person’’ under Regulation S for purposes provides investment advisory services, solicits, paragraph (c)(2)(i) (‘‘A person that is in the United of the safe harbor for offshore offers and sales. meets with, or otherwise communicates with States may be treated as not being in the United 260 See supra discussion in section II.B.4 of this clients.’’). States if such person was not in the United States Release regarding the definition of United States 264 Proposed rule 202(a)(30)–1(c)(3). at the time of becoming a client or, in the case of persons and the treatment of discretionary 265 Under section 222(d) of the Advisers Act, a an investor in a private fund, at the time the accounts. state may not require an adviser to register if the investor acquires the securities issued by the 261 See supra notes 219–220 and accompanying adviser does not have a ‘‘place of business’’ within, fund.’’). paragraph. and has fewer than six clients resident in, the state.

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business’’ for purposes of the foreign Should we, as proposed, require foreign account the activities of its advisory private adviser exemption. private advisers to calculate assets affiliates when determining eligibility We request comment on our under management consistent with the for an exemption. For example, should definition of ‘‘place of business’’ as it proposed ‘‘regulatory assets under the rule specify that the exemption is relates to the definition of ‘‘foreign management’’ calculation for Form not available to an affiliate of a private adviser.’’ Is this definition of ADV? Or should we require a different registered investment adviser? 271 ‘‘place of business’’ appropriate in this calculation? For example, should III. Request for Comment context? Do commenters recommend foreign private advisers be permitted to any alternative definitions? exclude proprietary assets or assets they The Commission requests comment manage without compensation? on the proposed rules in this Release. 5. Assets Under Management We also request suggestions for For purposes of rule 202(a)(30)–1 we D. Subadvisory Relationships and additional changes to existing rules, and propose to define ‘‘assets under Advisory Affiliates comments on other matters that might management’’ by reference to the We generally interpret advisers as have an effect on the proposals calculation of ‘‘regulatory assets under including subadvisers,269 and therefore contained in this Release. Commenters management’’ for Item 5 of Form believe it is appropriate to permit are requested to provide empirical data ADV.266 As discussed above, in Item 5 subadvisers to rely on each of the new to support their views. of Form ADV we are proposing to exemptions, provided that subadvisers IV. Paperwork Reduction Act Analysis implement a uniform method of satisfy all terms and conditions of the calculating assets under management applicable proposed rules. We are aware The proposed rules do not contain a that can be used for several purposes that in many subadvisory relationships ‘‘collection of information’’ requirement under the Advisers Act, including the a subadviser has contractual privity within the meaning of the Paperwork 272 foreign private adviser exemption.267 with a private fund’s primary adviser Reduction Act of 1995. Accordingly, Because the foreign private adviser rather than the private fund itself. the Paperwork Reduction Act is not exemption is also based on assets under Although both the private fund and the applicable. management, we believe that all fund’s primary adviser may be viewed V. Cost-Benefit Analysis advisers should use the same method as clients of the subadviser, we would The Commission is sensitive to the for calculating assets under management consider a subadviser eligible to rely on to determine if they are required to costs and benefits imposed by its rules. section 203(m) if the subadviser’s We have identified certain costs and register or may be eligible for the services to the primary adviser relate exemption. We believe that uniformity benefits of the proposed rules, and we solely to private funds and the other request comment on all aspects of this in the method for calculating assets conditions of the exemptions are met. under management would result in cost-benefit analysis, including Similarly, a subadviser may be eligible identification and assessment of any more consistent asset calculations and to rely on section 203(l) if the reporting across the industry and, costs and benefits not discussed in this subadviser’s services to the primary analysis. We seek comment and data on therefore, in a more coherent adviser relate solely to venture capital application of the Advisers Act’s the value of the benefits identified. We funds and the other conditions of the also welcome comments on the regulatory requirements and of our rule are met. staff’s risk assessment program.268 accuracy of the cost estimates in this We anticipate that an adviser with analysis, and request that commenters We request comment on our advisory affiliates will encounter definition of ‘‘assets under management’’ provide data that may be relevant to interpretative issues as to whether it as it relates to the definition of ‘‘foreign these cost estimates. In addition, we may rely on any of the exemptions private adviser.’’ Is this definition of seek estimates and views regarding discussed in this Release without taking ‘‘assets under management’’ appropriate these benefits and costs for advisers into account the activities of its in this context? Are there any special solely to venture capital funds, private affiliates. The adviser, for example, considerations relevant to foreign fund advisers with less than $150 might have advisory affiliates that are private advisers? Do commenters million in aggregate assets under registered or that provide advisory recommend any alternative definitions? management and foreign private services that are inconsistent with an Should assets under management be advisers as well as any other costs or exemption on which the adviser may calculated at a particular point of time? benefits that may result from the seek to rely.270 We request comment on adoption of the proposed rules. Where whether any proposed rule should 266 See proposed rule 202(a)(30)–1(c)(4); possible, we request commenters instructions to Item 5.F of Form ADV, Part 1A. As provide that an adviser must take into discussed above, we are proposing to take the same 271 We have received a number of letters approach under proposed rule 203(m)–1. See supra 269 See, e.g., Pay to Play Release, supra note 10, requesting interpretative guidance on whether and section II.B.2 of this Release. at n.391–94 and accompanying and following text; to what extent certain prior staff positions would 267 See supra note 190 and accompanying text. Hedge Fund Adviser Registration Release, supra apply to the new exemptions provided by the Dodd- 268 Id. See also Letter of Shearman and Sterling note 17, at n.243. Frank Act. See, e.g., Letter of Katten Muchin LLP (Nov. 3, 2010) (‘‘Shearman & Sterling Letter’’) 270 Generally, a separately formed advisory entity Rosenman LLP (Sept. 14, 2010); Letter of TA Jones (in response to our request for public views, arguing that operates independently of an affiliate may be (Sept. 25, 2010); Letter of Ropes & Gray LLP (Nov. that ‘‘[w]hile each [exemption related asset eligible for an exemption if it meets all of the 1, 2010) in response to our solicitation for public threshold established by the Dodd-Frank Act] criteria set forth in the relevant rule. However, the views. See generally supra note 24. We serves a different purpose, it appears to us that any existence of separate legal entities may not by itself acknowledge that such determinations will depend steps that might be taken in the way of be sufficient to avoid integration of the affiliated on the particular facts and circumstances of non- harmonization will facilitate both compliance with entities. The determination of whether the advisory U.S. advisers. Advisers should consider whether the requirements by the industry and their businesses of two separately formed affiliates may they may avail themselves of either the foreign administration by the Commission and its Staff,’’ be required to be integrated is based on the facts private adviser exemption or the private fund and suggesting that as an example, we raise the and circumstances. Our staff has taken this position adviser exemption as proposed in this Release, and assets under management threshold under the in Richard Ellis, Inc., SEC Staff No-Action Letter are encouraged to submit comment letters foreign private adviser exemption to $150 million (Sept. 17, 1981) (discussing the staff’s views of addressing with particularity and specificity in line with the assets threshold under the private factors relevant to the determination of whether a interpretative issues that may not be addressed in fund adviser exemption). See generally supra note separately formed advisory entity operates our proposed rules. 24. independently of an affiliate). 272 44 U.S.C. 3501.

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provide empirical data to support any We propose to define a ‘‘qualifying Congress that stressed the lack of positions advanced. portfolio company’’ as any company leverage in venture capital investing.278 As discussed above, we are proposing that: (i) Is not publicly traded; (ii) does Our research suggests that on occasion, rules 203(l)–1, 203(m)–1 and 202(a)(30)– not incur leverage in connection with however, some venture capital funds 1 to implement certain provisions of the the investment by the private fund; (iii) may provide financing on a short-term Dodd-Frank Act. As a result of the uses the capital provided by the fund for basis to portfolio companies as a Dodd-Frank Act’s repeal of the private operating or business expansion ‘‘bridge’’ between funding rounds.279 It adviser exemption, some advisers that purposes rather than to buy out other is possible that certain types of bridge previously were eligible to rely on that investors; and (iv) is not itself a fund financing currently used by venture exemption will be required to register (i.e., is an operating company).275 capital funds may not satisfy the under the Advisers Act unless these We also propose to grandfather definition of equity security under our advisers are eligible for a new existing funds by including in the proposed rule. exemption. Thus, the benefits and costs definition of ‘‘venture capital fund’’ any Although the limitation on acquiring associated with registration are private fund that: (i) Represented to debt securities from portfolio companies attributable to the Dodd-Frank Act. The investors and potential investors at the may not be characteristic of some Commission has discretion, however, to time the fund offered its securities that existing venture capital funds, the adopt rules to define the terms used in it is a venture capital fund; (ii) prior to failure of existing venture capital funds the Advisers Act, and we undertake December 31, 2010, has sold securities to meet the proposed definition would below to discuss the benefits and costs to one or more investors that are not not preclude advisers to those funds of the defined terms that we are related persons of any investment from relying on the exemption in proposing. adviser of the venture capital fund; and section 203(l) of the Advisers Act under (iii) does not sell any securities to, our proposed rule. An adviser of A. Definition of Venture Capital Fund including accepting any additional existing venture capital funds could capital commitments from, any person Our proposed rule is designed to: (i) avail itself of the exemption under the after July 21, 2011 (the ‘‘grandfathering proposed grandfathering provision implement the directive from Congress 276 provision’’). An adviser seeking to provided that each fund (i) Has to define the term venture capital fund rely on the exemption under section in a manner that reflects Congress’ represented to investors that it is a 203(l) of the Advisers Act would be venture capital fund, (ii) has initially understanding of what venture capital eligible for the venture capital funds are, and as distinguished from sold interests by December 31, 2010, exemption only if it exclusively advised and (iii) does not sell any additional other private equity funds and hedge venture capital funds that met all of the funds; and (ii) facilitate the transition to interests after July 21, 2011.280 We elements of the proposed definition or expect that all advisers to existing the new exemption. Our proposal would grandfathering provision. define the term venture capital fund venture capital funds that currently rely consistently with what we believe 1. Benefits on the private adviser exemption would Congress understood venture capital Based on the testimony presented to be exempt from registration in reliance funds to be, and in light of other Congress and our research, we believe on the proposed grandfathering provisions of the federal securities laws that venture capital funds today would provision. As a result of this provision, that seek to achieve similar meet most, if not all, of the elements of we expect that advisers to existing objectives.273 our proposed definition of venture venture capital funds that do not meet Using these characteristics as our capital fund. Our proposed definition our proposed definition would benefit model, we propose to define a venture includes one specific element, however, because those advisers could continue capital fund as a private fund that: (i) that may not be characteristic of some to manage existing funds without Invests in equity securities of private existing venture capital funds. The having to (i) Weigh the relative costs companies in order to provide operating proposed rule defines a venture capital and benefits of registration and and business expansion capital (i.e., fund as one that does not issue debt or modification of fund operations to ‘‘qualifying portfolio companies’’) and at provide guarantees except on a short- conform existing funds with our least 80 percent of each company’s term basis (and correspondingly defines proposed definition and (ii) incur the equity securities owned by the fund a qualifying portfolio company as one costs associated with registration with were acquired directly from the that does not borrow or otherwise incur the Commission or modification of qualifying portfolio company; (ii) leverage in connection with the venture existing funds. Advisers to venture directly, or through its investment capital fund investment). We propose capital funds that are in formation that advisers, offers or provides significant this element of the qualifying portfolio would be able to launch by December managerial assistance to, or controls, the company definition because of the focus 31, 2010 and meet the July 21, 2011 qualifying portfolio company; (iii) does on leverage in the Dodd-Frank Act as a deadline for sales of all securities also not borrow or otherwise incur leverage potential contributor to systemic risk as would benefit from the grandfathering (other than limited short-term discussed by the Senate Committee provision because they would not have borrowing); (iv) does not offer its report,277 and the testimony before to incur these costs. investors redemption or other similar Going forward, we recognize that liquidity rights except in extraordinary 275 Proposed rule 203(l)–1(c)(4). some advisers to existing venture capital circumstances; (v) represents itself as a 276 Proposed rule 203(l)–1(b). funds that seek to rely on the exemption 277 venture capital fund to investors; and See supra note 99. See also S. Rep. No. 111– in section 203(l) of the Advisers Act 176, supra note 7, at 73–74 (stating that advisers of might have to structure new funds (vi) is not registered under the venture capital funds are not required to register Investment Company Act and has not with the SEC because they do not present the same investment positions’’). See also supra notes 136– elected to be treated as a BDC.274 risks as advisers to other private funds that are required to register, and specifying that the 137 and accompanying text. Commission shall require advisers of private funds 278 See supra note 100. 273 See supra notes 38–43 and accompanying and to report systemic risk data including, among other 279 See, e.g., supra note 83 and accompanying following text. things, information on the ‘‘use of leverage, text. 274 Proposed rule 203(l)–1(a). counterparty credit risk exposure, trading and 280 Proposed rule 203(l)–1(b).

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differently to meet the proposed flexibility in the proposed definition of (and/or provide) managerial assistance limitation on qualified portfolio venture capital fund than a more rigid to the portfolio company. company leverage. To the extent that or narrow definition, which should Our proposed definition of qualifying advisers choose not to change how they allow them more easily to structure and portfolio company is similarly broad structure or manage new funds they operate funds that meet the definition. because the definition does not restrict launch, those advisers would have to This flexibility should facilitate qualifying companies to ‘‘small or start- register with the Commission,281 which compliance with the proposed rule and up’’ companies. As we have noted offers many benefits to the investing transition to the new exemption. For above, we believe that such definitions public and facilitates our mandate to example, we propose to define equity would be too restrictive and provide venture capital fund advisers with too protect investors. Registered investment securities broadly to cover many types little flexibility and limited options with advisers are subject to periodic of equity securities in which venture examinations by our staff and are also respect to potential portfolio company capital funds typically invest, rather subject to our rules including rules on investments.289 In addition, we propose than limit the definition solely to to define a ‘‘qualifying portfolio recordkeeping, custody of client funds 285 and compliance programs. We believe common stock. To meet the proposed company’’ as a company that does not that in general Congress considered definition, at least 80 percent (not 100 borrow from, or issue debt in registration to be beneficial to investors percent) of the equity securities of a connection with the investment from, because of, among other things, the portfolio company in which a venture venture capital funds. Thus, a qualifying added protections offered by capital fund invests must be acquired portfolio company could borrow for registration. Accordingly, Congress directly from the issuing portfolio working capital or other operating needs limited the section 203(l) exemption to company (including securities that have from other lenders, such as banks, advisers to venture capital funds. As been converted into equity securities), without jeopardizing the venture capital noted above, we proposed certain but there is no limit as to how the fund adviser’s eligibility for the elements in the portfolio company remaining 20 percent could be exemption. These proposed broad definition because of the focus on acquired.286 Furthermore, under the definitions and criteria should benefit leverage in the Dodd-Frank Act as a proposed definition, the venture capital advisers that intend to rely on the potential contributor to systemic risk as fund may offer or provide managerial exemption because they give the adviser discussed by the Senate Committee assistance to or alternatively control the flexibility to structure transactions and report,282 and the testimony before qualified portfolio company directly, or investments in underlying portfolio Congress that stressed the lack of may do so through its advisers. As noted companies in a manner that meets their leverage in venture capital investing.283 above, we have modeled this element of business objectives without unduly We expect that distinguishing between the definition in part on existing creating systemic or other risks of the venture capital funds and other private provisions under the Advisers Act and kind that Congress suggested should funds that pursue investment strategies Investment Company Act dealing with require registration of the fund’s involving financial leverage that BDCs.287 Our proposed definition also is adviser. For commenters recommending more narrow elements for our Congress highlighted for concern would designed to be a simplified version of benefit financial regulators mandated by definition, we request comment on the the definition of ‘‘making available the Dodd-Frank Act (such as the costs to advisers of having to change significant managerial assistance’’ under Financial Stability Oversight Council) their business practices to comply with the BDC provisions, which we expect with monitoring and assessing potential such narrower elements. systemic risks. Because advisers that would reduce confusion and facilitate We believe that the grandfathering 288 manage funds with these characteristics understanding of the proposed rule. provision would promote efficiency would be required to register, we expect This approach would preserve because it will allow advisers to existing that financial regulators could more flexibility for venture capital funds that venture capital funds to continue to rely easily obtain information and data invest as a group to determine which on the exemption without having to regarding these financial market members of the group are best qualified, restructure funds that may not meet the participants, which should benefit those or best able, to control the portfolio proposed definition. It also would allow regulators to the extent it helps to company or alternatively to offer advisers to funds that are currently in reduce the overall cost of systemic risk formation and can meet the monitoring and assessment.284 285 See supra notes 85–87 and accompanying text. requirements of the grandfathering In addition to the benefits discussed 286 See supra section II.A.1.d of this Release. provision to rely on the exemption above, we expect that investment 287 See supra notes 123–128 and accompanying without the potential costs of having to advisers that seek to rely on the text. renegotiate with potential investors and 288 See supra note 128 and accompanying and exemption would benefit from the following text. For example, unlike the BDC restructure those funds within the provision, the proposed definition does not limited period before the rule must be 281 See infra text following note 294; notes 299– specifically define managerial assistance by adopted. Advisers that seek to form new 303 and accompanying text for a discussion of referring to a fund’s directors, officers, employees funds should have sufficient time and potential costs for advisers that would have to or general partners. In addition, like the BDC choose between registering or restructuring venture provision, the proposed definition would require notice to structure those funds to meet capital funds formed in the future. the venture capital fund to control the qualifying the proposed definition should they 282 See supra note 99. portfolio company (if it does not offer or provide seek to rely on the exemption in section 283 See supra note 100. significant managerial assistance), but without 203(l) of the Advisers Act. 284 See S. Rep. No. 111–176, supra note 7, at 39 reference to exercising a controlling influence Finally, we believe that our proposed (explaining the requirement that private funds because the ability to exercise a controlling disclose information regarding their investment influence is inherent in the control relationship. definition would include an additional positions and strategies, including information on See section 202(a)(12) of the Advisers Act (defining benefit for investors and regulators. fund size, use of leverage, counterparty credit risk control to mean the power to exercise a controlling Section 203(l) of the Advisers Act exposure, trading and investment positions and any influence over the management or policies of a other information that the Commission in company unless such power is solely the result of provides an exemption specifically for consultation with the Financial Stability Oversight an official position with such company). See supra Council determines is necessary and appropriate to note 129 for the definition of ‘‘making available 289 See supra discussion in section II.A.1.a of this protect investors or assess systemic risk). significant managerial assistance’’ by a BDC. Release.

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advisers that ‘‘solely’’ advise venture advisers to grandfathered funds would number of these advisers and provide us capital funds. Currently none of our incur minimal costs, at most, to confirm with specific examples of why such rules requires that an adviser exempt that existing venture capital funds advisers would not be able to rely on the from registration specify the basis for managed by the adviser meet the grandfathering provision. the exemption. We are proposing, conditions of the grandfathering Costs for new advisers and advisers to however, to require exempt reporting provision. We estimate that these costs new venture capital funds. We expect advisers to identify the exemption(s) on would be no more than $800 to hire that existing advisers that seek to form which they are relying.290 Requiring outside counsel to assist in this new venture capital funds and that venture capital funds represent determination.293 investment advisory firms that seek to themselves as such to investors should We recognize, however, that advisers enter the venture capital industry would allow the Commission and the investing to funds that are currently in the process incur one-time ‘‘learning costs’’ to public (particularly potential investors of being formed and negotiated with determine how to structure new funds in venture capital funds) to determine, investors may incur costs to determine they may manage to meet the elements and confirm, an adviser’s rationale for whether they qualify for the of our proposed definition. We estimate remaining unregistered with the grandfathering provision. For example, that on average, there are 24 new Commission. This element is designed these advisers may need to assess the advisers to venture capital funds each to deter advisers to private funds other impact on the fund of selling interests year.295 We expect that the one-time than venture capital funds from to initial third party investors by learning costs would be no more than claiming to rely on an exemption from December 31, 2010 and selling interests between $2,800 and $4,800 on average registration for which they are not to all investors no later than July 21, for an adviser if it hires an outside eligible. 2011. We do not expect that the cost of consulting or law firm to assist in We request comment on the potential evaluating the grandfathering provision determining how the elements of our benefits we have identified above. Are would be significant, however, because proposed definition may affect intended there benefits of the proposed definition we believe that most funds in formation business practices.296 Thus, we estimate that we have not identified? represent themselves as being venture the aggregate cost to existing advisers of capital funds or funds that pursue a determining how the proposed 2. Costs venture capital investing strategy to definition would affect funds they plan Costs for advisers to existing venture their potential investors and the typical to launch would be from $67,200 to capital funds. As discussed above, we fundraising period for a venture capital $115,200.297 We request comment on do not expect that the proposed rule fund is approximately 12 months.294 whether these estimates accurately would result in any significant costs for Thus, we do not anticipate that venture reflect the fees an adviser would be unregistered advisers to venture capital capital fund advisers would have to likely to pay to consulting and law firms funds currently in existence and alter typical business practice to it hires. As they launch new funds and operating. We estimate that currently structure or raise capital for venture negotiate with potential investors, these there are 800 advisers to venture capital capital funds being formed. advisers would have to determine funds.291 We expect that all these Nevertheless, we recognize that after the whether it is more cost effective to advisers, which we assume currently are final rule goes into effect, exempt register or to structure the venture not registered in reliance on the private advisers of such funds in formation may capital funds they manage to meet the adviser exemption, would continue to forgo the opportunity to accept proposed definition. Such be exempt after the repeal of that investments from investors that may considerations of legal or other exemption on July 21, 2011 in reliance seek to invest after July 21, 2011 in requirements, however, comprise a on the proposed grandfathering order to comply with the grandfathering typical business and operating expense provision.292 We anticipate that such provision. of conducting new business. New We request comment on the potential advisers that enter into the business of costs of this aspect of our proposed rule. 290 See Implementing Release, supra note 25, at managing venture capital funds also n.130 and accompanying text. Are there advisers to existing venture would incur such ordinary costs of 291 See NVCA Yearbook 2010, supra note 41, at capital funds or venture capital funds in doing business in a regulated ‘‘ ’’ figure 1.04 (providing number of active venture formation that would not be covered by 298 capital advisers who have raised a venture capital industry. the grandfathering provision? We We believe that existing advisers to partnership within the past eight years). request commenters to quantify the 292 We estimate that these advisers (and any other venture capital funds meet most, if not adviser that seeks to remain unregistered in reliance all, of the elements of the proposed on the exemption under section 203(l) of the investment advisers. See infra note 300. These Advisers Act) would incur, on average, $2,041 per reporting costs are attributable to the Dodd-Frank 295 year to complete and update related reports on Act, which directs the Commission to require This is the average annual increase in the Form ADV, including Schedule D information advisers to venture capital funds to provide such number of venture capital advisers between 1980 relating to private funds. See Implementing Release, annual and other reports as we determine necessary and 2009. See NVCA Yearbook 2010, supra note 41, supra note 25, at section IV.B.2. This estimate or in the public interest or for the protection of at figure 1.04. includes internal costs to the adviser of $1,764 to investors. See section 203(l) of the Advisers Act. 296 We expect that a venture capital adviser prepare and submit an initial report on Form ADV 293 We expect that a venture capital adviser would need between 7 and 12 hours of consulting and $277 to prepare and submit annual would need no more than 2 hours of legal advice or legal advice to learn the differences between its amendments to the report. These estimates are to learn the differences between its current business current business practices and the proposed based on the following calculations: $1,764 = practices and the conditions for reliance on the definition, depending on the experience of the firm ($3,528,000 aggregate costs ÷ 2,000 advisers); $277 proposed grandfathering provision. We estimate and its familiarity with the elements of the = ($554,400 aggregate costs ÷ 2,000 advisers). Id., at that this advice would cost $400 per hour per firm proposed rule. We estimate that this advice would nn.337, 339 and accompanying text. We estimate based on our understanding of the rates typically cost $400 per hour per firm based on our that one exempt reporting adviser would file Form charged by outside consulting or law firms. understanding of the rates typically charged by ADV–H per year at a cost of $204 per filing. Id., at 294 See BRESLOW & SCHWARTZ, supra note 144, at outside consulting or law firms. n.344 and accompanying text. We further estimate 2–22 (‘‘Once the first closing [of a private equity 297 This estimate is based on the following that three exempt reporting advisers would file fund] has occurred, subsequent closings are calculations: $2,800 x 24 = $67,200; 24 x $4,800 = Form ADV–NR per year at a cost of $57 per filing. typically held over a defined period of time [the $115,200. Id., at nn.347, 349 and accompanying text. We marketing period] of approximately six to twelve 298 For estimates of the costs of registration for anticipate that filing fees for exempt reporting months.’’). See also Dow Jones Report, supra note those advisers that would choose to register, see advisers would be the same as those for registered 145, at 22. infra notes 299–304.

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definition because it is modeled on additional investment strategies beyond nature of the adviser’s business, but in current business practices of venture venture capital investing or expand the any case would be an ordinary business capital funds. We thus do not anticipate potential investor base to include and operating expense of entering into that many venture capital fund advisers investors that are required to invest with any business that is regulated. We would have to change significantly the registered advisers), these choices may estimate that the one-time costs to new structure of new funds they launch. result in greater investment choices for registrants to establish a compliance Under our proposed definition, an investors, greater competition and infrastructure would range from $10,000 adviser would not be able to rely on the greater capital formation. to $45,000, while ongoing annual costs exemption if a venture capital fund Investment advisers to new venture of compliance and examination would invested in securities that were not capital funds that would not meet the range from $10,000 to $50,000.303 equity securities issued by qualifying proposed definition would have to We do not believe that the proposed portfolio companies. Although we register and incur the costs associated definition of venture capital fund is believe this practice is not common in with registration (assuming the adviser likely to affect whether advisers to the industry, this element of our could not rely on the private fund venture capital funds would choose to proposed rule may result in some adviser exemption). We estimate that launch new funds or whether persons venture capital funds incurring costs to the internal cost to register with the would choose to enter into the business structure and acquire equity Commission would be $11,526 on of advising venture capital funds investments that possess terms and average for a private fund adviser,299 because, as noted above, we believe the protections typically found in debt excluding the initial filing fees and proposed definition reflects the way instruments. To the extent that venture annual filing fees to the Investment most venture capital funds currently capital funds might not be able to Adviser Registration Depository operate. For this reason, we expect that structure equity investments in this (‘‘IARD’’) system operator.300 These the proposed definition is not likely to way, and portfolio companies would registration costs include the costs significantly affect the way in which have to forgo debt issuance, the attributable to completing and investment advisers to these funds do proposal could have an adverse effect periodically amending Form ADV, business and thus compete. For the on capital formation. preparing brochure supplements, and same reason, we do not believe that our We also recognize that some existing delivering codes of ethics to clients.301 proposed rule is likely to have a venture capital funds may have In addition to the internal costs significant effect on overall capital characteristics that differ from the described above, we estimate that for an formation. elements of the proposed definition adviser choosing to use outside legal We request comment on the costs we other than the limitation on investments services to complete its brochure, such have discussed above. Are there costs of in debt securities issued by portfolio costs would be $3,000 to $5,000.302 the proposed definition that we have companies. To the extent that New registrants would also face costs not identified? How many advisers to investment advisers seek to form new to bring their business operations into venture capital funds are likely to venture capital funds with these compliance with the Advisers Act and choose to register or structure new characteristics, those advisers would the rules thereunder. These costs would venture capital funds differently from have to choose whether to structure new vary depending on the size, scope and their existing funds in order to meet the venture capital funds to conform to the proposed definition? How costly would proposed definition, forgo forming new 299 This estimate is based upon the following it be for advisers to structure new funds, or register with the Commission. calculations: $11,526 = ($7,699,860 aggregate costs to complete Form ADV ÷ 750 advisers) + venture capital funds to conform to the In any case, each investment adviser ($1,197,000 aggregate costs to complete private fund proposed definition in order to qualify would assess the costs associated with reporting requirements ÷ 950 advisers). See registering with the Commission relative Implementing Release, supra note 25, at nn.355– 303 We expect that most advisers that might to the costs of remaining unregistered 361. This also assumes that an adviser’s registration choose to register have already built compliance process would be conducted by a senior compliance (and hence structuring funds to meet infrastructures as a matter of good business examiner and a compliance manager at an practice. Nevertheless, we expect advisers will our proposed definition in order to be estimated cost of $210 and $294 per hour, incur costs for outside legal counsel to evaluate eligible for the exemption). We expect respectively. See Implementing Release, supra note their compliance procedures initially and on an that this assessment would take into 25, at nn.354 and accompanying text. ongoing basis. We estimate that the costs to advisers 300 account many factors, including the The initial filing fee and annual filing fee for to establish the required compliance infrastructure advisers with $25 million to $100 million of assets will be, on average, $20,000 in professional fees and size, scope and nature of its business under management is $150 and for advisers with $25,000 in internal costs including staff time. These and investor base. Such factors will vary $100 million or more of assets under management estimates were prepared in consultation with from adviser to adviser, but each adviser is $200. See Electronic Filing for Investment attorneys who, as part of their private practice, have would determine whether registration, Advisers on IARD: IARD Filing Fees, available at counseled private fund advisers establishing their http://www.sec.gov/divisions/investment/iard/ registrations with the Commission. We have relative to other choices, is the most iardfee.shtml. included a range because we believe there are a cost-effective or strategic business 301 Part 1 of Form ADV requires advisers to number of unregistered private funds whose option for itself. answer basic identifying information about their compliance operations are already substantially in To the extent that advisers choose to business, their affiliates and their owners, compliance with the Advisers Act and that would structure new venture capital funds to information that is readily available to advisers, and therefore experience only minimal incremental thus should not result in significant costs to ongoing costs as a result of registration. In conform to the proposed definition, or complete. Registered advisers must also complete connection with previous estimates we have made choose not to form new funds in order Part 2 of Form ADV and file it electronically with regarding compliance costs for registered advisers, to avoid registration, these choices us. Part 2 requires disclosure of certain conflicts of we received comments from small advisers could result in fewer investment choices interest and could be prepared based on estimating that their annual compliance costs information already contained in materials would be $25,000 and could be as high as $50,000. for investors, less competition and less provided to investors, which could reduce the costs See, e.g., Comment Letter of Joseph L. Vidich (Aug. capital formation. To the extent that of compliance even further. 7, 2004). Cf. Comment Letter of Venkat Swarna advisers choose to register in order to 302 See Implementing Release, supra note 25, at (Sept. 14, 2004) (estimating costs of $20,000 to structure new venture capital funds n.363, 421 (noting the cost estimate for compliance $25,000). These comment letters were submitted in consulting services related to initial preparation of connection with Hedge Fund Adviser Registration without regard to the proposed the amended Form ADV ranges from $3,000 for Release, supra note 17, and are available on the definitional elements or in order to smaller advisers to $5,000 for medium-sized Commission’s Internet Web site at http:// expand their business (e.g., pursue advisers). www.sec.gov/rules/proposed/s73004.shtml.

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for an exemption from registration? anticipate that this uniform approach with GAAP or other international Would advisers choose not to launch would benefit regulators (both state and accounting standards.310 We new funds or not enter the venture federal) as well as advisers, because acknowledge that some advisers to capital industry in order to avoid the only a single determination of assets private funds may not use fair value costs associated with structuring under management would be required methodologies, which may be more venture capital funds to conform to the for purposes of registration and difficult to apply when the fund holds definition or registration? 304 exemption from federal registration. illiquid or other types of assets that are B. Exemption for Investment Advisers The instructions to Form ADV not traded on organized markets. Proposed rule 203(m)–1(c) specifies Solely to Private Funds With Less Than currently permit, but do not require, that an adviser relying on the exemption $150 Million in Assets Under advisers to exclude certain types of 307 would determine the amount of its Management managed assets. As a result, it is not possible to conclude that two advisers private fund assets quarterly, which we As discussed in Section II.B., reporting the same amount of assets believe would benefit advisers. We proposed rule 203(m)–1 would exempt under management are necessarily understand that a quarterly calculation any investment adviser solely to private comparable because either adviser may of assets under management is funds that has less than $150 million in elect to exclude all or some portion of consistent with business practice— assets under management in the United certain specified assets that it manages. many types of private funds calculate States. Our proposed rule is designed to By specifying that assets under fees payable to advisers and other implement the private fund adviser management must be calculated service providers on at least a quarterly exemption, as directed by Congress, in according to the instructions to Form basis.311 The quarterly calculation also section 203(m) of the Advisers Act and ADV, our proposed approach should would allow advisers that rely on the includes provisions for determining the benefit advisers by increasing exemption to maintain the exemption amount of an adviser’s private fund administrative efficiencies because despite short-term market value assets for purposes of the exemption advisers would have to calculate assets fluctuations that might result in the loss and when those assets are deemed under management only once for of the exemption if, for example, the 305 managed in the United States. multiple purposes.308 We expect this rule required daily valuation. We expect 1. Benefits would minimize costs relating to that quarterly valuation would also software modifications, recordkeeping, benefit these advisers by allowing them As discussed above and in the and training required to determine to avoid the cost of more frequent Implementing Release, we are proposing assets under management for regulatory valuations, including costs (such as a uniform method of calculating assets purposes. We also anticipate that the third party quotes) associated with under management in the instructions consistent calculation and reporting of valuing illiquid assets, which may be to Form ADV, which would be used to assets under management would benefit particularly difficult to value more often determine whether an adviser qualifies investors and regulators because it because of the lack of frequency with to register with the Commission rather would provide enhanced transparency which such assets are traded. than the states, and to determine and comparability of data, and allow Under proposed rule 203(m)–1(a), all eligibility for the private fund adviser investors and regulators to analyze on a of the private fund assets of an adviser exemption under section 203(m) of the more cost effective basis whether any with a principal office and place of Advisers Act and the foreign private particular adviser may be required to business in the United States would be adviser exemption under section register with the Commission or is considered to be ‘‘assets under 203(b)(3) of the Advisers Act.306 We eligible for an exemption. management in the United States,’’ even if the adviser has offices outside of the 304 We anticipate that the valuation of Commission staff estimates that the one-time 312 costs of registration for a venture capital fund private fund assets under proposed rule United States. A non-U.S. adviser adviser with $150 million in assets under 203(m)–1 would benefit private fund would need only count private fund management in the United States (i.e., an adviser advisers that seek to rely on the assets it manages from a place of that would not qualify for the exemption under 309 business in the U.S. toward the $150 section 203(m) of the Advisers Act), would be exemption. Under proposed rule approximately 0.01% of assets, and annual costs of 203(m)–1, each adviser would million limit under the exemption. As compliance and examination would range from determine the amount of its private fund discussed below, we believe that this 0.007% to 0.03% of assets under management. assets based on the fair value of the interpretation of ‘‘assets under These figures are based on the following management in the United States’’ calculations: ($11,526 (registration costs) + $3,000 assets at the end of each quarter. We (lower estimate of external costs to prepare propose that advisers use fair value of would offer greater flexibility to brochure)) ÷ $150,000,000 = 0.000097; ($11,526 private fund assets in order to ensure advisers and reduce many costs (registration costs) + $5,000 (higher estimate of that, for purposes of this exemption, associated with compliance. These costs external costs to prepare brochure)) ÷ $150,000,000 could include difficult attribution = 0.0001); $10,000 (lower estimate of ongoing costs) advisers value private fund assets on a ÷ $150,000,000 = 0.000067; $50,000 (higher meaningful and consistent basis. We determinations that would be required if estimate of ongoing costs) ÷ $150,000,000 = understand that many, but not all, assets are managed by teams located in 0.000333). advisers to private funds value assets multiple jurisdictions or if portfolio 305 See supra sections II.B.2–3 of this Release. based on their fair value in accordance managers located in one jurisdiction 306 See supra note 190 and accompanying text; rely heavily on research or other Implementing Release, supra note 25, at nn.58–59 and accompanying text. Thus, under proposed rule of the proposed rule’s exemption); proposed rule 203(m)–1, to determine its assets under 203(m)–1(e)(4) (defining ‘‘private fund assets’’ as the 310 See supra note 196. management for purposes of the proposed private investment adviser’s assets under management 311 See supra section II.B.2 of this Release; see, fund adviser exemption, an adviser would calculate attributable to a qualifying private fund). e.g., Breslow & Schwartz, supra note 144, at its ‘‘regulatory assets under management’’ 307 See proposed Form ADV: Instructions to Part § 2.8.2[C]. attributable to private funds according to the 1A, instr. 5.b(1). 312 As discussed above, the proposed rule looks instructions to Form ADV. Proposed rule 203(m)– 308 See Shearman & Sterling Letter, supra note to an adviser’s principal office and place of 1(a)(2), (b)(2) (conditioning the exemption on an 268. business as the location where it directs, controls adviser managing private fund assets of less than 309 See proposed rule 203(m)–1(c); Implementing and coordinates its global advisory activities. $150 million); proposed rule 203(m)–1(e)(1) Release, supra note 25, proposed Form ADV: Proposed rule 203(m)–1(e)(3). See supra notes 202– (defining ‘‘assets under management’’ for purposes Instructions to Part 1A, instr. 5.b(4). 203 and accompanying text.

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advisory services performed by by facilitating their continued anticipate that our proposed approach employees located in another participation in the U.S. market with would promote efficiency because jurisdiction. limited disruption to their non-U.S. advisers are familiar with it, and we do To the extent that this interpretation advisory business practices.316 This not anticipate that U.S. investment may increase the number of advisers approach also might benefit U.S. advisers to private funds would likely subject to registration under the investors and facilitate competition in change their business models, the Advisers Act, we anticipate that our the market for advisory services to the location of their private funds, or the proposal also would benefit investors by extent that it would maintain or location where they manage assets as a providing more information about those increase U.S. investors’ access to result of the proposed rule. We advisers (e.g., information that would potential advisers. Furthermore, because anticipate, however that non-U.S. become available through Form ADV, non-U.S. advisers that elect to avail advisers may incur minimal costs to Part I). We further anticipate that this themselves of the exemption would be determine whether they have assets would enhance investor protection by subject to certain reporting under management in the U.S. We increasing the number of advisers requirements,317 our proposed approach estimate that these costs would be no registering pursuant to the Advisers Act would increase the availability of greater than $6,940 to hire U.S. counsel and by improving the Commission’s information publicly available to U.S. and perform an internal review to assist ability to exercise its investor protection investors who invest in the private in this determination, in particular to and enforcement mandates over those funds advised by such exempt but assess whether a non-U.S. affiliate newly registered advisers. As discussed reporting non-U.S. advisers. manages a discretionary account for the above, registration offers benefits to the We request comment on the potential benefit of a United States person under investing public, including periodic benefits we have identified above. Are the proposed rule.321 examination of the adviser and there benefits of the proposed rule that As noted above, because our rule is compliance with rules requiring we have not identified? designed to encourage the participation recordkeeping, custody of client funds of non-U.S. advisers in the U.S. market, and compliance programs.313 2. Costs we anticipate that it would have Under proposed rule 203(m)–1(b), a As noted above, under proposed rule minimal regulatory and operational non-U.S. adviser with no U.S. place of 203(m)–1, we would look to an adviser’s burdens on foreign advisers and their business could avail itself of the principal office and place of business as U.S. clients. Non-U.S advisers would be exemption under section 203(m) even if the location where the adviser directs, able to rely on proposed rule 203(m)–1 it advised non-U.S. clients that are not controls or has responsibility for, the if they manage U.S. private funds with private funds, provided that it did not management of private fund assets and more than $150 million in assets from advise any U.S. clients other than therefore as the place where all the a non-U.S. location as long as the 314 private funds. We anticipate that the adviser’s assets are managed. Thus, a private fund assets managed from a U.S. proposed approach to the exemption U.S. adviser would include all its place of business are less than $150 under section 203(m) of the Advisers private fund assets under management million. This could affect competition Act, which would look primarily to the in determining whether it exceeds the with U.S. advisers, which must register principal office and place of business of $150 million limit under the exemption. when they have $150 million in private an adviser to determine eligibility for We also look to where day-to-day fund assets under management the exemption, would increase the management of private fund assets may regardless of where the assets are number of non-U.S. advisers that may occur for purposes of a non-U.S. managed. be eligible for the exemption. As with adviser, whose principal office and To avail themselves of proposed rule other Commission rules that adopt a place of business is outside the United 203(m)–1, some advisers might choose territorial approach, the private fund States.318 A non-U.S. adviser therefore to move their principal office and place adviser exemption would be available to would count only the private fund of business outside the United States a non-U.S. adviser (regardless of its non- assets it manages from a place of and manage private funds from that U.S. advisory activities) in recognition business in the United States in location. This might result in costs to that non-U.S. activities of non-U.S. determining the availability of the U.S. investors in private funds that are advisers are less likely to implicate U.S. exemption. This approach is similar to managed by these advisers because they regulatory interests and in consideration the way we have defined the location of would not have the investor protection of general principles of international the adviser for regulatory purposes and other benefits that result from an comity. This approach to the exemption under our current rules,319 and thus we adviser’s registration under the Advisers is designed to encourage the believe it is the way in which most Act. We do not expect that many participation of non-U.S. advisers in the advisers would be likely to relocate for U.S. market by applying the U.S. advisers would interpret the exemption without our proposed rule.320 We securities laws in a manner that does This arrangement reduces transmittal costs and increases efficiencies for securities settlements. See not impose U.S. regulatory and 316 See supra section II.B.3 of this Release. generally Bank for International Settlements, The operational requirements on an 317 See Implementing Release, supra note 25, at 315 Depository Trust Company: Response to the adviser’s non-U.S. advisory business. section II.B. Disclosure Framework for Securities Settlement We anticipate that our proposed 318 See supra paragraph accompanying note 205. Systems (2002), http://www.bis.org/publ/ interpretation of the availability of the 319 See supra note 202 and accompanying text. cpss20r3.pdf. An account also has no physical private fund adviser exemption for non- 320 We do not believe that the statutory text refers location even if the prime broker, custodian or other U.S. advisers may benefit those advisers to where the assets themselves may be located or service that holds assets on behalf of the customer traded or the location of the account where the does. Each of these approaches would be confusing assets are held. In today’s market, using the location and extremely difficult to apply on a consistent 313 See supra text following note 281 and of assets would raise numerous questions of where basis. preceding and accompanying text. a security with no physical existence is ‘‘located.’’ 321 We expect that a non-U.S. adviser would need 314 By contrast, a U.S. adviser could ‘‘solely Although physical stock certificates were once sent no more than 10 hours of external legal advice (at advise private funds’’ as specified in the statute. to investors as proof of ownership, stock certificates $400 per hour) and 10 hours of internal review by Compare proposed rule 203(m)–1(a)(1) with are now centrally held by securities depositories, a senior compliance officer (at $294 per hour) to proposed rule 203(m)–1(b)(1). which perform electronic ‘‘book-entry’’ changes in evaluate whether the adviser would qualify for the 315 See supra note 208 and accompanying text. their records to document ownership of securities. exemption under section 203(l).

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purposes of avoiding registration, value standard.325 In the event a fund source of the assets (i.e., U.S. private however, because we understand that does not have an internal capability for fund investors).327 Under this approach, the primary reasons for advisers to valuing specific illiquid assets, we a non-U.S. adviser would count the locate in a particular jurisdiction expect that it could obtain pricing or assets of private funds attributable to involve tax and other business valuation services from an outside U.S. investors towards the $150 million considerations. We also note that if an administrator or other service provider. threshold, regardless of the location adviser did relocate, it would incur the In the event a fund does not have an where it manages private funds, and a costs of regulation under the laws of internal capability for valuing specific U.S. adviser would exclude assets that most of the foreign jurisdictions in illiquid assets, we expect that it could are not attributable to U.S. investors. As which it may be likely to relocate. We obtain pricing or valuation services from a result, under this alternative more U.S. do not believe, in any case, that the an outside administrator or other service advisers might be able to rely on rule adviser would relocate if relocation provider. Staff estimates that the cost of 203(m)–1 than under our proposed would result in a material decrease in such a service would range from $1,000 approach. To the extent that non-U.S. the amount of assets managed because to $120,000 annually, which could be advisers have U.S. investors in funds that loss would likely not justify the borne by several funds that invest in that they manage from a non-U.S. benefits of avoiding registration, and similar assets or have similar location, fewer non-U.S. advisers would investment strategies.326 We request thus we do not believe our proposed be eligible for the exemption under this comment on these estimates. Do rule would have an adverse effect on approach than under our proposal. advisers that do not use fair value capital formation. Thus, this alternative could increase methodologies for reporting purposes costs for those non-U.S. advisers who Our proposed rule incorporates the have the ability to fair value private would have to register but reduce costs valuation methodology in the fund assets internally? If not, what for those U.S. advisers who would not instructions to Form ADV. More would be the costs to retain a third party have to register. We seek comment on specifically, proposed instruction 5.b(4) valuation service? Are there certain the number of U.S. advisers that would to Form ADV would require advisers to types of advisers (e.g., advisers to real be able to avail themselves of the private use fair value of private fund assets for estate private funds) that would fund adviser exemption under this determining regulatory assets under experience special difficulties in alternative approach, but would not be management. We acknowledge that performing fair value analyses? If so, able to rely on proposed rule 203(m)–1. there may be some private fund advisers why? This alternative approach could Our earlier discussion of the proposed that may not use fair value discourage U.S. advisers that may want 322 rule also seeks comment on an methodologies. The costs incurred by to avoid registration from managing U.S. alternative interpretation of ‘‘assets these advisers to use fair valuation investor assets, which could affect under management in the United methodology would vary based on competition for the management of States,’’ which would reference the factors such as the nature of the asset, those assets. We believe this is unlikely the number of positions that do not have however, because to the extent the 325 This estimate is based upon the following a market value, and whether the adviser calculation: 8 hours × $153/hour = $1,224. The adviser would manage fewer assets we has the ability to value such assets hourly wage is based on data for a fund senior do not believe the loss of managed internally or would rely on a third party accountant from SIFMA’s Management and assets would justify the savings from for valuation services.323 Nevertheless, Earnings in the Securities Industry 2009, modified by Commission staff to account for an 1,800-hour avoiding registration. we do not believe that the requirement work-year and multiplied by 5.35 to account for Under either the proposed approach to use fair value methodologies would bonuses, firm size, employee benefits and overhead. or the alternative, each adviser may result in significant costs for these 326 These estimates are based on conversations incur costs to evaluate whether it would advisers. We understand that private with valuation service providers. We understand that the cost of valuation for illiquid fixed income be able to avail itself of the exemption. fund advisers, including those that may securities generally ranges from $1.00 to $5.00 per We estimate that each adviser may incur not use fair value methodologies for security, depending on the difficulty of valuation, between $800 to $4,800 in legal advice reporting purposes, perform and is performed for clients on weekly or monthly to learn whether it may rely on the basis. We understand that appraisals of privately 328 administrative services, including placed equity securities may cost from $3,000 to exemption. Each adviser that valuing assets, internally as a matter of $5,000 with updates to such values at much lower registers would incur registration costs, business practice.324 Commission staff prices. For purposes of this cost benefit analysis, we which we estimate would be $11,526.329 are estimating the range of costs for (i) a private They also would incur estimated initial estimates that such an adviser would fund that holds 50 fixed income securities at a cost incur $1,224 in internal costs to of $5.00 to price and (ii) a private fund that holds compliance costs ranging from $10,000 conform its internal valuations to a fair privately placed securities of 15 issuers that each to $45,000 and ongoing annual cost $5,000 to value initially and $1,000 thereafter. compliance costs from $10,000 to We believe that costs for funds that hold both fixed- 330 322 $50,000. Nevertheless, to the extent See supra note 310 and accompanying and income and privately placed equity securities following text. would fall within the maximum of our estimated there would be an increase in registered 323 See supra note 197. range. We note that funds that have significant advisers, as we have noted above, there 324 For example, a hedge fund adviser may value positions in illiquid securities are likely to have the fund assets for purposes of allowing new in-house capacity to value those securities or 327 investments in the fund or redemptions by existing already subscribe to a third party service to value See supra paragraph following note 210. investors, which may be permitted on a regular them. We note that many private funds are likely 328 We expect that a private fund adviser would basis after an initial lock-up period. An adviser to to have many fewer fixed income illiquid securities obtain between 2 and 12 hours of external legal private equity funds may obtain valuation of in their portfolios, some or all of which may cost advice (at a cost of $400 per hour) to determine portfolio companies in which the fund invests in less than $5.00 per security to value. Finally, we whether it would be eligible for the private fund connection with financing obtained by those note that obtaining valuation services for a small adviser exemption. companies. Advisers to private funds also may number of fixed income positions on an annual 329 This range is attributable to the amount of value portfolio companies each time the fund basis may result in a higher cost for each security assets under management, which affects the makes (or considers making) a follow-on investment or require a subscription to the valuation service for magnitude of filing fees associated with registration, in the company. Private fund advisers could use those that do not already purchase such services. and whether the adviser chooses to retain outside these valuations as a basis for complying with the The staff’s estimate is based on the following legal services to prepare its brochure. See supra fair valuation requirement we propose with respect calculations: (50 × $5.00 × 4 = $1,000; (15 × $5,000) notes 300–302 and accompanying text. to private fund assets. + (15 × $1,000 × 3) = $120,000). 330 See supra note 303 and accompanying text.

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are benefits to registration for both owners.337 As mentioned above, we required to be qualified purchasers investors and the Commission.331 would not include the ‘‘special rule’’ that under section 3(c)(7).343 We seek comment on our analysis of allows advisers not to count as a client Third, proposed rule 202(a)(30)–1 the costs associated with the approach any person for whom the adviser defines ‘‘in the United States’’ generally we have proposed and the costs of the provides investment advisory services by incorporating the definition of a alternative on which we seek comment. without compensation.338 Finally, we ‘‘U.S. person’’ and ‘‘United States’’ under Are there costs of the proposed rule or propose to add a provision that would Regulation S.344 In particular, we would the alternative approach that we have permit advisers to avoid double- define ‘‘in the United States’’ in not identified? counting private funds and their proposed rule 202(a)(30)–1 to mean: 339 (i) With respect to any place of business C. Foreign Private Adviser Exemption investors. Second, section 202(a)(30) provides located in the ‘‘United States,’’ as that Section 403 of the Dodd-Frank Act that a ‘‘foreign private adviser’’ eligible term is defined in Regulation S; 345 (ii) replaces the current private adviser for the new registration exemption with respect to any client or private exemption from registration under the cannot have more than 14 clients ‘‘or fund investor in the United States, any Advisers Act with a new exemption for investors.’’ We propose to define person that is a ‘‘U.S. person’’ as defined a ‘‘foreign private adviser,’’ as defined in ‘‘investor’’ in a private fund in rule in Regulation S,346 except that under the new section 202(a)(30) of the Advisers 202(a)(30)–1 as any person that would proposed rule, any discretionary Act.332 We are proposing new rule be included in determining the number account or similar account that is held 202(a)(30)–1, which would define of beneficial owners of the outstanding for the benefit of a person ‘‘in the United certain terms in section 202(a)(30) for securities of a private fund under States’’ by a non-U.S. dealer or other use by advisers seeking to avail section 3(c)(1) of the Investment professional fiduciary is a person ‘‘in the themselves of the foreign private adviser Company Act, or whether the United States’’ if the dealer or exemption.333 Because eligibility for the outstanding securities of a private fund professional fiduciary is a related new foreign private adviser exemption, are owned exclusively by qualified person of the investment adviser relying like the current private adviser purchasers under section 3(c)(7) of that on the exemption; and (iii) with respect exemption, is determined, in part, by Act.340 We are also proposing to treat as to the public in the ‘‘United States,’’ as the number of clients an adviser has, we investors beneficial owners (i) who are that term is defined in Regulation S.347 propose to include in rule 202(a)(30)–1 ‘‘knowledgeable employees’’ with Fourth, proposed rule 202(a)(30)–1 the safe harbor and many of the client respect to the private fund; 341 and (ii) defines ‘‘place of business’’ to have the counting rules that appear in rule of ‘‘short-term paper’’ 342 issued by the same meaning as in Advisers Act rule 203(b)(3)–1, as currently in effect.334 In private fund, even though these persons 222–1(a).348 Finally, for purposes of rule addition, we propose to define other are not counted as beneficial owners for 202(a)(30)–1 we propose to define terms used in the definition of ‘‘foreign purposes of section 3(c)(1), and ‘‘assets under management’’ by reference private adviser’’ under section 202(a)(30) knowledgeable employees are not to ‘‘regulatory assets under including: (i) ‘‘Investor;’’ (ii) ‘‘in the management’’ as determined under Item United States;’’ (iii) ‘‘place of business;’’ 337 Proposed rule 202(a)(30)–1(a)(2)(i)–(ii). In 5 of Form ADV.349 ‘‘ ’’ 335 addition, proposed rule 202(a)(30)–1(b)(1) through and (iv) assets under management. 1. Benefits Proposed rule 202(a)(30)–1 clarifies (3) would retain the following related ‘‘special rules’’: (1) An adviser must count a shareholder, We are proposing to define certain several provisions used in the statutory partner, limited partner, member, or beneficiary definition of ‘‘foreign private adviser.’’ (each, an ‘‘owner’’) of a corporation, general terms included in the statutory First, the proposed rule would include partnership, limited partnership, limited liability definition of ‘‘foreign private adviser’’ in the safe harbor for counting clients company, trust, or other legal organization, as a order to clarify the meaning of these client if the adviser provides investment advisory terms and reduce the potential currently in rule 203(b)(3)–1, as services to the owner separate and apart from the modified to account for its use in the legal organization; (2) an adviser is not required to administrative and regulatory burdens foreign private adviser context. Under count an owner as a client solely because the for advisers that seek to rely on the the safe harbor, an adviser would count adviser, on behalf of the legal organization, offers, promotes, or sells interests in the legal organization 343 See rule 3c–5(b) under the Investment certain natural persons as a single client to the owner, or reports periodically to the owners 336 Company Act; section 3(c)(1) of the Investment under certain circumstances. as a group solely with respect to the performance Company Act. See also supra note 249 and Proposed rule 202(a)(30)–1 would also of or plans for the legal organization’s assets or accompanying text. retain another provision of rule similar matters; and (3) any general partner, 344 Proposed rule 202(a)(30)–1(c)(2). See supra 203(b)(3)–1 that permits an adviser to managing member or other person acting as an notes 253–261 and accompanying paragraphs. investment adviser to a limited partnership or 345 See 17 CFR 230.902(l). treat as a single ‘‘client’’ an entity that limited liability company must treat the partnership 346 See 17 CFR 230.902(k). We would allow or limited liability company as a client. receives investment advice based on the foreign advisers to determine whether a client or 338 entity’s investment objectives and two See rule 203(b)(3)–1(b)(4); supra notes 233– investor is ‘‘in the United States’’ by reference to the or more entities that have identical 235 and accompanying text. time the person became a client or an investor. See 339 See proposed rule 202(a)(30)–1(b)(4) proposed rule 202(a)(30)–1’s note to paragraph (specifying that an adviser would not be required (c)(2)(i). 331 See supra text following note 281. to count a private fund as a client if it counted any 347 See 17 CFR 230.902(l). 332 See supra note 224 and accompanying text. investor, as defined in the proposed rule, in that 348 See proposed rule 202(a)(30)–1(c)(3); proposed The new exemption is codified as amended section private fund as an investor in the United States in rule 222–1(a) (defining ‘‘place of business’’ of an 203(b)(3). that private fund). investment adviser as: ‘‘(i) An office at which the 333 See supra section II.C of this Release. 340 See proposed rule 202(a)(30)–1(c)(1); supra investment adviser regularly provides investment 334 See supra section II.C.1 of this Release. Rule section II.C.2 of this Release. In order to avoid advisory services, solicits, meets with, or otherwise 203(b)(3)–1, as currently in effect, provides a safe double-counting, we would allow an adviser to treat communicates with clients; and (ii) Any other harbor for determining who may be deemed a single as a single investor any person that is an investor location that is held out to the general public as a client for purposes of the private adviser in two or more private funds advised by the location at which the investment adviser provides exemption. We would not, however, carry over investment adviser. See proposed rule 202(a)(30)– investment advisory services, solicit, meets with, or rules 203(b)(3)–1(b)(4), (5), or (7). See supra notes 1(c)(1), at note to paragraph (c)(1). otherwise communicates with clients.’’). See supra 228 and 233 and accompanying text. 341 See proposed rule 202(a)(30)–1(c)(1)(A); supra section II.C.4 of this Release. 335 Proposed rule 202(a)(30)–1(c). See supra note 246 and accompanying text. 349 See proposed rule 202(a)(30)–1(c)(4); proposed section II.C.2–4 of this Release. 342 See proposed rule 202(a)(30)–1(c)(1)(B); supra Form ADV: Instructions to Part 1A, instr. 5.b(4). See 336 Proposed rule 202(a)(30)–1(a)(1). notes 247–248 and accompanying text. also supra section II.C.5 of this Release.

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foreign private adviser exemption. As Advisers Act, which is used to 2. Costs discussed above, our proposed rule determine whether a state may assert We do not believe that the proposed references definitions set forth in other regulatory jurisdiction over the definitions would result in significant 355 Commission rules under the Advisers adviser. costs for foreign advisers. We anticipate Act, the Investment Company Act and As noted above, the proposed that each foreign adviser that seeks to the Securities Act, all of which are definitions of ‘‘investor’’ and ‘‘United avail itself of the foreign private adviser likely to be familiar to foreign advisers States’’ under our proposed rule would exemption may incur costs to determine active in the U.S. capital markets. We rely on existing definitions, with slight 356 whether it is eligible for the exemption. anticipate that by defining these terms, modifications. Our proposed rule We expect that these advisers would we would benefit foreign advisers by also would incorporate the current safe consult with outside U.S. counsel and providing clarity with respect to the harbor in rule 203(b)(3)–1 for counting perform an internal review of the extent proposed terms that advisers would clients, except that it would no longer to which an advisory affiliate manages otherwise be required to interpret (and allow an adviser to disregard clients for discretionary accounts owned by a U.S. which they would likely interpret with whom the adviser provides services person that would be counted toward 357 reference to the rules we reference).350 without compensation. We propose the limitation on clients and investors The proposal would provide these modifications in order to preclude in the United States. We estimate these consistency among these other rules and some advisers from excluding certain costs would be $6,940.360 the new exemption. This would limit assets or clients from their calculation Without the proposed rule, we expect foreign advisers’ need to undertake so as to avoid registration with the that most advisers would interpret the additional analysis with respect to these Commission and the regulatory new statutory provision by reference to terms for purposes of determining the requirements associated with the same rules we propose to cross availability of the foreign private adviser registration.358 We believe that without reference in rule 202(a)(30)–1. Without exemption.351 We believe that the a definition of these terms, advisers our proposal, some advisers would consistency and clarity that would would likely rely on the same likely incur additional costs because result from the proposed rule would definitions we propose to cross they would seek guidance in promote efficiency for foreign advisers reference in rule 202(a)(30)–1, but interpreting the terms used in the and the Commission. without the proposed modifications. statutory exemption. By defining the For example, for purposes of Our proposal, therefore, would likely statutory terms in a rule, we believe that determining eligibility for the foreign have the practical effect of narrowing we can provide certainty for foreign private adviser exemption, advisers the scope of the exemption, and thus advisers and limit the time, compliance would count clients substantially in the would result in more advisers costs and legal expenses foreign same manner they count clients under registering. advisers might incur in seeking an the current private adviser We believe that any increase in interpretation, all of which costs could exemption.352 In identifying ‘‘investors,’’ registration as compared to the number inhibit capital formation or reduce advisers could rely on the determination of foreign advisers that might register if efficiency. We expect that advisers also made to assess whether the private fund we did not propose rule 202(a)(30)–1 would be less likely to seek additional meets the counting or qualification would benefit investors. Investors assistance from us because they could requirements under sections 3(c)(1) and whose assets are, directly or indirectly, rely on relevant guidance we have 3(c)(7) of the Investment Company managed by the foreign advisers that previously provided with respect to the Act.353 In determining whether a client, would be required to register would definitions we propose to cross an investor, or a place of business is ‘‘in benefit from the increased protection reference. We also believe that foreign the United States,’’ or whether it holds afforded by federal registration of the advisers’ ability to rely on the itself out as an investment adviser to the adviser and application to the adviser of definitions that we have referenced in public ‘‘in the United States,’’ an adviser all of the requirements of the Advisers the proposed rule and the guidance would apply the same analysis it would Act. As noted above, registration offers provided with respect to the referenced otherwise apply under Regulation S.354 benefits to the investing public, rules may reduce Commission resources In identifying whether it has a place of including periodic examination of the that would be otherwise applied to business in the United States, an adviser adviser and compliance with rules administering the private foreign would use the definition of ‘‘place of requiring recordkeeping, custody of adviser exemption, which resources business’’ under section 222 of the client funds and compliance could be allocated to other matters. programs.359 We anticipate that our proposed 350 See Paul Hastings Letter, supra note 258 (in We request comment on the potential instruction allowing foreign advisers to response to our request for public views, urging us benefits we have identified above. Are determine whether a client or investor to provide guidance on the interpretation of the there benefits of the proposed rule that terms of the statutory definition of ‘‘foreign private is ‘‘in the United States’’ by reference to adviser’’). See generally supra note 24. we have not identified? the time the person became a client or 351 This is true for all of the proposed definitions an investor, would also reduce advisers’ except for ‘‘assets under management.’’ An adviser 355 See supra section II.C.3 of this Release. Under costs.361 Advisers would make the that relies on the foreign private adviser exemption section 222 of the Advisers Act a state may not would need to calculate its assets under require an adviser to register if the adviser does not determination only once and would not management according to the proposed instructions have a ‘‘place of business’’ within, and has fewer be required to monitor changes in the to Item 5 of Form ADV only for purposes of the than 6 client residents of, the state. availability of the exemption. As discussed, above, 356 See supra notes 238, 246–251, 253–257 and 360 This estimate is based on consultation with proposed rule 202(a)(30)–1 includes a reference to accompanying text. outside counsel (at a cost of $400 per hour) of 10 Item 5 of Form ADV in order to ensure consistency 357 See supra notes 336–339 and accompanying hours and an internal review of discretionary in the calculation of assets under management for text. accounts owned by U.S. persons performed by a various purposes under the Advisers Act. See supra 358 See supra notes 246–251, 253–257 and senior compliance officer (at a cost of $294 per note 266 and accompanying text. accompanying text. See also infra notes 362–363 hour) of 10 hours. The calculation is as follows: 352 See supra section II.C.1 of this Release. and accompanying text for an estimate of the costs (10 hours × $400) + (10 hours × $294) = $6,940. 353 See supra paragraph accompanying note 240. associated with registration. 361 See proposed rule 202(a)(30)–1, at note to 354 See supra notes 258–259 and accompanying 359 See supra text accompanying and following paragraph (c)(2)(i); supra notes 267–268 and paragraph. note 281. accompanying text.

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status of each client and private fund management. Some foreign advisers to Business Regulatory Enforcement investor. Moreover, if a client or an private funds may value assets based on Fairness Act of 1996,370 the Commission investor moved to the United States, their fair value in accordance with also requests information regarding the under our approach the adviser would GAAP or other international accounting potential annual effect of the proposals not be forced to choose among standards, while other advisers to on the U.S. economy. Commenters are registering with us, terminating the private funds may not use fair value requested to provide empirical data to relationship with the client, or forcing methodologies.365 As discussed above, support their views. the investor out of the the private fund. the costs associated with fair valuation VI. Regulatory Flexibility Act The proposed modifications may would vary based on factors such as the Certification result in some costs for foreign advisers nature of the asset, the number of who might change their business positions that do not have a market Pursuant to section 605(b) of the practices in order to rely on the value, and whether the adviser has the Regulatory Flexibility Act,371 the exemption. Some foreign advisers may ability to value such assets internally or Commission hereby certifies that have to choose to limit the scope of their would rely on a third party for valuation proposed rules 203(l)–1 and 203(m)–1 contacts with the United States in order services.366 Nevertheless, we do not under the Advisers Act would not, if to rely on the statutory exemption for believe that the requirement to use fair adopted, have a significant economic foreign private advisers or to register value methodologies would result in impact on a substantial number of small with us. As noted above, we have significant costs for these advisers to entities. Under Commission rules, for estimated the costs of registration to be these funds.367 Commission staff the purposes of the Advisers Act and $11,526.362 In addition, registered estimates that such advisers would each the Regulatory Flexibility Act, an advisers would incur initial costs to incur $1,224 in internal costs to investment adviser generally is a small establish a compliance infrastructure, conform its internal valuations to a fair entity if it: (i) Has assets under which we estimate would range from value standard.368 In the event a fund management having a total value of less $10,000 to $45,000 and ongoing annual does not have an internal capability for than $25 million; (ii) did not have total costs of compliance and examination, valuing illiquid assets, we expect that it assets of $5 million or more on the last which we estimate would range from could obtain pricing or valuation day of its most recent fiscal year; and $10,000 to $50,000.363 In either case, services from an outside administrator (iii) does not control, is not controlled foreign advisers would assess the costs or other service provider. Staff estimates by, and is not under common control of registering with the Commission that the annual cost of such a service with another investment adviser that relative to relying on the exemption. would range from $1,000 to $120,000 has assets under management of This assessment, however, would take annually which could be borne by $25 million or more, or any person into account many factors, which would several funds that invest in similar (other than a natural person) that had vary from one adviser to another, to assets or have similar investment $5 million or more on the last day of its determine whether registration, relative strategies.369 We request comment on most recent fiscal year (‘‘small to other options, is the most cost- these estimates. Do foreign advisers that adviser’’).372 effective business option for the adviser do not use fair value methodologies for Investment advisers solely to venture to pursue. If a foreign adviser limited its reporting purposes have the ability to capital funds and advisers solely to activities within the United States in fair value private fund assets internally? private funds in each case with assets order to rely on the exemption, the If not, what would be the costs to retain under management of less than modifications might have the effect of a third party valuation service? Are $25 million would remain generally reducing competition in the market for there certain types of foreign advisers ineligible for registration with the advisory services. Were the foreign (e.g., advisers to real estate private Commission under section 203A of the adviser to register, competition among funds) that would experience special Advisers Act.373 We expect that any registered advisers would increase. difficulties in performing fair value small adviser solely to existing venture Furthermore, to the extent that the analyses? If so, why? capital funds that would not be modifications included in the definition We request comment on the potential ineligible to register with the of ‘‘investor’’ (in particular the one costs we have identified above. Are Commission would be able to avail itself concerning knowledgeable employees) there costs of the proposed rule that we of the exemption from registration would limit a foreign adviser’s ability to have not identified? under the grandfathering provision. If an adviser solely to a new venture attract certain private fund investors, D. Request for Comment those modifications may have an capital fund could not avail itself of the adverse effect on capital formation. The Commission requests comments exemption because, for example, the By referencing the method of on all aspects of the cost-benefit fund it advises did not meet the calculating assets under management analysis, including the accuracy of the proposed definition of ‘‘venture capital under Form ADV, certain foreign private potential costs and benefits identified fund,’’ we anticipate that the adviser advisers would use the valuation and assessed in this Release, as well as could avail itself of the exemption in method provided in the instructions to any other costs or benefits that may section 203(m) of the Advisers Act as Form ADV to verify compliance with result from the proposals. We encourage the $25 million asset threshold included commenters to identify, discuss, 370 Public Law 104–121, Title II, 110 Stat. 857 in the foreign private adviser analyze, and supply relevant data (1996) (codified in various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C. 601). exemption.364 More specifically, regarding these or additional costs and benefits. For purposes of the Small 371 5 U.S.C. 605(b). proposed instruction 5.b(4) to Form 372 Rule 0–7(a) (17 CFR 275.0–7(a)). ADV would require advisers to use fair 373 Section 203A of the Advisers Act (prohibiting 365 value of private fund assets for See supra note 310 and accompanying and an investment adviser that is regulated or required following text. to be regulated as an investment adviser in the State determining regulatory assets under 366 See supra notes 322–325 and accompanying in which it maintains its principal office and place paragraph. of business from registering with the Commission 362 See supra note 299 and accompanying text. 367 See supra note 324 and accompanying text. unless the adviser has $25 million or more in assets 363 See supra note 303 and accompanying text. 368 See supra note 325. under management or is an adviser to a registered 364 See supra section II.C.5 of this Release. 369 See supra note 326 and accompanying text. investment company).

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implemented by proposed rule Text of Proposed Rules (2) You are not required to count an 203(m)–1. Similarly, we expect that any For reasons set out in the preamble, owner as a client solely because you, on small adviser solely to private funds the Commission proposes to amend behalf of the legal organization, offer, would be able to rely on the exemption Title 17, Chapter II of the Code of promote, or sell interests in the legal in section 203(m) of the Advisers Act as Federal Regulations as follows: organization to the owner, or report implemented by proposed rule periodically to the owners as a group 203(m)–1. We further believe that these PART 275—RULES AND solely with respect to the performance advisers would be able to avail REGULATIONS, INVESTMENT of or plans for the legal organization’s themselves of the exemption for private ADVISERS ACT OF 1940 assets or similar matters; fund advisers regardless of whether our (3) A limited partnership or limited implementing rules required them to 1 . The general authority citation for liability company is a client of any calculate assets under management as Part 275 is revised to read as follows: general partner, managing member or proposed approach or under the Authority: 15 U.S.C. 80b–2(a)(11)(G), 80b– other person acting as investment alternative method on which we request 2(a)(11)(H), 80b–2(a)(17), 80b–3, 80b–4, 80b– adviser to the partnership or limited comment.374 6(4), 80b–6(a), and 80b–11, unless otherwise liability company; and noted. Thus, we believe that small advisers (4) You are not required to count a solely to venture capital funds and * * * * * private fund as a client if you count any small advisers to other private funds 2. Section 275.202(a)(30)–1 is added investor, as that term is defined in would generally be ineligible to register to read as follows: paragraph (c)(1) of this section, in that with the Commission. Those small private fund as an investor in the United § 275.202(a)(30)–1 Foreign private States in that private fund. advisers that may not be ineligible to advisers. register with the Commission, we (a) Client. You may deem the Note to paragraphs (a) and (b): These believe, would be able to rely on the following to be a single client for paragraphs are a safe harbor and are not intended to specify the exclusive method for venture fund exemption under section purposes of section 202(a)(30) of the Act 203(l) of the Advisers Act or the private determining who may be deemed a single (15 U.S.C. 80b–2(a)(30)): client for purposes of section 202(a)(30) of fund adviser exemption under section (1) A natural person, and: the Act (15 U.S.C. 80b–2(a)(30)). 203(m) of that Act as implemented by (i) Any minor child of the natural our proposed rules. For these reasons, person; (c) Definitions. For purposes of we are certifying that proposed rules (ii) Any relative, spouse, or relative of section 202(a)(30) of the Act (15 U.S.C. 203(l)–1 and 203(m)–1 under the the spouse of the natural person who 80b–2(a)(30)), Advisers Act would not, if adopted, has the same principal residence; (1) Investor means any person that have a significant economic impact on (iii) All accounts of which the natural would be included in determining the a substantial number of small entities. person and/or the persons referred to in number of beneficial owners of the outstanding securities of a private fund The Commission requests written this paragraph (a)(1) are the only primary beneficiaries; and under section 3(c)(1) of the Investment comments regarding this certification. Company Act of 1940 (15 U.S.C. 80a– The Commission requests that (iv) All trusts of which the natural person and/or the persons referred to in 3(c)(1)), or whether the outstanding commenters describe the nature of any securities of a private fund are owned impact on small businesses and provide this paragraph (a)(1) are the only primary beneficiaries; exclusively by qualified purchasers empirical data to support the extent of under section 3(c)(7) of that Act (15 the impact. (2)(i) A corporation, general partnership, limited partnership, U.S.C. 80a–3(c)(7)), except that any of VII. Statutory Authority limited liability company, trust (other the following persons is also an than a trust referred to in paragraph investor: The Commission is proposing rule (a)(1)(iv) of this section), or other legal (i) Any beneficial owner of the private 202(a)(30)–1 under the authority set organization (any of which are referred fund that pursuant to § 270.3c–5 of this forth in sections 403 and 406 of the to hereinafter as a ‘‘legal organization’’) title would not be included in the above Dodd-Frank Act, to be codified at to which you provide investment advice determinations under section 3(c)(1) sections 203(b) and 211(a) of the based on its investment objectives rather and 3(c)(7) of the Investment Company Advisers Act, respectively (15 U.S.C. than the individual investment Act of 1940 (15 U.S.C. 80a–3(c)(1), (7)); 80b–3(b), 80b–11(a)). The Commission objectives of its shareholders, partners, and is proposing rule 203(l)–1 under the limited partners, members, or (ii) Any beneficial owner of any authority set forth in sections 406 and beneficiaries (any of which are referred outstanding short-term paper, as 407 of the Dodd-Frank Act, to be to hereinafter as an ‘‘owner’’); and defined in section 2(a)(38) of the codified at sections 211(a) and 203(l) of (ii) Two or more legal organizations Investment Company Act of 1940 the Advisers Act, respectively (15 U.S.C. referred to in paragraph (a)(2)(i) of this (15 U.S.C. 80a–2(a)(38)), issued by the 80b–11(a), 80b–3(l)). The Commission is section that have identical owners. private fund. proposing rule 203(m)–1 under the (b) Special rules regarding clients. For Note to paragraph (c)(1): You may treat as authority set forth in sections 406 and purposes of this section: a single investor any person that is an 408 of the Dodd-Frank Act, to be (1) You must count an owner as a investor in two or more private funds you codified at sections 211(a) and 203(m) of client if you provide investment advise. the Advisers Act, respectively (15 U.S.C. advisory services to the owner separate (2) In the United States means with 80b–11(a), 80b–3(m)). and apart from the investment advisory respect to: List of Subjects in 17 CFR Part 275 services you provide to the legal (i) Any client or investor, any person organization, provided, however, that that is a ‘‘U.S. person’’ as defined in Reporting and recordkeeping the determination that an owner is a § 230.902(k) of this title, except that any requirements; Securities. client will not affect the applicability of discretionary account or similar account this section with regard to any other that is held for the benefit of a person 374 See supra section II.B.2 of this Release. owner; in the United States by a dealer or other

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professional fiduciary is in the United provide, and if accepted, does so traded on any exchange or organized States if the dealer or professional provide, significant guidance and market operating in a foreign fiduciary is a related person of the counsel concerning the management, jurisdiction. investment adviser relying on this operations or business objectives and (4) Qualifying portfolio company section and is not organized, policies of the qualifying portfolio means any company that: incorporated, or (if an individual) company; or (i) At the time of any investment by resident in the United States. (ii) Controls the qualifying portfolio the private fund, is not publicly traded company; and does not control, is not controlled Note to paragraph (c)(2)(i): A person that by or under common control with is in the United States may be treated as not (4) Does not borrow, issue debt being in the United States if such person was obligations, provide guarantees or another company, directly or indirectly, not in the United States at the time of otherwise incur leverage, in excess of 15 that is publicly traded; becoming a client or, in the case of an percent of the private fund’s aggregate (ii) Does not borrow or issue debt investor in a private fund, at the time the capital contributions and uncalled obligations, directly or indirectly, in investor acquires the securities issued by the committed capital, and any such connection with the private fund’s fund. borrowing, indebtedness, guarantee or investment in such company; (ii) Any place of business, in the leverage is for a non-renewable term of (iii) Does not redeem, exchange or United States, as that term is defined in no longer than 120 calendar days; repurchase any securities of the § 230.902(l) of this chapter; and (5) Only issues securities the terms of company, or distribute to pre-existing (iii) The public, in the United States, which do not provide a holder with any security holders cash or other company as that term is defined in § 230.902(l) of right, except in extraordinary assets, directly or indirectly, in this chapter. circumstances, to withdraw, redeem or connection with the private fund’s (3) Place of business has the same require the repurchase of such securities investment in such company; and (iv) Is not an investment company, a meaning as in § 275.222–1(a). but may entitle holders to receive (4) Assets under management means distributions made to all holders pro private fund, an issuer that would be an the regulatory assets under management rata; and investment company but for the exemption provided by § 270.3a–7, or a as determined under Item 5.F of Form (6) Is not registered under section 8 of commodity pool. ADV (§ 279.1 of this chapter). the Investment Company Act of 1940 4. Section 275.203(m)–1 is added to (d) Holding out. If you are relying on (15 U.S.C. 80a–8), and has not elected read as follows: this section, you shall not be deemed to to be treated as a business development be holding yourself out generally to the company pursuant to section 54 of that § 275.203(m)–1 Private fund adviser public in the United States as an Act (15 U.S.C. 80a–53). exemption. investment adviser, within the meaning (b) Certain pre-existing venture (a) United States investment advisers. of section 202(a)(30) of the Act (15 capital funds. For purposes of section For purposes of section 203(m) of the U.S.C. 80b–2(a)(30)), solely because you 203(l) of the Act (15 U.S.C. 80b–3(l)) Act (15 U.S.C. 80b–3(m)), an investment participate in a non-public offering in and in addition to any venture capital adviser with its principal office and the United States of securities issued by fund as set forth in paragraph (a) of this place of business in the United States is a private fund under the Securities Act section, a venture capital fund also exempt from the requirement to register of 1933 (15 U.S.C. 77a). includes any private fund that: under section 203 of the Act if the 3. Section 275.203(l)–1 is added to (1) Has represented to investors and investment adviser: read as follows: potential investors at the time of the (1) Acts solely as an investment offering of the private fund’s securities adviser to one or more qualifying § 275.203(l)–1 Venture capital fund that it is a venture capital fund; private funds; and defined. (2) Prior to December 31, 2010, has (2) Manages private fund assets of less (a) Venture capital fund defined. For sold securities to one or more investors than $150 million. purposes of section 203(l) of the Act (15 that are not related persons, as defined (b) Non-United States investment U.S.C. 80b–3(l)), a venture capital fund in § 275.204–2(d)(7), of any investment advisers. For purposes of section 203(m) is any private fund that: adviser of the private fund; and of the Act (15 U.S.C. 80b–3(m)), an (1) Represents to investors and (3) Does not sell any securities to investment adviser with its principal potential investors that it is a venture (including accepting any committed office and place of business outside of capital fund; capital from) any person after July 21, the United States is exempt from the (2) Owns solely: 2011. requirement to register under section (i) Equity securities issued by one or (c) Definitions. For purposes of this 203 of the Act if: more qualifying portfolio companies, section: (1) The investment adviser has no and at least 80 percent of the equity (1) Committed capital means any client that is a United States person securities of each qualifying portfolio commitment pursuant to which a except for one or more qualifying company owned by the fund was person is obligated to acquire an interest private funds; and acquired directly from the qualifying in, or make capital contributions to, the (2) All assets managed by the portfolio company; and private fund. investment adviser from a place of (ii) Cash and cash equivalents, as (2) Equity securities has the same business in the United States are solely defined in § 270.2a51–1(b)(7)(i), and meaning as in section 3(a)(11) of the attributable to private fund assets, the U.S. Treasuries with a remaining Securities Exchange Act of 1934 (15 total value of which is less than $150 maturity of 60 days or less; U.S.C. 78c(a)(11)) and § 240.3a11–1 of million. (3) With respect to each qualifying this chapter. (c) Calculations. For purposes of this portfolio company, either directly or (3) Publicly traded means, with section, private fund assets are indirectly through each investment respect to a company, being subject to calculated as the total value of such adviser not registered under the Act in the reporting requirements under assets as of the end of each calendar reliance on section 203(l) thereof: section 13 or 15(d) of the Securities quarter. (i) Has an arrangement whereby the Exchange Act of 1934 (15 U.S.C. 78m or (d) Transition rule. With respect to fund or the investment adviser offers to 78o(d)), or having a security listed or the calendar quarter period immediately

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following the calendar quarter end date (3) Principal office and place of (7) United States has the meaning set that the investment adviser ceases to be business of an investment adviser forth in § 230.902(l) of this chapter. exempt from registration under section means the executive office of the (8) United States person means any 203(m) of the Act (15 U.S.C. 80b–3(m)) investment adviser from which the person that is a ‘‘U.S. person’’ as defined due to having $150 million or more in officers, partners, or managers of the in § 230.902(k) of this chapter, except private fund assets, the Commission investment adviser direct, control, and that any discretionary account or similar will not assert a violation of the coordinate the activities of the account that is held for the benefit of a requirement to register under section investment adviser. United States person by a dealer or 203 of the Act (15 U.S.C. 80b–3) by an (4) Private fund assets means the other professional fiduciary is a United investment adviser that was previously investment adviser’s assets under States person if the dealer or exempt in reliance on section 203(m) of management attributable to a qualifying professional fiduciary is a related the Act; provided that such investment private fund. person of the investment adviser relying adviser has complied with all applicable (5) Qualifying private fund means any on this section and is not organized, Commission reporting requirements. private fund that is not registered under incorporated, or (if an individual) (e) Definitions. For purposes of this section 8 of the Investment Company resident in the United States. section, Act of 1940 (15 U.S.C 80a–8) and has By the Commission. (1) Assets under management means not elected to be treated as a business the regulatory assets under management development company pursuant to Dated: November 19, 2010. as determined under Item 5.F of Form section 54 of that Act (15 U.S.C. 80a– Elizabeth M. Murphy, ADV (§ 279.1 of this chapter). 53). Secretary. (2) Place of business has the same (6) Related person has the meaning set [FR Doc. 2010–29957 Filed 12–9–10; 8:45 am] meaning as in § 275.222–1(a). forth in § 275.204–2(d)(7). BILLING CODE P

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