Advisers Act Registration Exemptions for July 20 , 2011 Venture Capital Fund Advisers and Private Practice Groups: Fund Advisers: The SEC Adopts Final Investment Management Rules Hedge Funds and Venture Funds On June 22, 2011, the Securities and Exchange Commission (“SEC”) issued a release adopting rules Financial Services to implement and define the scope of two new exemptions from registration under the Investment Reform Advisers Act of 1940 (“Advisers Act”). 1 Congress created or directed the SEC to create these Private Equity exemptions in Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010 (“Dodd-Frank Act”). The Dodd-Frank Act exempts from registration, among others: • advisers solely to one or more venture capital funds (“Venture Capital Advisers”), and • advisers solely to one or more qualifying private funds with aggregate assets under management in the United States of less than $150 million (“Private Fund Advisers”). The Release adopts rules and definitions that give substance to these exemptions and clarify the terms and methods of their application. Below we discuss each exemption and the rules in the Release relating to such exemptions. Exempted advisers do not avoid new regulation entirely. We discuss below reporting requirements that will be applicable to Venture Capital Advisers and Private Fund Advisers (referred to collectively in the Release as “Exempt Reporting Advisers”) that were simultaneously adopted in a separate release (the “Reporting Release”). The Reporting Release addresses a broad range of changes to investment adviser registration and regulation as a result of the Dodd-Frank Act. 2 As also noted below, Exempt Reporting Advisers will be subject to inspections (generally only for cause) by the SEC staff. I. Venture Capital Advisers Section 407 of the Dodd-Frank Act creates a new Section 203(l) of the Advisers Act, which exempts Venture Capital Advisers from registration. The Dodd-Frank Act charged the SEC with defining the term “venture capital fund” within one year of the Dodd-Frank Act’s enactment. The Release adopts a definition of “venture capital fund” and also a broad grandfathering provision that would permit existing funds that meet certain requirements to be treated as venture capital funds even if they do not meet the definition. A. The Definition. The Release adopts a new Rule 203(l)-1, which defines the term “venture capital 1 Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers with Less than $150 Million in Assets Under Management, and Foreign Private Advisers , Investment Advisers Act Release No. 3222 (June 22, 2011) (the “Release”), available here. The rules adopted were initially proposed on November 19, 2010. 2 Rules Implementing Amendments to the Investment Advisers Act of 1940 , Investment Advisers Act Release No. 3221 (June 22, 2011), available here. For a more detailed discussion of these additional changes to investment adviser registration and reporting, see K&L Gates’ alerts on the subject, available here and here, respectively.
fund” as a private fund that: • represents to investors and potential investors that it pursues a venture capital strategy; • immediately after acquisition of any asset (other than “qualifying investments” (as defined below) or “short-term holdings” 3 ) holds no more than 20% of its aggregate capital contributions and uncalled capital commitments in assets (other than short-term holdings) that are not qualifying investments, valued at cost or fair value, consistently applied by the fund; • does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage in excess of 15% of the fund’s aggregate capital contributions and uncalled capital (“Permitted Borrowing”), and limits Permitted Borrowing arrangements to a non-renewable term of no longer than 120 calendar days (provided that the 120-day limit does not apply to guarantees of obligations of qualifying portfolio companies (as defined below) up to the value of the fund’s investment); • does not provide investors with redemption, withdrawal or repurchase rights, except in extraordinary circumstances; 4 and • is not registered under Section 8 of the Investment Company Act of 1940 (“1940 Act”) and has not elected to be treated as a business development company. A “qualifying investment” means: • an equity security: 5 o issued by a “qualifying portfolio company” (as defined below) that has been acquired directly by the fund from the company; o issued by a qualifying portfolio company in exchange for an equity security issued by the parent company or predecessor of the qualifying portfolio company; or o issued by a company of which a qualifying portfolio company is a majority-owned subsidiary or a predecessor acquired in exchange for an equity security described in the two bullet points above. 3 “Short-term holdings” are defined as cash and cash equivalents (meaning bank deposits, certificates of deposit, bankers acceptances and similar bank instruments), U.S. Treasuries with a remaining maturity of 60 days or less and registered money market mutual funds. This definition broadens the proposed definition by adding registered money market funds as a cash management option. 4 The Release provides examples of “extraordinary circumstances,” including “a material change in tax law after an investor invests in the fund” or “the enactment of laws that may prohibit an investor’s participation in the fund’s investment in particular countries or industries.” See Release at 62. The touchstone of “extraordinary circumstances” appears to be that “the trigger events.. are typically beyond the control of the adviser and fund investor ( e.g ., tax and regulatory changes).” 5 “Equity security” is defined in the rules by reference to Section 3(a)(11) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 3a11-1 thereunder to include “any stock or similar security, certificate of interest or participation in any profit sharing agreement, preorganization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for an equity security, limited partnership interest, interest in a joint venture, or certificate of interest in a business trust; any security future on any such security; or any security convertible, with or without consideration into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any put, call, straddle, or other option or privilege of buying such a security from or selling such a security to another without being bound to do so.” 2
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