Under a regime created by the National Securities Markets Improvement Act of 1996, certain investment advisers are required to register with the SEC, and other advisers are prohibited from registering with the SEC. Advisers that register with the SEC are exempt from state registration requirements, although the states may require notice filing and may license adviser representatives that exceed a specified threshold of involvement with clients that are natural persons.
Advisers that are prohibited from registering with the SEC may be required to register in the states where they have a place of business, depending on the registration exemptions available under the state’s law. Advisers Act Section 222(d) prohibits states from requiring registration of advisers that do not have a place of business in the state and have had fewer than six clients residing in that state during the preceding 12-month period.23 (see "Federal De Minimis Exemption from State Registration” below).
Advisers with $25 million or less in assets under management (“small advisers”) are, and under the news will continue to be, required to register in the states in which they do business unless: (1) they are exempt from registration; (2) they have their principal office and place of business in a state that does not regulate investment advisers;24 or (3) they qualify for one of the exemptions in Rule 203A-2, which permits certain types of investment advisers to register with the SEC even though they have less than $25 million of assets under management. Federal registered advisers register with the SEC; no state may require them to register, although the states may require notice filing.
Section 410 of the Dodd-Frank Act creates a new category of “mid-sized advisers,” having assets under management between $25 million and $100 million, and places these advisers under the primary regulation of the states. Unlike a small adviser, a mid-sized adviser must register with the SEC if (1) the adviser is not required to be registered as an investment adviser in the state in which it maintains its principal office and place of business, or (2) if registered with that state, the adviser would not be subject to examination as an investment adviser by the state securities administrator. In the Implementing Release, the SEC notes that in addition to Wyoming, which does not require registration of investment advisers, the states of Minnesota and New York had not advised the SEC that advisers registered with them are subject to examination; however, the SEC has since advised that Minnesota will subject advisers registered with them to examination.
Consequently, mid-sized investment advisers located in Wyoming and New York must register with the SEC, unless they otherwise qualify for a registration exemption. Section 203A(c) of the Advisers Act permits the SEC to create exemptions from the prohibition on federal registration for mid-sized advisers as it does for small advisers. As discussed below in the section entitled “Exemptions from Prohibition on Federal Registration,” the SEC is adopting amendments to two of the exemptions and eliminating the exemption for NRSROs. The five exemptions remaining after the amendments will apply to both mid-sized investment advisers and small investment advisers.
Transition Rules and Buffer. The SEC estimates that approximately 3,200 SEC-registered advisers will be required to withdraw their registrations and register with one or more state securities administrators. New Rule 203A-5 is intended to provide for an orderly transition to state registration for mid-sized advisers no longer eligible for SEC registration.
Exemptions from the Prohibition on SEC Registration.
There are currently six exemptions from the prohibition on registration with the SEC. Under the new rules, one of the exemptions will be eliminated and two others amended. The following is a description of the exemptions under the new rules:
Proposed State Exemption for ERAs.
As discussed above under “Exempt Reporting Advisers,” ERAs that would otherwise be required to register as investment advisers will be exempt from registration with the SEC, subject to reporting and other obligations. ERAs will generally not be “federal covered advisers” under state laws – i.e., advisers exempt from state registration because they are required to be registered with the SEC. Therefore, ERAs may be required to register with one or more states in which they do business unless there is an exemption available under state law. (Because the venture capital and private fund exemptions are not mandatory, advisers that are otherwise eligible for federal registration may elect, instead of claiming the venture capital or private fund exemption, to remain or become registered with the SEC to avoid state registration in the absence of a state exemption.)
The North American Securities Administrators Association (“NASAA”) has published a proposed model rule for reporting advisers exempt from SEC registration.28 The model rule, which individual states would be free to adopt as written (or with revisions) or disregard, would provide an exemption for advisers to private funds if:
The proposed rule would include additional requirements for an adviser to one or more funds exempt under Section 3(c)(1) that are not “venture capital funds” under the definition discussed above:
The proposed rule also contains transition and grandfathering provisions, as well as a corresponding exemption from registration as an investment adviser representative.
The deadline for comment to NASAA on the proposed model rule is July 13, 2011.
Federal De Minimis Exemption from State Registration.
Advisers will still be able to qualify for the de minimis exemption from state registration provided by the Advisers Act. This exemption, Advisers Act Section 222(d), is available to advisers that do not have a place of business in a state and have had fewer than six clients residing in that state during the preceding 12-month period. “Client” is currently defined for purposes of Section 222(d) as it is in Rule 203(b)(3)-1, permitting hedge funds and other entities to be counted as one client. The SEC is replacing the definition of “client” in Rule 203(b)(3)-1, which will be repealed, with a new definition in Rule 202(a)(30)-1 which will continue to permit entities to be counted as one client for purposes of this exemption or the Foreign Private Adviser Exemption. Rule 222-2 under the federal de minimis standard will cross reference the new definition in Rule 202(a)(30)-1.
23 See “Federal De Minimis Exemption from State Registration.”
24 Wyoming is the only state that does not regulate investment advisers.
25 See the discussion below in the section entitled “Buffer Amount for Transition.”
26 The SEC notes that advisers in New York are not subject to examination and therefore that mid-sized advisers with their main office and principal place of business in those states must register with the SEC. Mid-sized advisers with their principal office and place of business in other states may be required to register with the SEC if they qualify for an exemption in the state not available under federal law – e.g., an exemption for advisers whose only clients in the state are institutional investors.
27 For more information about the transition of registration for mid-sized advisers, see the SEC publication "Frequently Asked Questions Regarding Mid-Sized Advisers."
28 The proposal was originally published in December 10, 2010, and amended in response to comments.
For more information about the contents of this alert, please contact:
Elizabeth Shea Fries
Private Investment Funds
Real Estate Investment Management & Joint Ventures
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