California Proposes State Registration Exemption for Investment Advisers to Private Funds Exempt from SEC Registration

Prepared by Barry A. Brust, Esq.
February 3, 2012

Now that the federal exemption from investment adviser registration under the Investment Advisers Act of 1940 (the “Advisers Act”) for advisers to 15 or fewer clients (the “Private Adviser Exemption”) has been eliminated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, investment advisers with assets under management of $100 million or more generally must register with the SEC, while investment advisers with assets under management of less than $100 million generally must register with each state in which they have a principal office or conduct business. The California Corporations Commissioner (“Commissioner”) has recently proposed new rules (“Proposed Rules”) that would replace California’s version of the Private Adviser Exemption, which is being phased out. The Proposed Rules would provide a new permanent exemption from registration to advisers of certain private funds but would obligate such advisers to report certain information to the Commissioner and to make certain disclosures to the investors in each fund it advises, including providing audited annual financial statements of such fund.

In General. Under the Proposed Rules, an investment adviser with its principal office or conducting business in California that provides advice solely to “qualified private funds” (i.e., an investment fund that qualifies for the exception to registration under Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 (“ICA”)) and is not registered as an investment adviser with the SEC would be exempt from registering in California as an investment adviser provided that (i) neither the adviser nor any of its advisory affiliates is subject to any statutory “bad boy” disqualifications, (ii) the adviser files with the Commissioner all reports that an “Exempt Private Adviser” is required to file with the SEC, and (iii) the adviser pays the standard annual registration fee ($125).

Additional Obligations on Advisers to 3(c)(1) Funds. The Proposed Rules would impose additional obligations on any investment adviser to “qualifying private funds” that has a client that relies on Section 3(c)(1) of the ICA and is not a “venture capital company” (“3(c)(1) Fund”). Among these obligations is the requirement that each investor in a 3(c)(1) Fund must be an “accredited investor” at the time it purchases securities from the issuer. The adviser would also have to deliver to each fund investor annual audited financial statements of the 3(c)(1) Fund.

Performance Compensation. The Proposed Rules would require an exempt adviser to comply with the restrictions on receiving compensation based on capital gains or capital appreciation of the funds of a client, such as “promote”, “carried interest” or other performance fees. In order for an exempt adviser to receive such compensation, the investors in its funds must satisfy the “qualified client” standard of the Advisers Act, which is a somewhat higher standard than “accredited investor” (although lower than the “qualified purchaser” standard in the ICA).

Comment Period. The period within which to comment on the Proposed Rules ends on February 20, 2012. Our Funds Practice Group is discussing the Proposed Rules with certain clients to determine how they may or may not be impacted and whether they have any special concerns that we might address in a comment letter to the Commission.

If you have any questions or comments concerning this Legal Update or the Proposed Rules, please feel free to contact us:

William H. Jackson, Esq.
Michael R. Ray, Esq.
Andrea H. Bricker, Esq.
Barry A. Brust, Esq.
Pircher, Nichols & Meeks
1925 Century Park East, Suite 1700
Los Angeles, California 90067
(Tel.) 310.201.8900

Steven H. Shapiro, Esq.
Pircher, Nichols & Meeks
900 North Michigan Avenue
Suite 1050
Chicago, Illinois 60611
(Tel.) 312.915.3112

The PN&M Legal Update is published as a service to our clients and friends. It is intended to provide general information and should not be acted upon without first obtaining professional advise appropriately tailored to your individual needs.