Cheat sheet for recent SEC regulatory changes and amendments

Why 'assets under management' are now 'regulatory assets under management'

Thursday 7.7.11 by Brooke Southall

Brooke’s Note: Being an RIA means registering with the Securities and Exchange Commission or other regulatory authorities and agreeing to put the clients’ interests first. But who must register with whom and under what circumstances? Those rules have recently been undergoing some changes. I have borrowed heavily from MarketCounsel’s published summary of those changes for its clients, and added a couple of thoughts from a MarketCounsel attorney, Scott Brown and RIABiz contributors Pat Burns and Les Abromovitz, to try to capture, in a nutshell, the new rules affecting advisor registration that have resulted from Dodd-Frank.

On June 23, the SEC voted in favor of adopting several new rules and amendments in order to effect certain provisions of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the Dodd-Frank Act.

Most of the changes involve the amount of assets under management an RIA must have under its auspices. But there’s another important change: For the purposes of determining whether a firm needs to register at the SEC or state level, the term “assets under management” is being replaced with the term “regulatory assets under management.” There’s a good reason for the change in terminology, says Scott Brown, managing counsel of MarketCounsel.

“Before there was more flexibility for how to calculate assets under management, like excluding family assets [the RIA is] not charging fees on. This enabled certain advisors to opt in or out of federal or state regulation and circumvent the legislative intent of the rule,” he says.

Here are 10 takeaways from the new SEC rules and amendments:

1. Under the new rules, advisors currently registered with the SEC will have until March 30, 2012 to certify that they are qualified for SEC registration – e.g., that they have registered assets under management of at least $100 million. Advisors that fall short of the new threshold (the old threshold was $25 million) are required to register with the appropriate state authorities and withdraw from SEC registration by June 28, 2012. Advisors located in states that do not have formal examination programs may maintain their SEC registration. The SEC has reported that of 49 states with their own investment adviser laws (which excludes Wyoming), 47 indicated that they have examination programs. New York failed to reply to the SEC’s inquiries and therefore will be treated as if they do not examine advisors. Minnesota responded that they do not have an exam program, although there are some reports that the state may reverse its stance on this. Accordingly, investment advisors located in New York and Minnesota can remain SEC registered if they maintain more than $25 million in regulatory assets under management. See: The big change RIAs should expect when the SEC punts to the states.

2. In addition, advisors that currently rely upon the 14-client de minimus exemption from registration with the SEC will have until March 30, 2012 to register with the SEC or the appropriate state authorities. In preparation, the SEC will be amending the Form ADV to solicit organizational and operational fund information. Specifically, the SEC wants to obtain information on the major service providers to funds (e.g., auditors, prime brokers, custodians, marketers and administrators), as well as the advisor’s business model, affiliations and conflicts of interest. Hedge funds managers took advantage of this exemption by counting the fund itself as one client rather than citing the number of its investors. The new rules now prohibit this practice.

3. Pension consultants may be required to transition to state registration. SEC registration is only available for pension consultants with plan assets that exceed $200 million.

4. The new rules create a buffer zone for mid-sized advisors that have regulatory assets under management that fluctuate around the $100 million threshold. The new rules permit an adviser to wait until its assets hit $110 million before the firm is obliged to register with the commission. Once registered, however, the RIA need not withdraw its registration until the firm’s regulatory assets under management fall below $90 million as of the time of the firm’s annual updating amendment.

5. The largest source controversy in the formation of the revised rules is the measure imposing various reporting obligations on fund advisors otherwise exempt from registration. This affects both advisors to private funds with assets under $150 million and advisors to venture capital funds, among others. These formerly exempt reporting advisors willnow be required to file a limited subset of Form ADV and disclose additional information about the funds. As touched upon above, SEC commissioners Kathleen Casey and Troy Parades vigorously dissented, declaring that there is no meaningful distinction between reporting and registration procedures. They also referenced the inevitable slippery slope effect, voicing concern over additional regulatory mandates on exempt reporting advisors that are likely to follow, which could have a detrimental effect on capital formation and economic growth.

6. The rules include a number of exemptions from registration for advisors to qualifying VC funds, advisors to private funds with less than $150 million in aggregated assets under management and certain foreign private advisors. Under the new amendments, advisors to VC funds are now permitted to allocate up to 20% of committed capital among “non-qualifying” investments without becoming ineligible for the exclusion. While the definition still subjects VC fund advisors to a variety of conditions, this 20% basket gives them considerably more leeway to react to evolving market conditions and manage risk accordingly. Nonetheless, advisors to VC funds will still be subject to the exempt adviser reporting requirements, as discussed above. It should also be noted that Commissioner Parades pointed out that the location of the VC exemption language within the rule could arguably open these advisors up to the SEC’s examination authority, although there is nothing in the text to indicate that this was intended.

7. Additionally, advisors to private funds that manage aggregated assets of less than $150 million are excluded from registration with the SEC, but will also be considered an exempt reporting adviser. While not discussed at the meeting, the model rule proposed by the North American Securities Administrators Association (NASAA) appears to require registration for some of these advisors at the state level. Furthermore, the commissioners also approved exclusions for certain foreign advisors that have no U.S. clients outside of the private funds they manage. The SEC will be providing additional guidance on several terms within the provision in order to better define the reach of the applicable exemption.

8. The SEC Commissioners voted 5-0 in favor of adopting a new rule defining “family offices” that are excluded from registration requirements. Advisors are eligible for the exclusion if they are family owned and controlled; do not hold themselves out to the public as an investment adviser; provide investment advice only to those persons who are either related within 10 lineal generations or are key employees and their families’ charitable trust or non-profit organizations. “Some advisors probably should have been registered a while ago where their firms were advising multiple families and essentially acting as unregistered advisors,” says Pat Burns, principal of Advanced Regulatory Compliance, Inc..

9. At this point, advising family-run charitable or non-profit organizations that have accepted contributions from non-family members in the past does not in itself render an adviser ineligible for the exemption. However, the organization is prohibited from accepting donations from external sources after August 30, 2011 unless the contribution was previously pledged.

10. The compliance date for non-exempt family offices to register as investment advisors has been pushed back to March 30, 2012. Exempted family offices have until December 31, 2013 to cease providing advisory services to charitable trusts and non-profit organizations that have been seeded by non-family contributions.

Scott Brown

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