California Rules Propose Significant Changes to Private Fund Adviser Exemption
February 24, 2012 § 4 Comments
Recently, the California Department of Corporations proposed new rules that would make widespread changes to the state’s investment advisor regulatory scheme. The proposed rules would create a significant new exemption from full registration for investment advisers that advise hedge funds in California. After Dodd-Frank, advisers with less than $100 million will come under the authority of the DoC (and these proposed rules) rather than the SEC.
Historically, California-based advisers and fund managers with less than $25 million in assets under management were almost always required to register with the California Department of Corporations. The only significant exemption from state registration applied to advisers with over $25 million under management, assets sufficient to make them eligible for SEC registration — the so-called private fund adviser exemption for managers with fewer than 15 clients (where a hedge fund counted as a single client).
Under the proposed exemption, a “private fund adviser” is an adviser that provides advisory services solely to 3(c)(1) or 3(c)(7) funds (and some other specialized funds). Private fund advisers will be exempt from registering as an investment adviser if each of the following conditions is met:
- neither the adviser nor its affiliates are not subject to federal or state statutory disqualifications (“bad boy” provisions”);
- the adviser files exempt reporting adviser informational notices on Form ADV; and
- the adviser pays the state registration and renewal fees ($125).
If the private fund adviser advises a 3(c)(1) fund, then that fund must also meet additional requirements:
- each of the 3(c)(1) investors must be accredited.
- the adviser must provide each investor with certain financial and organizational disclosures, including audited financial statements.
- performance-based fees may only be charged to qualified clients.
For advisers with pre-existing 3(c)(1) funds, the rules specify grandfathering provisions so those advisers may still come within the exemption.
Advisers that manage any separate accounts will not be considered private fund advisers and will not be able to rely on the exemption.
The DoC acknowledged that advisers will need time to determine how the proposed exemption will affect them and to prepare any required application materials. Application of the current private adviser exemption has been extended to June 28, 2012. In the meantime, comments are still being accepted on the proposed rules until March 25, 2012. Given the nature and pace of the SEC’s own Dodd-Frank rule-making, we expect the DoC to move quickly to formally adopt the rules following completion of the comment period.
In future posts, we will expand on the nature and scope of the informational notices required under the proposed exemption. In short, even exempt private fund advisers can anticipate having to provide a fair amount of disclosure to California regulators.
- Text of the Revised Exemption
- DoC Notice and Executive Summary
- DoC Extension of Comment Period (with instructions of how to comment)
- DoC Extension of Current Private Adviser Exemption (until June 28, 2012)
Jack G. Martel is the author of Investment Adviser Law Blog which is devoted to providing information and discussion of interest to investment advisers, private fund managers and others in the financial management industry. Jack is a partner in Ragghianti | Freitas LLP. He has over fifteen years experience in general business and securities transactions with a focus on assisting investment advisers, fund sponsors and managers in all manner of legal, regulatory and compliance issues. Jack can be reached at 415.453.9433.