INVESTMENT ADVISER LAW BLOG

The Dodd-Frank Act created a wave of new registration, reporting and other regulatory burdens on investment advisers and managers of private funds. The Act has also had far-reaching effects on the SEC and state regulators as they create new registration and reporting systems and deal with shifting and growing groups of regulated entities. What might it mean for advisers and private fund managers as regulators struggle to deal with their own increased burdens?

It surprises no one that the Dodd-Frank Act–weighing in at around 850 pages (or, depending on who’s counting, over 2,300)–has created a flood of new regulatory burdens for a variety of financial institutions. In particular, investment advisers and private fund managers have found themselves in the crosshairs of new and expanded reporting schemes or subject to a host of registration requirements for conduct that was previously exempt from much regulatory oversight.

Other parties left scrambling in Dodd-Frank’s wake have been the SEC and state regulators themselves. By one count, the SEC has completed final rules for only 18 of the 98 mandates in Dodd-Frank. It’s hard to believe that, by that metric, we’ve only seen about 20% of the total effect of Dodd-Frank. In a recent speech, SEC Commissioner Daniel M. Gallagher indicated that he did not view failure to meet Dodd-Frank deadlines as a failure. Rather, he was pleased with that the SEC was “moving deliberately” in its rule-making role.

State regulators likewise have been under the gun in adopting new registration and reporting rules. In some cases, the states have simply been reacting to SEC rule-making and there may be a failure to consider how rules imposed at the state level are interacting with federal requirements.

One example is the private fund adviser exemption being proposed in a number of states based on model rules by the North American Securities Administrators Association (NASAA). The rules, already proposed in California, Virginia, Wisconsin and other states, exempt from investment adviser registration those advisers who advise only certain 3(c)(1) or 3(c)(7) funds and comply with other reporting and disclosure requirements. Exempt private fund advisers under the NASAA rules are not considered registered under state investment adviser laws and their employees need not register as investment adviser representatives in their home states. Meanwhile, the SEC has said that any investment adviser with AUM between $25 and $100 million that is exempt from registration in its home state, will need to register with the SEC (or find an SEC exemption). Presumably, the NASAA exemption rule will not be interpreted by the SEC or the various states to remove the registration requirement at the state level only to have it imposed at the SEC level. At a minimum, however, more clarity is required from all the regulators.

Leaving aside the burdens of adopting new rules and reporting schemes, both the SEC and states are finding that the pools of regulated entities for which they are responsible may be much larger than anticipated. The SEC has reported that about 1,250 private fund advisers have registered with the SEC this year–over 30% more than the SEC anticipated. State regulators can expect an influx of about 3,000 investment advisers transitioning from SEC to state registration. States can also expect a number of new registrations as formerly exempt advisers come under their authority.

The SEC is trying to address this increased load by requesting an almost 20% larger budget appropriation from Congress to be used in part for additional hires to its Office of Compliance Investigations and Examinations and the Division of Investment Management. Assuming these requests are granted, SEC-registered advisers can expect that a large number of examiners responsible for conducting on-site examinations and audits in the coming years may be new to the SEC and relatively inexperienced. If the budgetary requests are not granted, the SEC will find it even more difficult to meet its targeted rates for adviser examinations. In 2011, the SEC examined only 8% of its registered advisers, well short of its goal of 11%.

At the state level, we anticipate even more dire consequences. Cash-strapped state governments have often lacked the resources to handle their pre-Dodd-Frank registrant numbers. An additional influx of advisers and a higher AUM ceiling may leave state regulators struggling to process even routine registrations and updating amendments. Unless they find new funding sources, it is hard to foresee periodic examinations or regulatory audits being conducted at rates that regulators wish. Those advisers that are examined may find increased scrutiny as regulators seek results that could justify increased budgets or greater resources.

Sources:

• Keynote Address by Daniel M. Gallagher, 2012 Investment Adviser Compliance Conference
• California Proposes Private Fund Adviser Exemption
• SEC FY2013 Congressional Budget Justification

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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.

 

Tagged: California, Compliance, Dodd-Frank, Hedge Fund, Investment Adviser, Regulatory, SEC

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