Rules Implementing Amendments to the Investment Advisers Act of 1940

Federal RegisterDec 10, 2010

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 275 and 279

[Release No. IA-3110; File No. S7-36-10]

RIN 3235-AK82

Rules Implementing Amendments to the Investment Advisers Act of 1940

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission is proposing new rules and rule amendments under the Investment Advisers Act of 1940 to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules and rule amendments are designed to give effect to provisions of Title IV of the Dodd-Frank Act that, among other things, increase the statutory threshold for registration by investment advisers with the Commission, require advisers to hedge funds and other private funds to register with the Commission, and require reporting by certain investment advisers that are exempt from registration. In addition, we are proposing rule amendments, including amendments to the Commission's pay-to-play rule, that address a number of other changes to the Advisers Act made by the Dodd-Frank Act.

DATES:

Comments must be received on or before January 24, 2011.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

Use the Commission's Internet comment form (

http://www.sec.gov/rules/proposed.shtml

); or

• Send an e-mail to

rule-comments@sec.gov.

Please include File Number S7-36-10 on the subject line; or

• Use the Federal Rulemaking Portal (

http://www.regulations.gov

). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-36-10. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Web site (

http://www.sec.gov/rules/proposed.shtml

). Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549 on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

Jennifer R. Porter, Attorney-Adviser, Daniele Marchesani, Senior Counsel, Melissa A. Roverts, Senior Counsel, Devin F. Sullivan, Senior Counsel, Matthew N. Goldin, Branch Chief, Daniel S. Kahl, Branch Chief, or Sarah A. Bessin, Assistant Director, at (202) 551-6787 or

IArules@sec.gov,

Office of Investment Adviser Regulation, Division of Investment Management, U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:

The Commission is proposing rules 203A-5 and 204-4 [17 CFR 275.203A-5 and 275.204-4] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] (“Advisers Act” or “Act”),

amendments to rules 0-7, 203A-1, 203A-2, 203A-3, 204-1, 204-2, 206(4)-5, 222-1, and 222-2 [17 CFR 275.0-7, 275.203A-1, 275.203A-2, 275.203A-3, 275.204-1, 275.204-2, 275.206(4)-5, 275. 222-1, and 275.222-2] under the Advisers Act, and amendments to Form ADV, Form ADV-H, and Form ADV-NR [17 CFR 279.1, 279.3, and 279.4] under the Advisers Act. The Commission is also proposing to rescind rule 203A-4 [17 CFR 275.203A-4] under the Advisers Act.

15 U.S.C. 80b. Unless otherwise noted, when we refer to the Advisers Act, or any paragraph of the Advisers Act, we are referring to 15 U.S.C. 80b of the United States Code, at which the Advisers Act is codified, and when we refer to rule 0-7, rule 202(a)(11)-1, rule 203(b)(3)-1, rule 203(b)(3)-2, rule 203A-1, rule 203A-2, rule 203A-3, rule 203A-4, rule 203A-5, rule 204-1, rule 204-2, rule 204-4, rule 206(4)-5, rule 222-1, or rule 222-2, or any paragraph of these rules, we are referring to 17 CFR 275.0-7, 17 CFR 275.202(a)(11)-1, 17 CFR 275.203(b)(3)-1, 17 CFR 275.203(b)(3)-2, 17 CFR 275.203A-1, 17 CFR 275.203A-2, 17 CFR 275.203A-3, 17 CFR 275.203A-4, 17 CFR 275.203A-5, 17 CFR 275.204-1, 17 CFR 275.204-2, 17 CFR 275.204-4, 17 CFR 275.206(4)-5, 17 CFR 275.222-1, or 17 CFR 275.222-2, respectively, of the Code of Federal Regulations, in which these rules are published, or would be published, if adopted.

Table of Contents

I. Background

II. Discussion

A. Eligibility for Registration With the Commission: Section 410

1. Transition to State Registration

2. Amendments to Form ADV

3. Assets Under Management

4. Switching Between State and Commission Registration

5. Exemptions From the Prohibition on Registration With the Commission

a. NRSROs

b. Pension Consultants

c. Multi-State Advisers

6. Elimination of Safe Harbor

7. Mid-Sized Advisers

a. Required To Be Registered

b. Subject to Examination

B. Exempt Reporting Advisers: Sections 407 and 408

1. Reporting Required

2. Information in Reports

3. Updating Requirements

4. Transition

C. Form ADV

1. Private Fund Reporting: Item 7.B.

2. Advisory Business Information: Employees, Clients and Advisory Activities: Item 5

3. Other Business Activities and Financial Industry Affiliations: Items 6 and 7

4. Participation in Client Transactions: Item 8

5. Reporting $1 Billion in Assets: Item 1

6. Other Amendments to Form ADV

D. Other Amendments

1. Amendments to “Pay to Play” Rule

2. Technical and Conforming Amendments

a. Rules 203(b)(3)-1 and 203(b)(3)-2

b. Rule 204-2

c. Rule 0-7

d. Rule 222-1

e. Rule 222-2

f. Rule 202(a)(11)-1

III. General Request for Comment

IV. Cost-Benefit Analysis

A. Benefits

B. Costs

C. Request for Comment

V. Paperwork Reduction Act Analysis

A. Rule 203A-2(e)

B. Form ADV

C. Rule 203A-5

D. Form ADV-NR

E. Rule 203-2 and Form ADV-W

F. Form ADV-H

G. Rule 204-2

H. Request for Comment

VI. Initial Regulatory Flexibility Analysis

A. Need for the New Rules and Rule Amendments

B. Objectives and Legal Basis

C. Small Entities Subject to Rules and Rule Amendments

D. Reporting, Recordkeeping and Other Compliance Requirements

E. Duplicative, Overlapping, or Conflicting Federal Rules

F. Significant Alternatives

G. Solicitation of Comments

VII. Effects on Competition, Efficiency and Capital Formation

VIII. Consideration of Impact on the Economy

IX. Statutory Authority

Text of Rule and Form Amendments

APPENDIX A: Form ADV: General Instructions

APPENDIX B: Form ADV: Instructions for Part 1A

APPENDIX C: Form ADV: Glossary of Terms

APPENDIX D: Form ADV, Part 1A

APPENDIX E: Form ADV Execution Pages

APPENDIX F: Form ADV-H

APPENDIX G: Form ADV-NR

I. Background

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) which, among other things, amends certain provisions of the Advisers Act.

Title IV of the Dodd-Frank Act includes most of the amendments to the Advisers Act. These amendments include provisions that reallocate responsibility for oversight of investment advisers by delegating generally to the states responsibility over certain mid-sized advisers,

i.e.,

those that have between $25 and $100 million of assets under management.

This provision will require a significant number of advisers currently registered with the Commission to withdraw their registrations with the Commission and to switch to registration with one or more State securities authorities. In addition, Title IV repeals the “private adviser exemption” contained in section 203(b)(3) of the Advisers Act under which advisers, including those to many hedge funds, private equity funds and venture capital funds, had relied in order to avoid registration under the Act and our oversight.

In eliminating this provision, Congress created, or directed us to adopt other, in some ways narrower, exemptions for advisers to certain types of private funds—

e.g.,

venture capital funds—which provide that the Commission shall require such advisers to submit reports “as the Commission determines necessary or appropriate in the public interest.”

These provisions in Title IV of the Dodd-Frank Act will be effective on July 21, 2011.

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).

See

section 410 of the Dodd-Frank Act; Advisers Act section 203A.

See also

National Securities Markets Improvement Act of 1996, Public Law 104-290, 110 Stat. 3416, § 303 (1996) (“NSMIA”) (allocating to states responsibility for small investment advisers with less than $25 million in assets under management).

See

section 403 of the Dodd-Frank Act. Section 203(b)(3) exempts from registration any investment adviser who during the course of the preceding twelve months has had fewer than fifteen clients and who neither holds himself out generally to the public as an investment adviser nor acts as an investment adviser to any investment company registered under the Investment Company Act of 1940 (15 U.S.C. 80a-1) (“Investment Company Act”), or a company which has elected to be a business development company pursuant to section 54 of the Investment Company Act (15 U.S.C. 80a-54). Section 403 of the Dodd-Frank Act eliminates this “private adviser” exemption from section 203(b)(3) and replaces it with a new exemption for “foreign private advisers.” We are proposing a rule to clarify the definition of a “foreign private adviser” in a separate release.

Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers,

Investment Advisers Act Release No. 3111, published elsewhere in this issue of the

Federal Register

(“Exemptions Release”). Commenters wishing to address issues related to foreign private advisers should submit comments on the Exemptions Release.

See

sections 407 and 408 of the Dodd-Frank Act (“The Commission shall require [such advisers to] provide to the Commission such annual or other reports as the Commission determines necessary or appropriate in the public interest or for the protection of investors”). Section 407 of the Dodd-Frank Act, which adds section 203(l) to the Advisers Act, exempts advisers solely to one or more venture capital funds. Section 408, which added section 203(m) to the Advisers Act, exempts advisers solely to private funds with assets under management in the United States of less than $150 million.

See

section 419 of the Dodd-Frank Act. For purposes of this Release, when we refer to the effective date of the Dodd-Frank Act, we are referring to the effective date of Title IV, which is July 21, 2011, unless we indicate otherwise.

We are proposing to adopt new rules and amend existing rules and forms to give effect to these provisions. In addition, we are proposing rule amendments, including amendments to the Commission's “pay to play” rule, that address a number of other changes to the Advisers Act made by the Dodd-Frank Act. Also, in light of our increased responsibility for oversight of private funds, we are proposing to require advisers to those funds to provide us with additional information about the operation of those funds. As discussed in more detail below, this information would permit us to provide better oversight of these advisers by focusing our examination and enforcement resources on those advisers to private funds that appear to present greater compliance risks. Finally, we are proposing additional changes to Form ADV that we believe would enhance our oversight of advisers and also will enable us to identify advisers that are subject to the Dodd-Frank Act's requirements concerning certain incentive-based compensation arrangements.

See

section 956 of the Dodd-Frank Act.

II. Discussion

A. Eligibility for Registration With the Commission: Section 410

Section 203A of the Advisers Act generally prohibits an investment adviser regulated by the State in which it maintains its principal office and place of business from registering with the Commission unless it has at least $25 million of assets under management,

and preempts certain State laws regulating advisers that are registered with the Commission.

This provision, enacted in 1996 as part of the National Securities Markets Improvement Act (“NSMIA”), eliminated the duplicative regulation of advisers by the Commission and State securities authorities, making the states the primary regulators of smaller advisers and the Commission the primary regulator of larger advisers.

Advisers Act section 203A(a)(1). The prohibition does not apply if the investment adviser is an adviser to an investment company registered under the Investment Company Act, or the adviser is eligible for one of six exemptions the Commission has adopted.

See id.;

rule 203A-2;

infra

section II.A.5. of this Release. Section 403 of the Dodd-Frank Act also added exemptions to Section 203 of the Advisers Act for: (i) Any investment adviser that is registered with the Commodity Futures Trading Commission as a commodity trading advisor and advises a private fund; and (ii) any investment adviser, other than a business development company, that solely advises certain small business investment companies.

An investment adviser must register with the Commission unless it is prohibited from registering under section 203A of the Advisers Act or is exempt from registration under section 203(b). Advisers Act section 203(a). Investment advisers that are prohibited from registering with the Commission are subject to regulation by the states, but the anti-fraud provisions of the Advisers Act continue to apply to them.

See

Advisers Act sections 203A(b), 206. For SEC-registered investment advisers, State laws requiring registration, licensing and qualification are preempted, but states may investigate and bring enforcement actions alleging fraud or deceit, may require notice filings of documents filed with the Commission, and may require investment advisers to pay State notice filing fees.

See

Advisers Act section 203A(b); NSMIA,

supra

note 3, at sections 307(a) and (b). The Dodd-Frank Act did not amend sections 203A(a)(1) or 203(a) of the Advisers Act.

See

section 410 of the Dodd-Frank Act.

See

S. Rep. No. 104-293, at 4 (1996).

See also Rules Implementing Amendments to the Investment Advisers Act of 1940,

Investment Advisers Act Release No. 1633, section I (May 15, 1997) [62 FR 28112 (May 22, 1997)] (“NSMIA Adopting Release”).

Section 410 of the Dodd-Frank Act creates a new group of “mid-sized advisers” and shifts primary responsibility for their regulatory oversight to the State securities authorities. It does this by prohibiting from registering with the Commission an investment adviser that is registered as an investment adviser in the State in which it maintains its principal office and place of business and that has assets under management between $25 million and $100 million.

Unlike a small adviser, a mid-sized adviser is not prohibited from registering with the Commission: (i) If the adviser is not required to be registered as an

investment adviser with the securities commissioner (or any agency or office performing like functions) of the State in which it maintains its principal office and place of business; (ii) if registered, the adviser would not be subject to examination as an investment adviser by that securities commissioner; or (iii) if the adviser is required to register in 15 or more states.

Section 203A(c) of the Advisers Act, which was not amended by the Dodd-Frank Act, permits the Commission to exempt advisers from the prohibition on Commission registration, including small and mid-sized advisers, if the application of the prohibition from registration would be “unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes” of section 203A.

Under this authority, we have adopted six exemptions from the prohibition on registration.

See

section 410 of the Dodd-Frank Act. This amendment increases the threshold above which all investment advisers must register with the Commission from $25 million to $100 million.

See

S. Rep. No. 111-176, at 76 (2010) (“Senate Committee Report”).

See

section 410 of the Dodd-Frank Act. A mid-sized adviser also will be required to register with the Commission if it is an adviser to a registered investment company or business development company under the Investment Company Act.

Id.

As a result, mid-sized advisers to registered investment companies and business development companies will not have to withdraw their Commission registrations.

Compare

section 410 of the Dodd-Frank Act

with

Advisers Act section 203A(a)(1).

The Commission's exercise of this authority would not only permit registration with the Commission, but would result in the preemption of State law with respect to the advisers that register with us as a result of the exemption.

See

Advisers Act sections 203(a), 203A(b) and (c).

See

rule 203A-2 (permitting the following types of advisers to register with the Commission: (i) Nationally recognized statistical rating organizations (“NRSROs”); (ii) pension consultants; (iii) investment advisers affiliated with an adviser registered with the Commission; (iv) investment advisers expecting to be eligible for Commission registration within 120 days of filing Form ADV; (v) multi-State investment advisers; and (vi) internet advisers).

As a consequence of section 410 of the Dodd-Frank Act, we estimate that approximately 4,100 SEC-registered advisers will be required to withdraw their registrations and register with one or more State securities authorities.

We are working closely with the State securities authorities to assure an orderly transition of investment adviser registrants to State regulation. In addition, we are today proposing rules and rule amendments that would provide us a means of identifying advisers that must transition to State regulation, clarify the application of new statutory provisions, and modify certain of the exemptions from the prohibition on registration that we have adopted under section 203A of the Act.

According to data from the Investment Adviser Registration Depository (“IARD”) as of September 1, 2010, 4,136 SEC-registered advisers either: (i) Had assets under management between $25 million and $100 million and did not indicate on Form ADV Part 1A that they are relying on an exemption from the prohibition on Commission registration; or (ii) were permitted to register with us because they rely on the registration of an SEC-registered affiliate that has assets under management between $25 million and $100 million and are not relying on an exemption.

1. Transition to State Registration

We are proposing a new rule, rule 203A-5, which would require

each

investment adviser registered with us on July 21, 2011 to file an amendment to its Form ADV no later than August 20, 2011, 30 days after the July 21, 2011 effective date of the amendments to section 203A, and to report the market value of its assets under management determined within 30 days of the filing.

This filing would be the first step by which an adviser no longer eligible for Commission registration would transition to State registration. It would require each investment adviser to determine whether it meets the revised eligibility criteria for Commission registration, and would provide the Commission and the State regulatory authorities with information necessary to identify those advisers required to transition to State registration and to understand the reason for the transition or basis for continued Commission registration.

An adviser no longer eligible for Commission registration would have to withdraw its Commission registration by filing Form ADV-W no later than October 19, 2011 (60 days after the required refiling of Form ADV).

We would expect to cancel the registration of advisers that fail to file an amendment or withdraw their registrations in accordance with the rule.

Finally, the proposed rule would permit us to postpone the effectiveness of, and impose additional terms and conditions on, an adviser's withdrawal from SEC registration if we institute certain proceedings before the adviser files Form ADV-W.

Proposed rule 203A-5(a). We propose to give advisers 30 days from the effective date of the Dodd-Frank Act to prepare and submit the amended Form ADV. This approach would avoid requiring an adviser to respond to items about its eligibility to register with the Commission

before

the statutory changes affecting that eligibility will be effective on July 21, 2011. The additional 30 days would provide an adviser with the opportunity to evaluate the effect of the legislation (and our rules) on its eligibility and seek the advice of legal counsel, if necessary, before submitting an amendment. By permitting a 30-day period we also seek to avoid a large volume of filings on a single day (

i.e.,

July 21).

Proposed amended Item 2.A. of Form ADV, Part 1A would reflect the requirements of the Advisers Act (as amended by the Dodd-Frank Act) and the related rules, and would require an investment adviser to mark Item 2.A.(13) if the adviser is no longer eligible to remain registered with the Commission. For a discussion of the proposed rules,

see

infra

sections II.A.5. and II.A.7. of this Release, and for a discussion of Item 2.A, see

infra

section II.A.2. of this Release.

Proposed rule 203A-5(b).

See

Advisers Act section 203(h). As provided in the Advisers Act, an adviser would be given appropriate notice and opportunity for hearing to show why its registration should not be cancelled. Advisers Act section 211(c).

Proposed rule 203A-5(c) (“If, prior to the effective date of the withdrawal from registration of an investment adviser on Form ADV-W, the Commission has instituted a proceeding pursuant to section 203(e) * * * to suspend or revoke registration, or pursuant to section 203(h) * * * to impose terms or conditions upon withdrawal, the withdrawal from registration shall not become effective except at such time and upon such terms and conditions as the Commission deems necessary or appropriate in the public interest or for the protection of investors.”). This language largely is consistent with rule 203A-5 adopted after NSMIA.

See

NSMIA Adopting Release,

supra

note 10.

We propose to use our exemptive authority under section 203A(c)

to provide for a transitional process with two “grace periods,” the first providing 30 days from the July 21, 2011 effective date of the Dodd-Frank Act for an adviser to determine whether it is eligible for Commission registration and to file an amended Form ADV, and the second providing an additional 60 days (following the end of the first 30-day period) for an adviser to register in the states and to arrange for its associated persons to qualify for investment adviser representative registration, which may include preparing for and passing an examination, before withdrawing from Commission registration.

We are proposing a 90-day transition process, which is shorter than the 180-day transition period that our rules currently provide for advisers switching from SEC to State registration, in order to promptly implement this Congressional mandate and accommodate the processing of renewals and fees for State registration and licensing via the IARD system, while allowing for an orderly transition.

See supra

note 13 and accompanying text.

Proposed rule 203A-5. We would also amend the instructions on Form ADV to explain this process.

See

proposed Form ADV: General Instructions (special one-time instruction for Dodd-Frank transition filing for SEC-registered advisers).

Our current rule provides an SEC-registered adviser that has to switch to State registration a period of 180 days after its fiscal year end to file an annual amendment to Form ADV and to withdraw its SEC registration after reporting to us that it is no longer eligible to remain registered with us.

See

rule 203A-1(b)(2);

cf.

rule 204-1(a) (requiring an adviser to file an annual amendment 90 days after its fiscal year end).

We request comment on proposed rule 203A-5. Specifically, we request comment on the proposed transition process, including the amount of time we propose for advisers to transition to State registration by filing an amended

Form ADV within 30 days after July 21, 2011 and withdrawing from Commission registration within 60 days after the required Form ADV filing. We request comment on whether a transition process is necessary (

e.g.,

whether we should require advisers that do not meet the new eligibility requirements to withdraw from Commission registration as of July 21, 2011), whether two grace periods are necessary (

e.g.,

whether we should require the Form ADV filing and withdrawal of an adviser's registration to occur within the same period), or whether we should provide for a longer period (

e.g.,

whether we should provide 180 days to parallel our current switching rule).

Further, should the rule permit us to postpone the effectiveness of, and impose additional terms and conditions on, an adviser's withdrawal from SEC registration?

See

rule 203A-1(b)(2);

cf.

204-1(a).

Our ability to effect the timely transition to State regulation of advisers no longer eligible to register with the Commission may also be affected by our need to re-program the IARD system, through which advisers will file their amendments to Form ADV. We are working closely with the Financial Industry Regulatory Authority (“FINRA”), our IARD contractor, to make the needed modifications, but the programming may not be completed until after we adopt these rules. If IARD is unable to accept filings of Form ADV, including the proposed revisions discussed below to Item 2 of Part 1A, we may need to use our exemptive authority to further delay implementation of the increased threshold for mid-sized adviser registration until the system can accept electronic filing of the revised form. Should we instead require an alternative procedure, such as a paper filing, for advisers to indicate their eligibility for registration or lack thereof?

See Custody of Funds or Securities of Clients by Investment Advisers,

Investment Advisers Act Release No. 2968, n. 53 (Dec. 30, 2009) [75 FR 1456 (Jan. 11, 2010)] (requiring paper filing of Form ADV-E until IARD was upgraded to accept the form electronically); NSMIA Adopting Release at section II.A. (requiring advisers to file a separate paper form (Form ADV-T) to indicate whether they were eligible for SEC registration).

Since the enactment of the Dodd-Frank Act, our staff has received inquiries from State-registered advisers and advisers registering for the first time expressing concern that they might be required to register with the Commission (because their assets under management are more than $30 million) only to have to withdraw their registration next year when we implement section 410 of the Dodd-Frank Act (raising the threshold for Commission registration to $100 million of assets under management). To avoid such regulatory burdens, we will not object if any State-registered or newly registering adviser is not registered with us if, on or after January 1, 2011 until the end of the transition process (which would be October 19, 2011 under proposed rule 203A-5), the adviser reports on its Form ADV that it has between $30 million and $100 million of assets under management, provided that the adviser is registered as an investment adviser in the State in which it maintains its principal office and place of business, and it has a reasonable belief that it is required to be registered with, and is subject to examination as an investment adviser by, that State.

Such advisers should remain registered with, or in the case of a newly registering adviser, apply for registration with, the State securities authorities.

For a discussion of these requirements, see

infra

section II.A.7. of this Release.

As discussed above, the Dodd-Frank Act amendments to Advisers Act section 203A(a) will not be effective until July 21, 2011.

See supra

note 6 and accompanying text. Until that date, section 203A continues to apply, and all investment advisers registered with the Commission that remain eligible for registration under the current requirements must maintain their registrations and comply with the Advisers Act.

2. Amendments to Form ADV

Item 2 of Part 1A of Form ADV requires each investment adviser applying for registration to indicate its basis for registration with the Commission and to report annually whether it is eligible to remain registered. Item 2 reflects the current statutory threshold for registration with the Commission as well as our current rules. We propose to revise Item 2 to reflect the new statutory threshold and the revisions we propose to make to related rules as a result of the Dodd-Frank Act.

More specifically, we propose to amend Item 2 to require each adviser registered with us (and each applicant for registration) to identify whether, under section 203A, as amended, it is eligible to register with the Commission because it: (i) Is a large adviser (having $100 million or more of regulatory assets under management);

(ii) is a mid-sized adviser that does not meet the criteria for State registration and examination;

(iii) has its principal office and place of business in Wyoming (which does not regulate advisers) or outside the United States;

(iv) meets the requirements for one or more of the exemptive rules under section 203A of the Act (as we propose to amend and discuss below);

(v) is an adviser (or subadviser) to a registered investment company;

(vi) is an adviser to a business development company and has at least $25 million of regulatory assets under management;

or (vii) has some other basis for registering with the Commission.

We also expect to modify IARD to prevent an applicant from registering with us, and an adviser from continuing to be registered with us, unless it represents that it meets the eligibility criteria set forth in the Advisers Act and our rules.

We request comment on each of the changes we propose to make to Item 2. Are the requirements clearly stated? Do the proposed changes fairly reflect the new eligibility requirements under the Dodd-Frank Act and the amendments we are proposing to make to our rules?

We also propose to revise the terms used in the rules and Form ADV to refer to the securities authorities in each State with a single defined term, “State securities authority.”

Compare

proposed rules 203A-1, 203A-2(c) and (d), 203A-3(e); proposed Form ADV: Glossary

with

rules 203A-1(b)(1), 203A-2(e)(1), 203A-4; Form ADV: Glossary.

See generally

section 410 of the Dodd-Frank Act.

Proposed Form ADV, Part 1A, Item 2.A.(1). We are proposing to revise Form ADV to use the term “regulatory assets under management” instead of “assets under management.” For a discussion of regulatory assets under management, see

infra

section II.A.3. of this Release.

Proposed Form ADV, Part 1A, Item 2.A.(2). For a discussion of the criteria for State registration and examination for mid-sized advisers, see

infra

section II.A.7. of this Release.

Proposed Form ADV, Part 1A, Items 2.A.(3), 2.A.(4).

Proposed Form ADV, Part 1A, Items 2.A.(7)-2.A.(11). For a discussion of the exemptive rules, see

infra

section II.A.5. of this Release.

Proposed Form ADV, Part 1A, Item 2.A.(5).

Proposed Form ADV, Part 1A, Item 2.A.(6).

Proposed Form ADV, Part 1A, Item 2.A.(12). We also propose to delete current Item 2.A.(5) for NRSROs. For a discussion of NRSROs, see

infra

section II.A.5.a. of this Release.

We would also amend Item 2.A and the related items in Schedule D to reflect proposed revisions to rule 203A-2, which provides exemptions from the prohibition on registration with the Commission.

See

proposed Form ADV Items 2.A.(7), (10) and Section 2.A.(10) of proposed Schedule D;

infra

section II.A.5. of this Release. Additionally, we propose to make conforming changes to the instructions for Form ADV.

See

proposed Form ADV: Instructions for Part 1A, instr. 2.

3. Assets Under Management

In most cases, the amount of assets an adviser has under management will determine whether the adviser must be registered with the Commission or the states. Section 203A(a)(2) of the Act defines “assets under management” as the “securities portfolios” with respect to which an adviser provides “continuous and regular supervisory or

management services.”

Instructions to Form ADV provide advisers with guidance in applying this provision, including a list of certain types of assets that advisers may (but are not required to) include.

Today, we are proposing revisions to these instructions in order to implement a uniform method to calculate assets under management that can be used under the Act for purposes in addition to assessing whether an adviser is eligible to register with the Commission.

We also propose to amend rule 203A-3 to continue to require that the calculation of “assets under management” for purposes of Section 203A be the calculation of the securities portfolios with respect to which an investment adviser provides continuous and regular supervisory or management services, as reported on the investment adviser's Form ADV.

Advisers Act section 203A(a)(2). The Dodd-Frank Act renumbered current paragraph 203A(a)(2) as 203A(a)(3), but did not amend this definition.

See

section 410 of the Dodd-Frank Act.

See

Form ADV: Instructions for Part 1A, instr. 5.b. These assets include proprietary assets, assets an adviser manages without receiving compensation, and assets of foreign clients.

Compare

Form ADV: Instructions for Part 1A, instr. 5.b

with

proposed Form ADV: Instructions for Part 1A, instr. 5.b.

See

proposed rule 203A-3(d).

We provided the current instructions on calculating assets under management in 1997 as part of our implementation of the $25 million of assets threshold for registering with the Commission provided for in NSMIA.

In that limited context, we provided some options for advisers in determining what assets must be included, and which are not mandated by the Advisers Act. In light of the additional uses of the term “assets under management” by the Dodd-Frank Act

and any new regulatory requirements related to systemic risk that might be triggered by registration with the Commission,

we are proposing to eliminate the choices we have given advisers in the Form ADV instructions.

Our proposed change would eliminate an adviser's ability to opt into or out of State or Federal regulation (by including or excluding a class of assets such as proprietary assets) and any such regulatory requirements. We also would provide additional guidance to advisers on how to count assets managed through private funds.

Finally, we propose to alter the terminology we use in Part 1A of Form ADV to refer to an adviser's “regulatory assets under management” in order to acknowledge the distinction from the amount of assets under management the adviser discloses to clients in Part 2 of Form ADV, which need not necessarily meet the requirements of section 203A.

See

NSMIA Adopting Release at section II.B.

See

sections 402(a) and 408 of the Dodd-Frank Act (adding section 202(a)(30) of the Act defining a foreign private adviser as having “assets under management” attributable to U.S. clients and private fund investors of less than $25 million, and section 203(m) directing the Commission to provide for an exemption for advisers solely to private funds with assets under management in the United States of less than $150 million).

Section 404 of the Dodd-Frank Act gives the Commission authority to impose on investment advisers registered with the Commission reporting and recordkeeping requirements for systemic risk assessment purposes. The Commission could require registered advisers that meet a certain threshold of assets under management to submit systemic risk data pursuant to our authority in section 404 of the Dodd-Frank Act.

See also

section 203(n) of the Advisers Act, as amended by section 408 of the Dodd-Frank Act (“In prescribing regulations to carry out the requirements of [Section 203 of the Act] with respect to investment advisers acting as investment advisers to mid-sized private funds, the Commission shall take into account the size * * * of such funds to determine whether they pose systemic risk, and shall provide for registration and examination procedures with respect to the investment advisers of such funds which reflect the level of systemic risk posed by such funds.”).

See

proposed Form ADV: Instructions for Part 1A, instr. 5.b.(1).

See

proposed Form ADV: Instructions for Part 1A, instr. 5.b.(1), (4).

See also

section 402 of the Dodd-Frank Act (defining private fund as “an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3), but for section 3(c)(1) or 3(c)(7) of that Act”); Exemptions Release at section II.A.8. (discussing when a fund qualifies as a private fund) and at section II (providing additional descriptions of the proposed rules and their application for purposes of the new exemptions available to private fund advisers).

See

proposed Form ADV: Instructions for Part 1A, instr. 5.b.;

Amendments to Form ADV,

Investment Advisers Act Release No. 3060 (July 28, 2010) [75 FR 49234 (Aug. 12, 2010)] (“Part 2 Release”).

More specifically, we propose to require all advisers to include in their regulatory assets under management securities portfolios for which they provide continuous and regular supervisory or management services, regardless of whether these assets are proprietary assets, assets managed without receiving compensation, or assets of foreign clients, all of which an adviser currently may (but is not required to) exclude.

In addition, we would not allow an adviser to subtract outstanding indebtedness and other accrued but unpaid liabilities, which remain in a client's account and are managed by the adviser.

See

proposed Form ADV: Instructions for Part 1A, instr. 5.b.(1).

See

proposed Form ADV: Instructions for Part 1A, instr. 5.b.(2). Accordingly, an adviser would not be able to deduct accrued fees, expenses, or the amount of any borrowing.

We are proposing these changes in order to preclude some advisers from excluding certain assets from their calculation and thus remaining below the new assets threshold for registration with the Commission. The changes would result in some advisers reporting greater assets under management than they do today, but the assets we would require advisers to include in their assets under management are, in fact, assets managed by the adviser and allowing advisers to exclude such assets may have substantially more significant regulatory consequences than in 1997. The management of such assets, for example, may suggest that the adviser's activities are of national concern or have implications regarding the reporting for the assessment of systemic risk, a matter Congress considered important in enacting amendments to the Advisers Act in the Dodd-Frank Act.

The Commission, moreover, is proposing that advisers be required to include these assets so that the calculations would be more consistent among advisers. The Commission also believes that requiring that these assets be included in the calculation would better achieve the objective of the Dodd-Frank Act regarding which advisers must register with the Commission, which advisers must register with the states, and which advisers are exempt from Commission registration.

See supra

note 43. Congress did not address these systemic risk implications when it adopted NSMIA.

We also propose, as discussed below, to provide guidance regarding how an adviser that advises private funds determines the amount of assets it has under management. Form ADV currently provides no specific instructions applicable to this circumstance. We have designed our proposed instructions both to provide advisers with greater certainty in their calculation of regulatory assets under management, which they would also use as a basis to determine their eligibility for certain exemptions that we are proposing today in the Exemptions Release,

as well as to prevent advisers from understating those assets to avoid registration. First, we would require an adviser to include in its regulatory assets under management the value of any private fund over which it exercises continuous and regular supervisory or management services, regardless of the nature of the assets held by the fund.

As would be required for any other securities portfolio, a sub-adviser to a private fund would include in its assets under management only that portion of the

value of the portfolio for which it provides sub-advisory services.

See

Exemptions Release at sections II.B.2. and II.C.5.

See

proposed Form ADV: Instructions for Part 1A, instr. 5.b.(1).

Second, we propose to require such adviser to include in its calculation of regulatory assets under management the amount of any uncalled capital commitments made to the fund.

Private funds, such as venture capital and private equity funds, typically make investments following capital calls on their investors, who are contractually obligated to fund their committed capital amounts.

Advisers to these types of private funds provide supervisory or management services to the funds in anticipation of all investors fully funding their capital commitments, describe the size of their funds on the basis of these capital commitments and, in the early years of a fund's life, typically earn fees based on the total amount of capital committed.

Id.

A capital commitment is a contractual obligation of an investor to acquire an interest in, or provide the total commitment amount over time to, a private fund, when called by the fund.

See, e.g.,

James Schell, Private Equity Funds: Business Structure and Operations § 1.01 (2010) (“Schell”) (typical private equity fund partnership agreement requires investors to commit to make capital contributions to the fund, which would be paid as needed rather than upfront and would be used to pay expenses and make investments); Stephanie Breslow & Phyllis Schwartz, Private Equity Funds, Formation and Operation 2010, at § 2:5.6 (discussing the various remedies that may be imposed in the event an investor fails to fund its contractual capital commitment, including, but not limited to, “the ability to draw additional capital from non-defaulting investors;” “the right to force a sale of the defaulting partner's interests at a price determined by the general partner;” and “the right to take any other action permitted at law or in equity”).

See, e.g.,

Schell,

supra

note 53 at § 1.01 (noting that capital contributions made by the investors are used to “make investments in a manner consistent with the investment strategy or guidelines for the Fund.”) and at § 1.03 (“Management fees in a Venture Capital Fund are usually an annual amount equal to a fixed percentage of total Capital Commitments.”).

Third, we propose to add an instruction to require advisers to use the fair value of private fund assets in order to ensure that advisers value private fund assets on a more meaningful and consistent basis.

Use of the cost basis (

i.e.,

the value at which the assets were originally acquired), for example, could under certain circumstances grossly understate the value of appreciated assets, and thus result in advisers avoiding registration with the Commission. Use of the fair valuation method by all advisers, moreover, would result in more consistent asset calculations and reporting across the industry and, therefore, in a more coherent application of the Act's regulatory requirements and of our staff's risk assessment program. We understand that many, but not all, private funds value assets based on their fair value in accordance with U.S. generally accepted accounting principles (“GAAP”) or other international accounting standards.

We acknowledge some private funds do not use fair value methodologies, which may be more difficult to apply when the fund holds illiquid or other types of assets that are not traded on organized markets.

We believe, however, that for the reasons stated above it is important for all advisers to use the fair valuation method to calculate their private fund assets under management.

See

proposed Form ADV: Instructions for Part 1A, instr. 5.b.(4). A fund's governing documents may provide for a specific process for calculating fair value (

e.g.,

that the general partner, rather than the board of directors, determines the fair value of the fund's assets). An adviser would be able to rely on such a process also for purposes of calculating its “regulatory assets under management.”

See, e.g.,

Comment Letter of National Venture Capital Association, dated July 28, 2009, at 2, commenting on the Commission's proposed custody rule (Investment Advisers Act Release No. 2876) (the “vast majority of venture capital funds provide their LPs [

i.e.,

investors] quarterly and audited annual financial reports. These reports are prepared under generally accepted accounting principles, or GAAP, and audited under the standards established for all investment companies, including the largest mutual fund complexes.”); Comment Letter of Managed Funds Association, dated July 28, 2009, at 3 (a “substantial proportion of hedge fund managers, whether or not they are registered with the Commission, provide independently audited financial statements of the [hedge] fund to investors.”). Furthermore, advisers to private funds that prepare and distribute financial statements prepared in accordance with GAAP may be deemed to satisfy certain requirements of our custody rule.

See

rule 206(4)-2(b)(4) under the Advisers Act.

Those assets include, for example, “distressed debt” (such as securities of companies or government entities that are either already in default, under bankruptcy protection, or in distress and heading toward such a condition) or certain types of emerging market securities that are not readily marketable.

See

Gerald T. Lins et al., Hedge Funds and Other Private Funds: Reg and Comp § 5:22 (2009) (“At any given time, some portion of a hedge fund's portfolio holdings may be illiquid and/or difficult to value. This is particularly the case for certain types of hedge funds, such as those focusing on distressed securities, activist investing, etc.”).

Advisers, as discussed below, would apply this revised method to calculate assets under management for various purposes under the Advisers Act. As they do today, advisers would calculate their assets under management for purposes of assessing whether they are eligible to register with the Commission. As a result of the proposed amendments to rule 203A-1, which would remove the requirement that an adviser determine its eligibility for registration by the assets under management reported on Form ADV, we are proposing a new provision, rule 203A-3(d), to retain the requirement that the calculation of “assets under management” under section 203A and the related rules be made in accordance with the Form ADV calculation.

Advisers would also apply the method for purposes of the new exemptions for foreign private advisers and with respect to certain private fund advisers, which we address in the Exemptions Release. For purposes of calculating the assets under management relevant under the exemptions, our proposed rules cross-reference the method for calculating “regulatory assets under management” under Form ADV.

A uniform method of calculating assets under management for purposes of determining eligibility for SEC registration, reporting assets under management on Form ADV, and the new exemptions from registration under the Advisers Act would result in a more coherent application of the Act's regulatory requirements and more consistent reporting across the industry.

See

proposed rule 203A-3(d) (requiring advisers to determine “assets under management” by calculating the securities portfolios with respect to which an investment adviser provides continuous and regular supervisory or management services as reported on the investment adviser's Form ADV). This new provision reflects the current requirement in subsection (a) of rule 203A-1 that we propose to eliminate to remove the $5 million buffer, which also requires advisers to determine their eligibility to register with the Commission based on the amount of assets under management reported on Form ADV.

See

rule 203A-1(a).

See

Exemptions Release at sections II.B.2. and II.C.5.; proposed rules 202(a)(30)-1 (definitions of foreign private adviser exemption terms) and 203(m)-1 (private fund adviser exemption).

We request comment on our proposed changes to the instructions relating to the calculation of “regulatory assets under management.” Are changes to the rule and instructions necessary? Should we instead consider different changes? If so, in what way should we amend them? In particular, is our understanding that most private funds prepare financial statements using fair value accounting correct? Would the proposed approach result in advisers valuing their private fund assets in a generally uniform manner and in comparability of the valuations? We are not proposing to require advisers to determine fair value in accordance with GAAP. Should we adopt such a requirement? If not, should we specify that advisers may only determine the fair value of private fund assets in accordance with a body of accounting principles used in preparing financial statements? We understand that GAAP does not require some funds to fair value certain investments. Should we provide for an exception from the proposed fair valuation requirement with respect to any of those investments?

Should we adopt a different approach altogether and allow advisers to use a method other than fair value? Are there other methods that would not understate the value of fund assets? Should the instructions permit advisers to rely on the method set forth in a fund's governing documents, or the method used to report the value of assets to investors or to calculate fees (or other compensation) for investment advisory services? What method should apply if a fund uses different methods for different purposes? Should we modify the proposed rule to require that the valuation be derived from audited financial statements or be subject to review by auditors or another independent third party?

Advisers are currently only required to update their assets under management reported on Form ADV annually.

Should we require more frequent updating? For instance, should we require an adviser to update its regulatory assets under management quarterly or any time the adviser files an other-than-annual amendment?

See

General Instruction 4 to Form ADV.

See, e.g.,

Exemptions Release at section II.B.2. (proposed rule 203(m)-1 would require quarterly evaluation of private fund assets); Part 2 Release,

supra

note 46, at nn.46-48 and accompanying text (requiring advisers to update the amount of assets under management reported in Part 2 annually and when there are material changes if the adviser files an interim amendment for a separate reason).

4. Switching Between State and Commission Registration

Rule 203A-1 currently contains two means of preventing an adviser from having to switch frequently between State and Commission registration as a result of changes in the value of its assets under management or the departure of one or more clients.

First, the rule provides for a $5 million buffer that permits an investment adviser having between $25 million and $30 million of assets under management to remain registered with the states and does not subject the adviser to cancellation of its Commission registration until its assets under management fall below $25 million.

Second, the rule permits an adviser to rely on the firm's assets under management reported annually in the firm's annual updating amendments for purposes of determining its eligibility to register with the Commission, allowing an adviser to avoid the need to change registration status based upon fluctuations that occur during the course of the year.

If an adviser is no longer eligible for Commission registration, the rule provides a 180-day grace period from the adviser's fiscal year end to allow it to switch to State registration.

See

rule 203A-1(a), (b); NSMIA Adopting Release,

supra

note 10, at section II.C.;

Rules Implementing Amendments to the Investment Advisers Act of 1940,

Investment Advisers Act Release No. 1601, section II.C. (Dec. 20, 1996) [61 FR 68480 (Dec. 27, 1996)] (“NSMIA Proposing Release”).

Rule 203A-1(a).

Rule 203A-1(b).

See also

rule 204-1(a) (requiring annual amendment to Form ADV within 90 days of fiscal year end); General Instruction 4 (annual amendment to Form ADV must update amount of assets under management reported). Other criteria to determine an adviser's eligibility to register with the Commission must also be determined annually.

See

rule 203A-1(b)(2).

Rule 203A-1(b)(2).

We propose to amend rule 203A-1 to eliminate the $5 million buffer for advisers having between $25 million and $30 million of assets under management, but to retain the ability of an adviser to avoid the need to change registration status based upon intra-year fluctuations in its assets under management for purposes of determining its eligibility to register with the Commission.

The current buffer seems unnecessary in light of Congress's determination generally to require most advisers having between $30 million and $100 million of assets under management to be registered with the states.

Moreover, at this time, we believe it is not necessary to increase the $100 million threshold in order to provide a similar buffer for advisers crossing that threshold and becoming registered with the Commission under the amended statutory provisions. We believe that the requirement that advisers only assess their eligibility for registration annually and the grace periods provided to switch to and from State registration will be sufficient to address the concern that an investment adviser with assets under management approaching $100 million or affected by changes in other eligibility requirements will frequently have to switch between State and Federal registration.

See

proposed rule 203A-1. In addition, the proposed rule would permit an adviser to rely on an affirmation of other criteria reported in its annual updating amendments for purposes of determining its eligibility to register with the Commission.

See

proposed rule 203A-1(b) (continuing to require an adviser filing an annual updating amendment to its Form ADV reporting that it is not eligible for Commission registration to withdraw its registration within 180 days of its fiscal year end).

See

H.R. Rep. No. 111-517, at 867 (2010) (“Conference Committee Report”) (discussing fact that legislation “raise[d] the assets threshold for Federal regulation of investment advisers from $30 million to $100 million.”).

If during the 180-day grace period to switch to State registration an adviser's assets under management increase, making the adviser eligible for Commission registration again, the adviser could amend its Form ADV to indicate the new amount of assets under management and continue to remain registered with the Commission.

See

proposed rule 203A-1(b) (adviser must withdraw from SEC registration within 180 days of its fiscal year end unless it then is eligible for registration).

We request comment on our proposed elimination of the $5 million buffer. Do many advisers currently use this buffer? Should we retain the buffer given the new provisions regarding mid-sized advisers? Should we adopt a similar buffer for the new $100 million dollar threshold in amended section 203A? If so, what should be the amount of the buffer? Should it be $5 million, or higher or lower, and why? Do Item 2.A of Form ADV, Part 1A and the related instructions provide sufficient information to advisers about their eligibility to register with the Commission, or is additional guidance necessary?

5. Exemptions From the Prohibition on Registration With the Commission

Section 203A(c) of the Advisers Act provides the Commission with the authority to permit investment advisers to register with the Commission even though they would be prohibited from doing so otherwise.

As also noted above, under this authority, we have adopted six exemptions in rule 203A-2 from the prohibition on registration.

Our authority under this provision was unchanged by the Dodd-Frank Act and therefore extends to the new mid-sized adviser category in section 203A(a)(2) of the Act, as amended.

As a result, as currently drafted, each of these exemptions would, by its terms, apply to mid-sized advisers-exempting them from the prohibition on registering with the Commission if they meet the requirements of rule 203A-2. We are proposing amendments to three of the

exemptions to reflect developments since their adoption, including the enactment of the Dodd-Frank Act. We request comment on whether we should amend the rules so that some, or all, of the exemptions should not be available to mid-sized advisers.

See

Advisers Act section 203A(c). An investment adviser exempted from the prohibition on registration must register with the Commission, unless it otherwise qualifies for an exemption from registration under section 203(b) of the Advisers Act. Advisers Act section 203(a).

See supra

note 14 and accompanying text. The Commission has permitted six types of investment advisers to register with the Commission under rule 203A-2: (i) NRSROs; (ii) pension consultants; (iii) investment advisers affiliated with an adviser registered with the Commission; (iv) investment advisers expecting to be eligible for Commission registration within 120 days of filing Form ADV; (v) multi-State investment advisers; and (vi) internet advisers.

Today, rule 203A-2 provides that advisers meeting the criteria for a category of advisers under the rule will not be prohibited from registering with us by Advisers Act section 203A(a).

See

rule 203A-2; NSMIA Adopting Release at section II.D. We are not proposing to amend this part of rule 203A-2. The new prohibition on mid-sized advisers registering with the Commission also is established under Advisers Act section 203A(a); therefore, mid-sized advisers meeting the requirements for a category of exempt advisers under rule 203A-2 would be eligible to register with us.

See

section 410 of the Dodd-Frank Act; proposed rule 203A-2.

We are also renumbering and making minor conforming changes to, rule 203A-2(c), (d) and (f) regarding investment advisers affiliated with an SEC-registered adviser, newly formed advisers expecting to be eligible for Commission registration within 120 days, and internet advisers.

See

proposed rule 203A-2(b), (c) and (e).

a. NRSROs

We propose an amendment to eliminate the exemption in rule 203A-2(a) from the prohibition on Commission registration for nationally recognized statistical rating organizations (“NRSROs”). Since we adopted this exemption, Congress amended the Act to exclude NRSROs from the Act

and provided for a separate regulatory regime for NRSROs under the Securities Exchange Act of 1934 (“Exchange Act”).

Only one NRSRO remains registered as an investment adviser under the Act and reports that it has more than $100 million of assets under management and thus would not rely on the exemption.

Should we retain this exemption? If so, why?

Credit Rating Agency Reform Act of 2006, Public Law 109-291, 120 Stat. 1327, § 4(b)(3)(B) (2006) (“Credit Rating Agency Reform Act”).

See also

Advisers Act section 202(a)(11)(F) (excluding an NRSRO from the definition of investment adviser unless it issues recommendations about purchasing, selling, or holding securities or engages in managing assets that include securities).

Credit Rating Agency Reform Act,

supra

note 73, at sections 4(a), 5.

Based on IARD data as of September 1, 2010.

b. Pension Consultants

We propose to amend the exemption available to pension consultants in rule 203A-2(b) to increase the minimum value of plan assets from $50 million to $200 million.

Pension consultants typically do not have “assets under management,” but we have required these advisers to register with us because their activities have a direct effect on the management of large amounts of pension plan assets.

We had set the threshold at $50 million of plan assets for these advisers to ensure that, in order to register with us, a pension consultant's activities are significant enough to have an effect on national markets.

We propose to increase this threshold to $200 million in light of Congress's determination to increase from $25 million to $100 million the amount of “assets under management” that requires all advisers to register with the Commission.

This threshold would maintain a ratio to the statutory threshold that is the same as the ratio of the $50 million plan asset threshold and $25 million assets under management threshold currently in place. As a result, advisers currently relying on the pension consultant exemption advising plan assets of less than $200 million may be required to register with one or more states.

See

proposed rule 203A-2(a).

See

NSMIA Adopting Release at section II.D.2.; NSMIA Proposing Release at section II.D.2. Pension consultants provide services to pension and employee benefit plans and their fiduciaries, including assisting them to select investment advisers that manage plan assets.

See

rule 203A-2(b)(2), (3); NSMIA Adopting Release at section II.D.2. The exemption does not apply to pension consultants that solely provide services to plan participants.

See

NSMIA Adopting Release at section II.D.2.

See

NSMIA Adopting Release at n. 60 (the $50 million “higher threshold is necessary to demonstrate that a pension consultant's activities have an effect on national markets.”). The higher asset requirement also reflects that a pension consultant has substantially less control over client assets than an adviser that has “assets under management.”

Id.

To determine the aggregate value of plan assets, a pension consultant may only include the portion of the plan's assets for which the consultant provided investment advice. Rule 203A-2(b)(3).

See

section 410 of the Dodd-Frank Act.

We note, however, that a pension consultant required to register in 15 or more states would be eligible to register with the SEC pursuant to proposed rule 203A-2(d).

See infra

section II.A.5.c. of this Release.

We request comment on our proposed amendment. Does an adviser advising plan assets of $200 million or more have an impact on national markets? Should we use another amount instead? Does an adviser advising a smaller amount of plan assets also have an impact on national markets? Should we instead increase the threshold by the same amount that Congress increased the statutory threshold of assets under management, which would be $125 million of plan assets?

c. Multi-State Advisers

We propose to amend the multi-state adviser exemption to align the rule with the multi-State exemption Congress built into the mid-sized adviser provision under section 410 of the Dodd-Frank Act.

Under rule 203A-2(e), the prohibition on registration with the Commission does not apply to an investment adviser that is required to register in 30 or more states. Once registered with the Commission, the adviser remains eligible for Commission registration as long as it would be obligated, absent the exemption, to register in at least 25 states.

The Dodd-Frank Act provides that a mid-sized adviser that otherwise would be prohibited may register with the Commission if it would be required to register with 15 or more states.

See

proposed rule 203A-2(d).

Rule 203A-2(e)(1). An investment adviser relying on this exemption also must: (i) include a representation on Schedule D of Form ADV that the investment adviser has concluded that it must register as an investment adviser with the required number of states; (ii) undertake to withdraw from registration with the Commission if the adviser indicates on an annual updating amendment to Form ADV that it would be required by the laws of fewer than 25 states to register as an investment adviser with the State; and (iii) maintain a record of the states in which the investment adviser has determined it would, but for the exemption, be required to register. Rule 203A-2(e)(2)-(4). Advisers relying on rule 203A-2(e) may not include in the number of states those in which they are not required to register because of applicable State laws or the national

de minimis

standard of section 222(d) of the Advisers Act.

See Exemption for Investment Advisers Operating in Multiple States; Revisions to Rules Implementing Amendments to the Investment Advisers Act of 1940; Investment Advisers with Principal Offices and Places of Business in Colorado or Iowa,

Investment Advisers Act Release No. 1733, n. 17 (July 17, 1998) [63 FR 39708 (July 24, 1998)] (“Multi-State Adviser Adopting Release”).

See

section 410 of the Dodd-Frank Act (“* * * if by effect of this paragraph an investment adviser would be required to register with 15 or more States, then the adviser may register under section 203.”). Section 203A(a)(1) of the Advisers Act does not include a similar exemption from the prohibition on Commission registration for small advisers required to register in a particular number of states.

We believe that this provision of the Dodd-Frank Act reflects a Congressional view on the number of states with which an adviser must be required to be registered before the regulatory burdens associated with such regulation warrant registration solely with the Commission and application of the preemption provision.

Thus, we are reconsidering the threshold of our multi-State exemption, and propose to amend rule 203A-2(e) to permit all investment advisers required to register as an investment adviser with 15 or more states to register with the Commission.

We also propose to eliminate the provision in the rule that permits advisers to remain registered until the number of states in which they must register falls below 25 states, and we are not proposing a similar cushion for the 15-State threshold.

The Dodd-Frank Act contains no such cushion for mid-sized advisers.

We also believe that the requirement that advisers only assess their eligibility for registration annually and the grace periods provided

to switch to and from State registration may be sufficient to address the concern that an investment adviser required to register in 15 states would frequently have to switch between State and Federal registration.

See

Conference Committee Report,

supra

note 67, at 867 (bill “raises the assets threshold for Federal regulation of investment advisers from $30 million to $100 million. Those advisers who qualify to register with their home State must register with the SEC should the adviser operate in more than 15 states.”).

See

proposed rule 203A-2(d)(1).

See

proposed rule 203A-2(d).

See

section 410 of the Dodd-Frank Act.

See supra

notes 66-68 and related text. We also note that proposed rule 203A-2(d) would permit an adviser to choose to maintain its State registrations and not switch to SEC registration.

See

proposed rule 203A-2(d)(2) (adviser elects to rely on the exemption by making the required representations on Form ADV).

We request comment on whether the 15-State threshold should be applied to small advisers as well as mid-sized advisers. If not, should the threshold of 30 or more states continue to apply to small advisers? Should we, as proposed, eliminate the “cushion” that permits advisers to remain registered with us even if they are no longer registered in five of the states in which they were initially registered? Should we retain that provision or, alternatively, include a different number of states? Does the grace period currently provided in rule 203A-1 prevent the transient registration problems that the five-State cushion was designed to address?

See

proposed rule 203A-1;

supra

notes 66-68 and related text; Multi-State Adviser Adopting Release at section II.A. (five-State provision creates a cushion to prevent an adviser from having to de-register and then re-register with the Commission frequently as a result of a change in registration obligations in one or a few states).

6. Elimination of Safe Harbor

Rule 203A-4 provides a safe harbor from Commission registration for an investment adviser that is registered with the State securities authority of the State in which it has its principal office and place of business, based on a reasonable belief that it is prohibited from registering with the Commission because it does not have sufficient assets under management.

Advisers have not, in our experience, asserted, as a defense, the availability of this safe harbor, which protects only against enforcement actions by us and not any private actions, and we are not proposing to extend it to the higher threshold established by the Dodd-Frank Act. This rule was designed for smaller advisory businesses with assets under management of less than $30 million,

which may not employ the same tools or otherwise have a need to calculate assets as precisely as advisers with greater assets under management. We view it as unlikely that an adviser would be reasonably unaware that it has more than $100 million of regulatory assets under management when it is required to report its regulatory assets under management on Form ADV.

Commenters are requested to address whether advisers do, in fact, rely on this safe harbor today. We also request comment on whether we should, as we propose, rescind this safe harbor or, alternatively, extend its availability to the higher registration threshold of the Dodd-Frank Act.

Rule 203A-4.

See

rule 203A-4; NSMIA Adopting Release at section II.B.3.

We believe that whether an adviser has $100 million of assets under management is unlikely to be determined by whether non-discretionary assets could be treated as assets under management or whether the adviser provides continuous and regular supervisory or management services with respect to certain assets, which was the basis for the safe harbor.

See

NSMIA Adopting Release at section II.B.3.; NSMIA Proposing Release at section II.B.4.

7. Mid-Sized Advisers

As discussed above, section 203A(a)(2) of the Advisers Act, as amended by the Dodd-Frank Act, will prohibit mid-sized advisers from registering with the Commission, but only if: (i) the adviser is required to be registered as an investment adviser with the securities commissioner (or any agency or office performing like functions) of the State in which it maintains its principal office and place of business; and (ii) if registered, the adviser would be subject to examination as an investment adviser by such commissioner, agency, or office.

The Dodd-Frank Act does not explain how to determine whether a mid-sized adviser is “required to be registered” or is “subject to examination” by a particular State securities authority.

We propose to incorporate into Form ADV an explanation of how we construe these provisions.

See

section 410 of the Dodd-Frank Act.

The Advisers Act defines the term “State” to include any U.S. State, the District of Columbia, Puerto Rico, the Virgin Islands, or any other possession of the United States. Advisers Act section 202(a)(19). For purposes of section 203A of the Advisers Act and the rules thereunder, rule 203A-3(c) defines “principal office and place of business” to mean the executive office of the investment adviser from which its officers, partners, or managers direct, control, and coordinate its activities. We are not proposing changes to this definition.

See

rule 203A-3(c). For a discussion of amendments we propose to make to the calculation of assets under management, see

supra

section II.A.3. of this Release.

See

proposed Form ADV: Instructions for Part 1A, instr. 2.b.

a. Required To Be Registered

Under section 203A(a)(1) of the Act, an adviser that is not regulated or required to be regulated as an investment adviser in the State in which it has its principal office and place of business must register with the Commission regardless of the amount of assets it has under management.

We have interpreted “regulated or required to be regulated” to mean that a State has enacted an investment adviser statute, regardless of whether the adviser is actually registered in that State.

This interpretation has two relevant consequences. First, advisers with a principal office and place of business in Wyoming, or in foreign countries, must register with the Commission regardless of whether they have assets under management and would not otherwise be eligible for one of our exemptive rules.

Second, some smaller advisers exempt from State registration are not subject to registration with either the Commission or any of the states.

Advisers Act section 203A(a)(1).

See also

Advisers Act section 203(a).

See

NSMIA Adopting Release at section II.E.1.

See

NSMIA Adopting Release at section II.E.; NSMIA Proposing Release at section II.E. Currently, all U.S. states except Wyoming require certain investment advisers to register.

See Transition Rule for Ohio Investment Advisers,

Investment Advisers Act Release No. 1794, n. 4 (Mar. 25, 1999) [64 FR 15680 (Apr. 1, 1999)].

See, e.g.,

Advisers Act section 203A(a)(1); Uniform Securities Act §§ 102(15), 403(b) (2002) (“Uniform Securities Act”) (defining “investment adviser” and providing exemptions from State registration as an investment adviser).

We believe that Congress was concerned with the latter consequence when it passed this provision of the Dodd-Frank Act. The bills originally introduced and passed in the House and Senate increased up to $100 million the threshold for Commission registration under the “regulated or required to be regulated” standard that is used today in section 203A(a)(1).

100

Accordingly, some advisers with a significant amount (more than $25 million) of assets under management could have escaped oversight by either the Commission or any of the states by taking advantage of State registration exemptions. Perhaps to avoid this possibility, the Conference Committee included a provision to prohibit a mid-sized adviser from registering with the Commission if, among other things, it is “required to be registered” as an adviser with the State securities authority where it maintains its principal office and place of business.

101

A mid-sized adviser that can and does rely on an exemption under the law of the State in which it

has its principal office and place of business such that it is “not required to be registered” with the State securities authority

102

must register with the Commission, unless an exemption from registration with the Commission otherwise is available.

103

An adviser not registered under a State adviser statute in contravention of the statute, however, would not be eligible for registration with the Commission.

100

See

The Wall Street Reform and Consumer Protection Act of 2009, H.R. 4173, 111th Cong. § 7418 (2009) (requiring an adviser with between $25 million and $100 million of assets under management that “is regulated and examined, or required to be regulated and examined, by a State” to register with and be subject to examination by such State); Restoring American Financial Stability Act of 2010, S. 3217, 111th Cong. § 410 (2010) (prohibiting an investment adviser with assets under management of less than $100 million from registering with the Commission if the adviser “is regulated or required to be regulated as an investment adviser” in the State where it maintains its principal office and place of business).

101

See

section 410 of the Dodd-Frank Act.

102

See, e.g.,

Uniform Securities Act,

supra

note 99, at sections 102(15), 403(b).

103

See, e.g.,

Advisers Act sections 203(a) and (b), 203A(b); rule 203A-2. Such an adviser could not voluntarily register with the State securities authorities to avoid SEC registration.

We are proposing changes to Form ADV to require a mid-sized adviser filing with us to affirm, upon application and annually thereafter, that it is not required to be registered as an adviser with the State securities authority in the State where it maintains its principal office and place of business.

104

An adviser reporting that it is no longer able to make such an affirmation thereafter would have 180 days from its fiscal year end to withdraw from Commission registration.

105

Thus, the rule would operate to permit an adviser to rely on this affirmation reported in its annual updating amendments for purposes of determining its eligibility to register with the Commission.

106

Should these requirements apply to mid-sized advisers? Are there alternative interpretations of “required to be registered” that we should consider and why?

104

See

proposed Form ADV, Part 1A, Item 2.A.(2)(a). For a discussion of proposed changes to Form ADV, Part 1A, Item 2, see

supra

section II.A.2. of this Release.

105

See

proposed rule 203A-1(b).

106

This would allow an adviser to change registration status based upon a change during the course of the year regarding whether it is required to be registered with a State.

b. Subject to Examination

Not all State securities authorities conduct compliance examinations of advisers registered with them.

107

Congress therefore determined to require a mid-sized adviser to register with the Commission if the adviser is not subject to examination as an investment adviser by the State in which the adviser has its principal office and place of business.

108

107

See, e.g.,

North American Securities Administrators Association, Inc.,

State Securities Regulators Report on Regulatory Effectiveness and Resources with Respect to Broker-Dealers and Investment Advisers,

7 (2010) (“NASAA Report”). The NASAA Report was submitted in connection with the Commission's study regarding obligations of brokers, dealers, and investment advisers, and is available on the Commission's Web site at

http://www.sec.gov/comments/4-606/4606-2789.pdf.

108

See

section 410 of the Dodd-Frank Act.

The Commission does not intend either to review or evaluate each State's investment adviser examination program.

109

Instead, we will correspond with each State securities commissioner (or official with similar authority) and request that each advise us whether an investment adviser registered in the State would be subject to examination as an investment adviser by that State's securities commissioner (or agency or office with similar authority).

110

We believe that the states, being most familiar with their own circumstances, are in the best position to determine whether advisers in their State are subject to examination. Using the responses that we receive, we will identify for advisers filing on IARD the states in which the securities commissioner did not certify that advisers are subject to examination and incorporate that list into IARD to ensure that only mid-sized advisers with their principal office and place of business in one of those states (or, as discussed above, mid-sized advisers that are not registered with the states where they maintain their principal office and place of business) will register with the Commission.

111

We request comment on whether the Commission should take additional steps to determine whether an investment adviser would be subject to examination in a State, as well as any alternatives the Commission may adopt. We also request comment on the steps the Commission should take if a State determines not to respond to our request.

109

The bill introduced in the House included a requirement that we publish a list of the states that regulate and examine, or require regulation and examination of, investment advisers.

See

The Wall Street Reform and Consumer Protection Act of 2009, H.R. 4173, 111th Cong. § 7418 (2009). Congress did not include this requirement in the Dodd-Frank Act.

See

section 410 of the Dodd-Frank Act.

110

We also will request that each State notify the Commission promptly if advisers in the State will begin to be subject to examination or will no longer be subject to examination.

111

See

proposed Form ADV, Part 1A, Item 2.A.(2)(b). We will also make the list available on our Web site at

http://www.sec.gov.

B. Exempt Reporting Advisers: Sections 407 and 408

As discussed above, the Dodd-Frank Act, effective July 21, 2011, also repealed the “private adviser exemption” contained in section 203(b)(3) of the Advisers Act on which advisers to many hedge funds and other pooled investment vehicles had relied in order to avoid registration under the Act.

112

In eliminating this provision, Congress amended the Act to create, or direct us to adopt, other, in many ways narrower, exemptions for advisers to certain types of “private funds.” Both section 203(l) of the Advisers Act (which provides an exemption for an adviser that advises solely one or more “venture capital funds”) and section 203(m) of the Advisers Act (which instructs the Commission to exempt any adviser that acts solely as an adviser to private funds and has assets under management in the United States of less than $150 million) provide that the Commission shall require such advisers to maintain such records, which we have the authority to examine,

113

and to submit reports “as the Commission determines necessary or appropriate in the public interest.”

114

We refer to these advisers in this release as “exempt reporting advisers.”

112

Section 403 of the Dodd-Frank Act. Section 203(b)(3) exempts from registration any investment adviser who during the course of the preceding twelve months has had fewer than fifteen clients and who neither holds himself out generally to the public as an investment adviser nor acts as an investment adviser to any investment company registered under the Investment Company Act, or a company which has elected to be a business development company pursuant to Section 54 of the Investment Company Act (15 U.S.C. 80a-53).

113

Under section 204(a) of the Advisers Act, the Commission has the authority to examine records, unless the adviser is “specifically exempted” from the requirement to register pursuant to section 203(b) of the Advisers Act. Investment advisers that are exempt from registration in reliance on section 203(l) or 203(m) of the Advisers Act are not “specifically exempted” from the requirement to register pursuant to section 203(b).

114

See

sections 407 and 408 of the Dodd-Frank Act, adding Advisers Act sections 203(l) and (m). See

supra

note 45 for a discussion of the term “private fund.”

See also

Exemptions Release at section II.

See also

current section 204(a) of the Advisers Act and section 204(b)(5), as added by section 404 of the Dodd-Frank Act.

To implement sections 203(l) and 203(m), we are proposing a new rule to require exempt reporting advisers to submit, and to periodically update, reports to us by completing a limited subset of items on Form ADV.

115

We are also proposing amendments to Form ADV to permit the form to serve as a reporting, as well as a registration, form and to specify the seven items exempt reporting advisers must complete.

116

115

Recordkeeping requirements for exempt reporting advisers will be addressed in a future release.

See

sections 407 and 408 (providing that the Commission shall require investment advisers exempt from registration under either section 407 or 408 to maintain such records as the Commission determines necessary or appropriate in the public interest or for the protection of investors.).

116

For a discussion of additional amendments we are proposing to Part 1 of Form ADV, see

infra

section II.C. of this Release.

1. Reporting Required

We are proposing a new rule, rule 204-4, to require exempt reporting advisers to file reports with the Commission electronically on Form ADV.

117

Rule 204-4 would require these advisers to submit their reports through the IARD using the same process as registered investment advisers.

118

Each Form ADV would be considered filed with the Commission upon acceptance by the IARD,

119

and advisers filing the form would be required to pay a filing fee.

120

As we do for IARD filings by registered advisers, we would approve, by order, the amount of the filing fee charged by FINRA.

121

We anticipate that filing fees would be the same as those for registered investment advisers, which currently range from $40 to $200, based on the amount of assets an adviser has under management.

122

The filing fees would be set at amounts that are designed to pay the reasonable costs associated with the filing and the maintenance of the IARD.

117

Proposed rule 204-4(a).

118

Proposed rule 204-4(b).

See

General Instructions 6, 7, 8 and 9 (providing guidance about the IARD entitlement process, signing the form, and submitting it for filing).

119

Proposed rule 204-4(c).

Cf.

rule 0-4(a)(2) (“All filings required to be made electronically with the * * * [IARD] shall, unless otherwise provided by the rules and regulations in this part, be deemed to have been filed with the Commission upon acceptance by the IARD.”).

120

Proposed rule 204-4(d).

121

See

section 204(b) of the Advisers Act.

122

The current fee schedule may be found on our Web site at

http://www.sec.gov/divisions/investment/iard/iardfee.shtml.

The reports filed by exempt reporting advisers would be publicly available on our Web site.

123

Exempt reporting advisers unable to file electronically as a result of unanticipated technical difficulties may qualify for a temporary hardship exemption.

124

We also are proposing technical amendments to Form ADV-H, the form advisers use to request a hardship exemption from electronic filing, and Form ADV-NR, used to appoint the Secretary of the Commission as an agent for service of process for certain non-resident advisers.

125

123

The Investment Adviser Public Disclosure System (“IAPD”) allows the public to access the most recent Form ADV filing made by an investment adviser and is available at

http://www.adviserinfo.sec.gov.

We would, however, make it clear to the public viewing reports filed by an exempt reporting adviser on IAPD that the adviser is not registered with us.

124

See

proposed rule 204-4(e) (providing a temporary hardship exemption for an adviser having unanticipated technical difficulties that prevent submission of a filing to IARD). The temporary hardship exemption is based on a similar exemption for registered advisers contained in rule 203-3(a) under the Act [17 CFR 275.203-3(a)], which provides an exemption of no more than seven business days after the filing was due.

125

See

proposed amended Form ADV-H, proposed amended Form ADV-NR, and proposed General Instruction 18. The amendments to Form ADV-H and Form ADV-NR would reflect that exempt reporting advisers would be filing on IARD and the forms would be used in the same way and for the same purpose as they are currently used by registered investment advisers.

We are proposing to require reporting on Form ADV through the IARD to avoid the expense and delay of developing a new form and because the IARD already has the capacity to accept electronic filing of the form. Moreover, much of the information we propose that exempt reporting advisers would provide is required by Form ADV. Because exempt reporting advisers may be required to register on Form ADV with one or more State securities authorities,

126

use of the existing form and filing system would also permit exempt reporting advisers to satisfy both State and Commission requirements with a single electronic filing.

127

Our proposed approach would permit an adviser to transition from filing reports with us to applying for registration under the Act by simply amending its Form ADV; the adviser would check the box to indicate it is filing an initial application for registration, complete the items it did not have to answer as an exempt reporting adviser, and update the pre-populated items that it already has on file.

128

126

The Dodd-Frank Act exempts exempt reporting advisers from registration with the Commission.

See

sections 407 and 408 of the Dodd-Frank Act. It does not, however, exempt these advisers from registering or filing reports with State securities regulators.

See also

section 410 of the Dodd-Frank Act (re-allocating SEC and State jurisdiction over investment advisers); proposed

rule 203A-1 (proposing the process for switching to or from State or SEC registration); and proposed General Instruction 13 to Form ADV (noting that exempt reporting advisers who file reports with the SEC may continue to be subject to State registration, reporting, or other obligations).

127

Form ADV is used by advisers both to register with the Commission and with State securities authorities. At the request of the State securities authorities, we expect to add to Form ADV a check box and instructions that would permit exempt reporting advisers to direct the filing of reports filed with the Commission to the State securities authorities. Because these revisions to Form ADV and the obligation to file the report with the State securities authorities would not arise from a Federal law or Commission rule, we are not proposing them for comment. We urge interested persons to submit comments directly to the North American Securities Administrators Association, Inc. (“NASAA”) for consideration by the State securities authorities at the following e-mail address:

advcomments@nasaa.org.

In addition, we understand that NASAA may propose a model rule that would exempt certain exempt reporting advisers from State registration but would require these advisers to submit to the States a report identical to the report an exempt reporting adviser would be required to submit to the SEC. Interested persons should visit the NASAA Web site at

http://www.nasaa.org

for the full text of any proposed rule and to respond to any request for comment.

128

See proposed General Instruction 14 (providing procedural guidance to advisers that no longer meet the definition of exempt reporting adviser).

See also infra

note 140.

We request comment on proposed rule 204-4 and its requirement that exempt reporting advisers file reports by responding to a subset of items on Form ADV and filing the report through IARD. Should we instead create a new form and/or a new filing system for exempt reporting advisers? Rather than use IARD or a new system, should we instead require exempt reporting advisers to use EDGAR? Should we not make this information available to the public on our Web site? Are there alternative approaches to reporting by exempt reporting advisers that we should consider? If so, please explain. Are there additional ways the Commission could distinguish between registered advisers and exempt reporting advisers?

2. Information in Reports

We are proposing several amendments to Form ADV to facilitate filings by exempt reporting advisers. First, we would re-title the form to reflect its dual purpose as both the “Uniform Application for Investment Adviser Registration,” as well as the “Report by Exempt Reporting Advisers.” Second, we are proposing to amend the cover page so that exempt reporting advisers would indicate the type of report they are filing.

129

Finally, we propose to amend Item 2 of Part 1A, which requires advisers to indicate their eligibility for SEC registration, by adding a new subsection C that would require an exempt reporting adviser to identify the exemption(s) that it is relying on to report, rather than register, with the Commission.

130

129

An adviser would indicate whether it is submitting an initial report, an annual updating amendment, an other-than-annual-amendment, or a final report. We also propose corresponding changes to General Instruction 2.

130

An adviser would check that it qualifies for an exemption from registration: (i) As an adviser solely to one or more venture capital funds; and/or (ii) because it acts solely as an adviser to private funds and has assets under management in the United States of less than $150 million.

See

proposed Form ADV, Part 1A, Item 2.C. An adviser relying on the latter exemption, for private fund advisers, would also be required to indicate the amount of private fund assets it manages in Section 2.C. of Schedule D to Form ADV, Part 1A. Investment advisers who have their principal office and place of business outside of the United States, however, would need only to include private fund assets that they manage from a place of business in the United States.

See

Exemptions Release at section II.B.2.

Form ADV is today designed to obtain information from registered advisers that provide a wide variety of types of

advisory services, including providing advice to private funds. Therefore, the information that we propose to collect from exempt reporting advisers is for the most part currently required by Form ADV.

131

We would provide an instruction to these advisers to complete only certain items in the form, but we do not propose to change the content of the items for exempt reporting advisers.

132

As noted above, we propose to require exempt reporting advisers to complete a limited subset of Form ADV items, which would provide us and the public with some basic information about the adviser and its business, but is not all of the information we require registered advisers to submit to us, and which is designed to support our regulatory program. We propose to require exempt reporting advisers to complete the following items in Part 1A of Form ADV: Items 1 (Identifying Information), 2.C. (SEC Reporting by Exempt Reporting Advisers), 3 (Form of Organization), 6 (Other Business Activities), 7 (Financial Industry Affiliations and Private Fund Reporting), 10 (Control Persons), and 11 (Disclosure Information). In addition, exempt reporting advisers would have to complete corresponding sections of Schedules A, B, C, and D. We would not require exempt reporting advisers to complete and file with us other Items in Part 1A or prepare a client brochure (Part 2).

133

131

Some of the amendments we propose to Form ADV would apply to both registered and exempt reporting advisers.

See infra

section II.C. of this Release.

132

We propose amending General Instruction 3 to explain which portions of Form ADV are applicable to exempt reporting advisers.

133

Part 2 of Form ADV, which requires advisers to prepare a narrative, plain English client brochure, contains 18 items including information on the adviser's business practices, conflicts of interest, and background. Part 2 also requires advisers to prepare brochure supplements that include information about advisory personnel on whom clients rely for investment advice. Currently, only a

registered

adviser must deliver a brochure under rule 204-3, and only an adviser that must deliver a brochure must prepare and file one as part of its Form ADV.

See

rule 203-1.

Congress gave us broad authority to require exempt reporting advisers to file reports as necessary or appropriate in the public interest or for the protection of investors.

134

The Dodd-Frank Act neither specifies the types of information we could require in the reports nor specifies the purpose for which we would use the information.

135

We have sought information that we believe would assist us to identify the advisers, their owners, and their business models. The items that we have proposed would also provide us with information as to whether these advisers or their activities might present sufficient concerns as to warrant our further attention in order to protect their clients, investors, and other market participants. We have also considered the broader public interest in making this information generally available and believe there may be benefits of providing information about their activities to the public. We acknowledge that there may be costs associated with providing this information to us, and that the adviser may provide some or all of this information to private fund investors or prospective investors, however we believe there will be benefits, which we describe in more detail below.

134

See

sections 407 and 408 of the Dodd-Frank Act.

135

The Dodd-Frank Act does, however, specify that the reports are those “the Commission determines necessary or appropriate in the public interest or for the protection of investors.”

Id.

Items 1, 3, and 10 would elicit basic identification details about an exempt reporting adviser such as name, address, contact information, form of organization, and who owns the adviser. Items 6 and 7.A. would provide us with details regarding other business activities that the adviser and its affiliates are engaged in, which would permit us to identify conflicts that the adviser may have with its clients that may suggest significant risks to those clients. Item 11 would require advisers to disclose the disciplinary history for the adviser and its employees. An exempt reporting adviser that has, for example, an officer that has been found guilty of fraud or other crimes or has committed substantial regulatory infractions would be of concern to us and to investors and prospective investors in funds advised by the exempt reporting adviser.

Because exempt reporting advisers manage private funds, we also propose to require them to complete Item 7.B. and Section 7.B of Schedule D for the private funds they advise. As discussed in more detail in Section II.C. below, we are proposing significant amendments to Section 7.B.1. of Schedule D that are designed to provide us with a comprehensive overview, or census, of private funds.

136

Exempt reporting advisers' responses to Item 7.B., and Section 7.B.1. of Schedule D, in conjunction with information provided by registered advisers, would provide us with important data about these funds that we would use to identify risks to their investors.

136

For instance, advisers who complete section 7.B.1. of Schedule D would have to provide identifying information about each private fund, such as its name and domicile, as well as information about its ownership, service providers, and its total and net assets.

See

proposed Form ADV, Part 1A, Schedule D, Section 7.B.1.

Do commenters agree with our judgments regarding the items applicable to exempt reporting advisers? We have not proposed to require exempt reporting advisers to complete Items 4, 5, 8, 9, or 12 of Part 1 of Form ADV. We request comment on whether we should require exempt reporting advisers to complete any of these items to provide us and investors with the information required by those items.

Part 2 of Form ADV, the client brochure, is required of registered advisers to provide clients and potential clients with detailed information about their qualifications, investment strategies, and business practices. Our proposal would not require exempt reporting advisers to prepare Part 2 of Form ADV. Should we require exempt reporting advisers to complete Part 2 of Form ADV, file it with us on IARD, and make it available to the public on our Web site? Would some or all of this information be helpful to clients and potential clients of these advisers? Should we not require exempt reporting advisers to complete certain items of Part 2? For example, should we exclude those items that would require information similar to those items of Part 1 that we are not proposing to require exempt reporting advisers to complete? Are there other items we should include or not include? Should we require these advisers to complete brochure supplements? Would the information in the brochure supplements be helpful to the clients of these advisers? Do investors currently receive this type of information as a result of their investment in a private fund?

Should the reporting requirements be identical for exempt reporting advisers as they are for registered advisers? Are there items that we have proposed to apply to exempt reporting advisers that we should not apply or are unnecessary, and why? Is any of the information we propose to require not readily available to an exempt reporting adviser? Would any of the items require disclosure of proprietary or competitively sensitive information? If so, which items, and if competitively sensitive, describe the competitive impact. Would any of these disclosure requirements, either individually or cumulatively, impose a significant burden? Would they require disclosure of proprietary or competitively sensitive information such that they could impact or influence business or other decisions by these advisers? Would they materially affect a decision by an adviser whether to form a private fund? If so, why?

3. Updating Requirements

We are also proposing to amend rule 204-1 under the Advisers Act, which requires advisers to update their Form ADV filings, to require exempt reporting advisers to file updating amendments to reports filed on Form ADV.

137

Proposed rule 204-1(a) would require an exempt reporting adviser, like a registered adviser, to amend its reports on Form ADV: (i) At least annually, within 90 days of the end of the adviser's fiscal year; and (ii) more frequently, if required by the instructions to Form ADV. Consequently, we are proposing to amend General Instruction 4 to Form ADV to require an exempt reporting adviser to update Items 1 (Identification Information), 3 (Form of Organization), or 11 (Disciplinary Information) promptly if they become inaccurate in any way, and to update Item 10 (Control Persons) if it becomes materially inaccurate.

138

We are proposing the same updating requirements with respect to these Items as are applicable to registered advisers because we believe it is equally important for exempt reporting advisers to report information on a timely basis. We also believe it could create confusion to apply different updating standards

within

each item of the form depending on who completes the item. Consequently, we are proposing to require exempt reporting advisers to follow the same instructions applicable to the items they must complete, although they are required to complete fewer items than a registered adviser.

137

Proposed rule 204-1. We also propose to amend the title of the rule to be “Amendments to Form ADV,” rather than “Amendments to application for registration,” to reflect use of the Form by exempt reporting advisers.

138

See

General Instruction 4 to Form ADV.

We request comment on the proposed amendments to rule 204-1 to extend its requirements to exempt reporting advisers. Should exempt reporting advisers be permitted to update Form ADV, or certain items, less frequently? If so, what should be the updating requirements, and should we be concerned that, as a result, an exempt reporting adviser that is also registered with a State securities regulator would have to update its Form ADV on a different schedule than an exempt reporting adviser that is not also registered with a State? Would less frequent reporting result in information that is less useful or materially inaccurate? Should exempt reporting advisers be required to update other items more frequently than annually?

We propose to include a provision in rule 204-4 to require an exempt reporting adviser to file an amendment to its Form ADV when it ceases to be an exempt reporting adviser.

139

The exempt reporting adviser would indicate in this amendment that it is filing a final report pursuant to rule 204-4 in order to alert us that the adviser no longer will be filing reports, and allow us to distinguish such a filer from one that is inattentive to its filing obligations.

140

We request comment on this proposed final report requirement. Is there an alternative approach we could take?

139

See

proposed rule 204-4(f).

140

Proposed rule 204-4(f). Advisers filing a final report would not be required to pay a filing fee. We note that failure to file a final report would result in a violation of the rule.

Finally, we propose amending the instructions to Form ADV to provide guidance to exempt reporting advisers who file final reports because they must register with the Commission. Such a transition may occur, for example, if an adviser relying on the “venture capital exemption” in section 203(l) of the Advisers Act accepts a client that is not a venture capital fund,

141

or the value of the assets under management in the United States of an adviser relying on the “private fund exemption” in section 203(m) of the Advisers Act meets or exceeds $150 million.

142

A transitioning adviser would file an amendment to its Form ADV simultaneously indicating that the filing will be its final “report” on Form ADV and applying for registration with the Commission.

143

We request comment on this proposed guidance.

141

See

section 407 of the Dodd-Frank Act.

142

See

section 408 of the Dodd-Frank Act.

143

See

proposed General Instruction 14. In the Exemptions Release we propose that an adviser relying on the private fund adviser exemption would have three months from the end of a calendar quarter at which it failed to qualify for the exemption because of a fluctuation in private fund assets to apply to the Commission for registration unless it qualifies for another exemption.

See

proposed rule 203(m)-1(d).

4. Transition

We propose requiring each exempt reporting adviser to file its initial report with us on Form ADV no later than August 20, 2011, 30 days after the July 21, 2011 effective date of the Dodd-Frank Act.

144

We believe this would provide sufficient time to enable an adviser to determine whether it must report to us and to take the steps necessary to complete and submit its initial filing. We request comment on our proposed transition, including the amount of time we propose for exempt reporting advisers to submit their initial reports.

144

See

sections 403, 407, 408, and 419 of the Dodd Frank Act.

As discussed above, our ability to effect this transition may be affected by our need to reprogram IARD.

145

We are working closely with FINRA, our IARD contractor, to make the needed modifications, but the programming may not be completed until after we adopt these rules. If IARD is unable to accept filings of amended Form ADV by that time, we may want to delay the reporting deadline until the system can accept electronic filing of the revised form. Should we instead require an alternative procedure, such as a paper filing, for advisers to indicate their eligibility for this exemption from registration and to satisfy their reporting requirements?

145

See supra

section II.A.1. of this Release.

C. Form ADV

Data collected from Form ADV is of critical importance to our regulatory program and our ability to protect investors. We use information reported to us on Form ADV for a number of purposes, one of which is to efficiently allocate our examination resources based on the risks we discern or the identification of common business activities from information provided by advisers. The information is used to create risk profiles of investment advisers and permits our examiners to better prepare for, and more efficiently conduct, their on-site examinations. Moreover, the information in Form ADV allows us to better understand the investment advisory industry and evaluate the implications of policy choices we must make in administering the Advisers Act.

To enhance our ability to oversee investment advisers, we are proposing to require advisers to provide us additional information about three areas of their operations.

146

First, we are proposing to require advisers to provide information regarding private funds they advise. Second, we are proposing to expand the data advisers provide about their advisory business, (including data about the types of clients they have, their employees, and their advisory activities), as well as about their business practices that may present significant conflicts of interest (such as the use of affiliated brokers, soft dollar arrangements, and compensation for client referrals). Third, we are proposing to require additional information about advisers'

non-advisory activities and their financial industry affiliations. We are also proposing certain additional changes intended to improve our ability to assess compliance risks and also to identify advisers that are subject to the Dodd-Frank Act's requirements concerning certain incentive-based compensation arrangements.

147

We understand that advisers would have ready access to all of the new information as part of their normal operations or compliance programs, and thus these new requirements should impose few additional regulatory burdens. We request comment on whether our understanding is correct. In addition to (or instead of) these three areas of operations, are there other areas about which we should require advisers to report additional information?

146

In addition, we are proposing several clarifying or technical amendments based on frequently asked questions we receive from advisers as well as in our experience administering the form.

See infra

section II.C.6. of this release.

147

See

section 956 of the Dodd-Frank Act.

1. Private Fund Reporting: Item 7.B.

We propose to expand the information we require advisers to provide us about the private funds they advise in response to Item 7.B., and Schedule D. Both registered and exempt reporting advisers would complete this Item. The information would provide us with a more complete understanding of the private funds advised by advisers and would permit us to enhance our assessment of private fund advisers for purposes of targeting our examinations. The information also would help us identify particular practices that may harm investors. We have been concerned that unregistered funds have been used as a vehicle for perpetrating fraud on investors.

148

The private fund reporting requirements we are proposing would provide a level of transparency that we believe would help us to identify practices that may harm investors,

149

and would deter advisers' fraud and facilitate earlier discovery of potential misconduct.

150

148

For example, since January 2009, the Commission has brought more than 50 enforcement cases in which we assert hedge fund advisers have defrauded hedge fund investors or used the fund to defraud others.

149

For instance, census data about a private fund's gatekeepers, including administrators and auditors, would be available on proposed Section 7.B.1. of Schedule D and would be verifiable by investors and the Commission. Recent enforcement actions suggest that the availability of such information could be helpful.

See, e.g., SEC

Grant Ivan Grieve, et al.,

Litigation Release No. 21402 (Feb. 2, 2010) (default judgment against hedge fund adviser that was alleged to have fabricated and disseminated false financial information for the fund that was “certified” by a sham independent back-office administrator and phony accounting firm);

See In the Matter of John Hunting Whittier,

Investment Advisers Act Release No. 2637 (Aug. 21, 2007) (settled action against hedge fund manager for, among other things, misrepresenting to fund investors that a particular auditor audited certain hedge funds, when in fact it did not).

150

See, e.g.,

Second Amended Complaint,

SEC

Hoover,

Civil Action No. 01-10751-RGS, (D. Mass. Mar. 20, 2002)

available at http://www.sec.gov/litigation/complaints/complr17487.htm

(adviser allegedly participated in a scheme to defraud clients of his advisory firm by, among other things, misappropriating assets and overbilling expenses. When he became aware that the Commission staff was investigating his firm, he established a separate, unregistered advisory firm and perpetuated his fraud through use of a hedge fund he created and controlled.);

SEC

Hoover,

Litigation Release No. 17981 (Feb. 11, 2003) (announcing final judgment by consent).

Currently, Item 7 requires each adviser to complete Section 7.B. of Schedule D for any “investment-related limited partnership” that the adviser or a related person advises. A separate Schedule D must be completed for each partnership. We propose to modify the scope of Item 7 by requiring completion of Section 7.B. only for a private fund that the adviser (and not a related person) advises. This amendment would incorporate the new term “private fund,” defined in section 202(a)(29) of the Act, the primary effect of which would be to require advisers to report pooled investment vehicles regardless of whether they are organized as limited partnerships.

151

We would no longer require an adviser to report to us funds that are advised by affiliates, which in many cases would now be reported to us by an affiliate that is either registered under the Act or is now an exempt reporting adviser.

152

151

See supra

note 45 (discussing the definition of private fund). In 2004, the Commission adopted amendments to Form ADV to require reporting of “private fund” information, including a similar amendment to Item 7. A Federal appeals court vacated the 2004 amendments to Item 7 that we had adopted for private funds.

See Registration under the Advisers Act of Certain Hedge Fund Advisers,

Investment Advisers Act Release No. 2333 (Dec. 2, 2004) [69 FR 72054 (Dec. 10, 2004)] (“Hedge Fund Adviser Registration Release”);

Goldstein

Securities and Exchange Commission,

451 F.3d 873 (D.C. Cir. June 23, 2006) (“

Goldstein”

). The amendments we propose would, in part, reinstate these amendments we adopted in 2004.

152

Currently, a related person may be able to rely on the private adviser exemption from registration, which, as discussed above, was repealed by the Dodd Frank Act effective July 21, 2011.

See supra

at sections I, II.B. of this Release.

To avoid multiple reporting for each private fund, we propose to permit a sub-adviser to exclude private funds for which an adviser is reporting on another Schedule D,

153

and would permit an adviser sponsoring a master-feeder arrangement to submit a single Schedule D for the master fund and all of the feeder funds that would otherwise be submitting substantially identical data.

154

Finally, we propose to permit an adviser with a principal office and place of business outside the United States to omit a Schedule D for a private fund that is not organized in the United States and that is not offered to, or owned by, “United States persons.”

155

This approach is designed to limit the reporting burden imposed on foreign advisers with respect to funds in which U.S. investors have no direct interest.

153

If an investment adviser completes section 7.B.1. of Schedule D for a private fund, other advisers to that fund (most of which are likely to be sub-advisers) would not have to complete section 7.B.1. for that private fund.

See

proposed Form ADV, Part 1A, Note to Item 7.B.; proposed Section 7.B.2. of Schedule D. When filing Section 7.B.1. of Schedule D for a private fund, an adviser would acquire a unique identification number to the fund. The adviser would be required to continue to use the same identification number whenever it amends Section 7.B.1. for that fund. Any adviser that files a Section 7.B.1. for a private fund for which an identification number has already been acquired by another adviser would not be permitted to acquire a new identification number, but would be required to instead utilize the existing number.

See

proposed Form ADV: Instructions for Part 1A, instr. 6.b.

154

See

proposed Form ADV: Instructions for Part 1A, instr. 6. In a master-feeder arrangement, one or more funds (“feeder funds”) invest all or substantially all of their assets in a single fund (“master fund”). Advisers would report on a single Schedule D if their responses to certain questions of Section 7.B.1. of Schedule D would be identical for each master and feeder fund. Our staff estimates that most master-feeder arrangements involving private funds would meet this condition. An adviser filing a single Schedule D for a master-feeder arrangement would complete its Schedule D under the name of the master fund, following our proposed instructions for Section 7.B.

155

Id. See also

proposed Form ADV: Glossary. We propose to define “United States person” by reference to the definition in proposed rule 203(m)-1(e)(8), which tracks the definition of a “U.S. person” under Regulation S, except that it contains a special rule for discretionary accounts maintained for the benefit of United States persons.

See

Exemptions Release at section II.B.4. As discussed in the Exemptions Release, our proposed use of the Regulation S definition for various purposes under the Advisers Act would lessen the burden imposed on advisers, which are familiar with the definition because they apply it for other purposes under the securities laws.

We request comment on the scope of the Schedule D filing requirements about private funds. Should we, as proposed, require exempt reporting advisers to file Section 7.B. of Schedule D? Would the disclosure of private fund information by exempt reporting advisers impact or influence business or other decisions by these advisers, such as whether to form additional private funds or discourage entry into management of private funds all together?

Should we require advisers to report information also about other pooled investment vehicles they may advise, such as foreign funds not offered to U.S. persons? Specifically, are there sufficient investor protection or other concerns that the Commission should seek to require this information? Is information about these funds important to understand conduct that directly

involves U.S. investors? Are the instructions eliminating multiple filing of Section 7.B. by advisers helpful? Are there different approaches we might take to achieve our intended goals? We request that commenters review our proposed instructions and identify any ambiguities that we should address.

We propose to amend Section 7.B. of Schedule D, which currently requires very limited information about limited partnerships established by an adviser, and which provides us with little data about the operations of the many large hedge funds and other types of private funds advised by a growing number of advisers registered with the Commission.

156

New Section 7.B.1. would expand on the identifying information currently required to be reported in order to provide us with basic organizational, operational and investment characteristics of the fund; the amount of assets held by the fund; the nature of the investors in the fund; and the fund's service providers.

157

Although we are proposing several new items of information that would be reported to us, much of the information should be readily available to private fund advisers (

e.g.,

the amount of fund assets) and the responses to many of the items are unlikely to change from year to year (

e.g.,

on which exclusion from the Investment Company Act the fund relies) and thus the additional reporting should not involve a significant reporting burden. As discussed in more detail below, the information will help us identify potential compliance risks and inform our regulatory activities.

156

Today, Section 7.B. of Schedule D requires an adviser to a private fund that is a limited partnership or limited liability company to identify: (1) The name of the fund; (2) the name of the general partner or manager; (3) whether the adviser's clients are solicited to invest in the fund; (4) the approximate percentage of the adviser's clients that have invested in the fund; (5) the minimum investment commitment; and (6) the current value of the total assets of the fund.

157

We have considered the potential application of section 210(c) of the Advisers Act (which precludes us from requiring advisers to disclose to us the “identity, investments, or affairs” of any of its clients) to the information about private fund clients of advisers and have concluded that the Dodd-Frank Act permits us to require this information in Form ADV.

See, e.g.,

section 404(2) of the Dodd-Frank Act, adding Advisers Act section 204(b)(1)(A) (authorizing the Commission to require any investment adviser registered under the Act “to maintain such records of, and file with the Commission such reports regarding, private funds advised by the investment adviser, as necessary and appropriate in the public interest and for the protection of investors * * *”).

Part A of the Section would require identifying information, including the name of the private fund. We propose to add an instruction to the item to permit an adviser that seeks to preserve the anonymity of a private fund client by maintaining its identity in code in its records to identify the private fund in Schedule D using the same code.

158

We request comment on this new instruction.

158

Rule 204-2(d) permits any books and records required to be maintained by the rule “in such manner that the identity of any client to whom such investment adviser renders investment supervisory services is indicated by numerical or alphabetical code or some similar designation.” We included the provision in the rule in 1961 to reconcile our then new examination authority (the exercise of which has required us to examine client records) with section 210(c) of the Act.

See Notice of Proposed Rule to Require Investment Advisers to Maintain Specified Books and Records Under the Investment Advisers Act of 1940,

Investment Advisers Act Release No. 111 (Jan. 25, 1961) [26 FR 987 (Feb. 1, 1961)]. We are proposing to add the instruction to permit the few advisers that in our experience have sought to encode the identity of their clients to do so.

We also propose to revise Part A to require an adviser to identify the State or country where the private fund is organized, and the name of its general partner, directors, trustees or persons occupying similar positions.

159

The item would ask information about the organization of the fund, including whether it is a master or a feeder fund, and some information about the regulatory status of the fund and its adviser, including the exclusion from the Investment Company Act on which it relies, whether the adviser is subject to a foreign regulatory authority, and whether the fund relies on an exemption from registration of its securities under the Securities Act of 1933.

160

The Item also would contain questions regarding whether the adviser is a subadviser to the private fund and would require the adviser to identify by name and SEC file number any other advisers to the fund.

161

We are proposing several questions to help us better understand the private fund's investment activities and other areas of potential investor protection concerns. For example, we would ask about the size of the fund, including both its gross and net assets, from which we could better understand the scope of its operations and the extent of leverage it employs.

162

We would ask the adviser to identify within seven broad categories (which the applicable instruction would define) the type of investment strategy employed by the adviser,

163

and to break down the assets and liabilities held by the fund by class and categorization in the fair value hierarchy established under U.S. generally accepted accounting principles (GAAP).

164

Many private funds managed by investment advisers that would be reporting to us prepare financial statements in accordance with GAAP.

165

Others may use international accounting standards requiring substantially similar information. Their adviser, therefore, should have access to this information from such financial statements. We would ask about both the number and the types of investors in the fund, as well as the minimum amounts required to be invested by fund investors to get a better idea of the types of investors the fund is intended to serve and to get a sense of the extent to which investors may themselves be in a position to exercise oversight of the adviser.

166

Finally, some items would ask information about characteristics of the fund that may present the fund manager with conflicts of interest with fund investors of the sort that may implicate the adviser's fiduciary obligations to the fund and, in some cases, create risks for the fund investors. Thus we would continue to ask whether clients of the adviser are solicited to invest in the fund and what percentage of the other clients has invested in the fund.

167

159

See

proposed Form ADV, Part 1A, Section 7.B.1.A. of Schedule D, questions 2-3.

160

Id.

questions 4-7 and questions 23-24 (asking whether the fund relies on Regulation D and what is the fund's Form D file number, if any).

161

Id.

questions 19-20.

162

Id.

question 11.

163

Id.

question 10. The categories include: (i) Hedge fund; (ii) liquidity fund; (iii) private equity fund; (iv) real estate fund; (v) securitized asset fund; (vi) venture capital fund; and (vii) other private fund.

164

Id.

question 12.

See

FASB ASC 820-10-50-2b. We also propose to ask whether the fund invests in securities of registered investment companies, which is relevant to evaluating compliance with the fund of funds provision of the Investment Company Act, section 12(d)(1).

See

section 12(d)(1) of the Investment Company Act; proposed Form ADV, Part 1A, Section 7.B.1.A. of Schedule D, question 9.

165

See supra

note 56. In addition, advisers to private funds that prepare and distribute financial statements prepared in accordance with GAAP may be deemed to satisfy certain requirements of our custody rule.

See

Advisers Act rule 206(4)-2(b)(4).

166

See

proposed Form ADV, Part 1A, Section 7.B.1.A. of Schedule D, questions 13-18.

167

Id.

questions 21-22.

In Part B of the Section, we propose to require advisers to report information concerning five types of service providers that generally perform important roles as “gatekeepers” for private funds (

i.e.,

auditors, prime brokers, custodians, administrators and marketers).

168

We would require that an adviser identify them, provide their location, and State whether they are related persons. For each of these service providers, we would also require specific information that would clarify the services they provide and include certain identifying information such as

registration status. This information includes the following for each service provider. For the auditors, whether they are independent, registered with the Public Company Accounting Oversight Board (PCAOB) and subject to its regular inspection, and whether audited statements are distributed to fund investors.

169

For the prime broker, whether it is SEC-registered and whether it acts as custodian for the private fund.

170

For the custodian, whether it is a related person of the adviser.

171

For the administrator, whether it prepares and sends to investors account statements and what percentage of the fund's assets are valued by the administrator or another person that is not a related person of the adviser.

172

Finally, for marketers, whether they are related persons of the adviser, their SEC file number (if any), and the address of any Web site they use to market the fund.

173

The questions in Part B are generally designed to improve our ability to assess conflicts and potential risks, identify funds with service provider arrangements that raise a “red flag,” and identify firms for examination. For instance, it would be relevant to us to know that a private fund is using a service provider that we are separately investigating for alleged misconduct.

168

See

proposed Form ADV, Part 1A, Section 7.B.1.B. of Schedule D.

169

See

proposed Form ADV, Part 1A, Section 7.B.1.B. of Schedule D, question 25. We are also proposing amendments to the instructions contained in Item 9 to avoid having advisers reporting overlapping information (relevant to compliance with rule 206(4)-2, the “custody rule”) under Section 9 and Section 7.B. of Schedule D.

170

See id.

question 26.

171

See id.

question 27. “Related Person” is defined in Form ADV: Glossary.

172

See id.

question 28.

173

See id.

question 29. For purposes of this question, marketers include placement agents, consultants, finders, introducers, municipal advisors or other solicitors, or similar persons.

The information we propose to require advisers to report on private funds is similar to (although less extensive than) the information that we understand investors in hedge funds and other private funds commonly seek in their due diligence questionnaires.

174

Professional investors use information acquired as part of their vetting process before they invest. We likewise are seeking to acquire the information to help us identify private fund advisers that present investors with greater compliance or other risks. Each particular item of information may not itself indicate an elevated risk of a compliance failure, but could serve as an input to the risk metrics by which our staff identifies potential risk and allocates examination resources. The staff conducts similar analyses today, but have limited inputs, which constrains their effectiveness.

174

See, e.g.,

AIMA's Illustrative Questionnaire For Due Diligence of Hedge Fund Managers,

available at

(registration required)

http://www.aima.org/en/knowledge_centre/index.cfm.

The information would be publicly available as is other information on Form ADV, and we expect it would be used by investors to supplement their due diligence efforts. We expect the use of these data could further help investors and other industry participants protect against fraud. For example, using the IARD data, auditors would be able to compare their list of funds they audit with those whose advisers report them as auditor in order to uncover false representations.

175

Investors (and their consultants) would be able to compare representations made on Schedule D with those made in private offering documents or other material provided to prospective investors.

175

See In the Matter of John Hunting Whittier,

We request comment on our proposed amendments to Section 7.B. of Schedule D. Should we modify our requests for information? Is there information requested in due diligence questionnaires that would yield additional or more relevant risk information and that we should require? For instance, should we require advisers to report information regarding their legal counsel? If so, what information? Is the information we request readily available to fund managers, and in particular to sub-advisers? If not, is there information that is readily available that could serve the same purpose?

In crafting these new disclosure items, we have sought to avoid requiring disclosure of proprietary information that could harm the interests of the fund or fund investors. Have we succeeded? Commenters asserting that information not be reported should identify the specific harm asserted. Do commenters agree with our belief that reporting and disclosure of private fund information will be beneficial to investors (although they may currently receive some or all of this information) as well as prospective investors and other market participants?

Will it be burdensome for registered or exempt reporting advisers to use for purposes of Question 12 the valuation hierarchy established under GAAP with respect to those funds that do not have financial statements prepared in accordance with GAAP? If we require all advisers to fair value their private fund assets under management as proposed,

176

would advisers be able to rely on such a valuation for purposes of Question 12? Should we require that the information provided in response to Question 12 be part of audited financial statements or be subject to review by auditors or another independent third party? Are there additions, deletions, or changes to the definitions of the seven categories of private fund we would require advisers to use to identify a private fund that we should consider? Should some of the items apply only to certain types of private funds (

e.g.,

hedge funds)? If so, which items and why?

176

See supra

section II.A.3.

2. Advisory Business Information: Employees, Clients and Advisory Activities: Item 5

Item 5 of Part 1A requires an adviser to provide basic information regarding the business of the adviser that allows us to identify the scope of the adviser's business, the types of services it provides, and the types of clients to whom it provides those services. The item requires information from the adviser about the number of its employees, the amount of assets it manages, the number and types of its clients, and the types of advisory services provided. The modifications we are proposing today, which primarily refine or expand existing questions, would help us better understand the operations of advisers.

First, we propose to seek additional information about the adviser's employees. Currently, Item 5 asks for the number of employees that are registered representatives of a broker-dealer, which we would expand to ask for the number of employees that are registered as investment adviser representatives or insurance agents.

177

In order to obtain more precise data, we also propose that advisers provide a single numerical approximate response to the questions about employees, instead of checking a box corresponding to a range of numbers, as is currently required.

178

This additional employee data would, for instance, permit us to develop ratios (

e.g.,

number of employees to assets under management of clients) that we can use to identify

advisers to inform our risk-based examination program.

177

Proposed Form ADV, Part 1A, Items 5.B.(3) and (5).

178

For instance, proposed Item 5.B.(1) asks how many of an adviser's employees perform advisory functions. Under the current Form, an adviser with seven such employees would check a box for “6-10.” We propose the adviser simply fill in a blank with the number “7.”

Second, we propose to add some questions to help us better understand an adviser's business by reference to the types of clients the adviser services. Items 5.C. and D. currently require an adviser to report how many clients it has (in ranges) and to indicate the types of clients,

e.g.

high net worth individuals, investment companies. We propose to expand the list of types of clients provided in Item 5.D., to include business development companies, insurance companies, and other investment advisers, as well as to distinguish pension and profit-sharing plans subject to ERISA

179

from those that are not. As amended, this Item also would require an adviser to indicate the approximate amount of its regulatory assets under management attributable to each client type.

180

We also propose to ask approximately what percentage of the adviser's clients are not United States persons.

181

This additional information would allow us to better understand the focus of an adviser's business.

179

Employee Retirement Income Security Act of 1974 (29 U.S.C. 18).

180

Proposed Form ADV, Part 1A, Item 5.D. We are also proposing amendments to the calculation of an adviser's regulatory assets under management.

See supra

section II.A.3. of this Release.

181

Proposed Form ADV, Part 1A, Item 5.C.(2).

See supra

note 155 (discussing the definition of “United States person”). We also propose to add an instruction to Item 5.C., 5.D. and 5.H. to clarify that advisers should not count as clients the investors in a private fund they advise unless they have a separate advisory relationship with them.

Third, we are proposing two amendments related to the advisory activities that are reported in Item 5. Item 5.G. requires an adviser to select from a list the advisory services that it provides, such as financial planning or portfolio management. We propose to expand the list of advisory activities to include portfolio management for pooled investment vehicles,

other

than registered investment companies, and educational seminars or workshops.

182

We would also require advisers to provide the SEC file number for a registered investment company if they check the box for portfolio management for an investment company, which would permit our examination staff to link information reported on Form ADV to information reported on forms filed through our EDGAR system by investment companies managed by these advisers.

183

We are proposing new Item 5.J. that would require advisers to select from a list the types of investments about which they provided advice during the fiscal year for which they are reporting.

184

These changes would provide us with more details regarding the services an adviser provides, allowing us to better identify candidates if, for instance, we choose to do a risk-targeted examination of advisers based on the nature of the advice they provide.

182

Proposed Form ADV, Part 1A, Item 5.G.

183

Proposed Form ADV, Part 1A, Schedule D, Section 5.G.(3).

184

Advisers would also be required to indicate the types of investments, such as various types of swaps and variable life insurance, about which they provided advice. Proposed Form ADV, Part 1A, Item 5.J.

We request comment on our proposed amendments to Item 5. Would advisers readily have access to the additional data we request? Does the switch from ranges to a single approximate number of employees in Items 5.A. and 5.B. pose any significant problems or burdens for advisers? If so, would providing an instruction to permit an adviser to round its responses up or down help? Are there additional types of clients, advisory activities, and investments we should add to our proposed lists in Items 5.D., 5.G., and 5.J., respectively?

3. Other Business Activities and Financial Industry Affiliations: Items 6 and 7

Items 6 and 7 of Part 1A require advisers, including exempt reporting advisers, to report those financial services the adviser or a related person is actively engaged in providing from lists of financial services set forth in the items. We are proposing several changes to these Items that would provide us with a more complete picture of the activities of an adviser and its related persons, which would better allow us to assess the conflicts of interest and risks that may be created by those relationships and to identify affiliated financial service businesses. We propose to expand the lists in both Items 6 and 7 to include business as a trust company, registered municipal advisor, registered security-based swap dealer, and major security-based swap participant, the latter three of which are new SEC-registrants under the Dodd-Frank Act's amendments to the Exchange Act.

185

We also propose to add accountants (or accounting firms) and lawyers (or law firms) to the list in Item 6, to parallel current Item 7. We are also proposing to move from Item 7.B. to Item 7.A. the question that asks whether a related person is a sponsor or the general partner or managing member of a pooled investment vehicle.

186

Finally, we would clarify in the instruction to Item 7 that advisers are to include related persons that are foreign affiliates.

185

Proposed Form ADV, Part 1A, Items 6.A. and 7.A. Section 975 of the Dodd-Frank Act amends the Exchange Act to require “municipal advisors” to register with the Commission, Section 761 of that Act amends the Exchange Act to define the terms “security-based swap dealer” and “major security-based swap participant,” and section 764 amends the Exchange Act to require these entities to register with the Commission.

186

The question we propose to ask in Item 7.A. would, therefore, retain information about related persons that would otherwise not be required as a result of our proposed changes to Item 7.B. As discussed above, we are proposing to require advisers to report in Item 7.B. and section 7.B.1. of Schedule D private fund information only about funds they advise, not funds advised by a related person.

See supra

section II.C.1. of this Release.

We would also delete “investment company” from the list in Item 7 as duplicative of information we obtain in Item 5.

See, e.g.,

Form ADV, Part 1A, Items 5.D., 5.G., and proposed Form ADV, Part 1A, Section 5.G.(3) of Schedule D.

See also

17 CFR 275.206(4)-7;

Compliance Programs of Investment Companies and Investment Advisers,

Investment Advisers Act Release No. 2204 (Dec. 17, 2003) [68 FR 74714 (Dec. 24, 2003)] (adopting rule 206(4)-7 requiring registered investment advisers to designate a chief compliance officer). An exempt reporting adviser that does not have a chief compliance officer would instead provide a designated person's contact information in Item 1.K. Proposed Form ADV, Part 1A, Item 1.K. Likewise, we would not require an exempt reporting adviser to provide the name of a chief compliance officer on Schedule A of Form ADV.

198

Proposed Form ADV, Part 1A, Item 1.K. We note that clients will be provided with a supervisory contact in brochure supplements.

See

Part 2 Release,

supra

note 46.

199

Proposed Form ADV, Part 1A, Items 1.N., 10.B., and Section 10.B. of Schedule D.

200

Proposed Form ADV, Part 1A, Item 3.A.

We are also proposing to add an additional custody question to Item 9 to require advisers to indicate the

total

number of persons that act as qualified custodians for the adviser's clients in connection with advisory services the adviser provides to its clients.

201

We recently modified Item 9 to elicit

information about the adviser or its related person(s) acting as qualified custodian.

202

We did not, however, request information about

other

qualified custodians. We expect this discrete piece of additional data to provide us with a more complete picture of an adviser's custodial practices.

203

201

Proposed Form ADV, Part 1A, Item 9.F.

202

See Custody of Funds or Securities of Clients by Investment Advisers,

Investment Advisers Act Release No. 2968 (Dec. 30, 2009) [75 FR 1456 (Jan. 11, 2010)].

203

Consistent with the updating requirements for Items 9.A.(2), 9.B.(2), and 9.E., we propose requiring new Item 9.F. to be updated only annually.

See

proposed General Instruction 4.

Finally, we are proposing three technical changes with respect to the reporting of disciplinary events. First, we propose to add a box to Item 11 for advisers to check if any disciplinary information reported in that item and the corresponding disclosure reporting pages is being reported about the adviser or any of its supervised persons.

204

This would enable us to easily determine if an adviser is only reporting disciplinary events for its affiliates, and would facilitate our ability to focus examination and enforcement resources on those advisers that appear to present the greatest compliance risks. Second, we propose to add a third reason to each disclosure reporting page (DRP) that permits an adviser to remove the DRP from its filing by adding a box an adviser could check if it was filed in error. Third, we propose to amend Item 3.D. of Part 2B, the brochure supplement, to correct a drafting error regarding when a brochure supplement would need to include disclosure regarding the revocation or suspension of a professional attainment, designation, or license. The amendment would replace “proceeding” in that item with “hearing or formal adjudication.”

205

By using the term “proceeding,” which is defined in the Form ADV Glossary, this item limits the required disclosure to actions initiated by a government agency, self-regulatory organization or foreign financial regulatory authority. The item was intended to require disclosure of actions taken by the designating authority to revoke or suspend the use of the attainment, designation, or license that it administers, and not actions taken by regulatory authorities who are unlikely to bring an action to revoke or suspend a professional designation.

204

Proposed Form ADV, Part 1A, Item 11.

205

If adopted, the revised item would State “[A]ny other hearing or formal adjudication in which a professional attainment, designation, or license of the supervised person was revoked or suspended because of a violation of rules relating to professional conduct. If the supervised person resigned (or otherwise relinquished the attainment, designation, or license) in anticipation of such a hearing or formal adjudication (and the adviser knows, or should have known, of such resignation or relinquishment), disclose the event.”

We request comment on these proposed changes. Are there additional items we should consider amending, and why? We are considering whether to add an additional reporting requirement to Item 1 that would require advisers to provide a unique identification code to provide additional uses for the data that we collect. For example, the Office of Financial Research (OFR) is required to publish a financial company reference database as part of its role in assisting the Financial Stability Oversight Council (FSOC) under the Dodd-Frank Act.

206

Would a unique identification code assigned by, on behalf of, or otherwise used by FSOC or OFR that is reported on Form ADV permit cross-referencing of the data we collect with this future database? Is there a reason why we should not require an adviser to report such an identifier on Form ADV if one is provided?

206

See

sections 154(b)(2)(A) and 201(a)(11) of the Dodd Fra

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