# Rules Implementing Amendments to the Investment Advisers Act of 1940

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/fr%3A2011-16318

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** July 19, 2011
- **Citation:** 76 FR 42950

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
[Release No. IA-3221; File No. S7-36-10]
RIN 3235-AK82
Rules Implementing Amendments to the Investment Advisers Act of 1940

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission is adopting 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 adopting rule amendments, including amendments to the Commission's pay to play rule, that address a number of other changes made by the Dodd-Frank Act.

DATES:

Effective dates:
The effective date of 17 CFR 275.204-4 and 275.203A-5(b) and (c), amendments to 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, and amendments to Forms ADV, ADV-E, ADV-H, and ADV-NR (referenced in 17 CFR part 279) is September 19, 2011. The effective date of 17 CFR 275.203A-5(a) and the amendment to 17 CFR 275.203-1 is July 21, 2011. 17 CFR 275.202(a)(11)-1, 275.203(b)(3)-1, 275.203(b)(3)-2, and 275.203A-4 are removed effective September 19, 2011.

Compliance Date:
See section III of this Release.

FOR FURTHER INFORMATION CONTACT:

David P. Bartels, Attorney-Adviser, Michael J. Spratt, Attorney-Adviser, Jennifer R. Porter, Senior Counsel, Devin F. Sullivan, Senior Counsel, Melissa A. Roverts, Branch Chief, Matthew N. Goldin, Branch Chief, or Daniel S. Kahl, 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 adopting 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”),
1

amendments to rules 0-7, 203-1, 203A-1, 203A-2, 203A-3, 204-1, 204-2, 206(4)-5, 222-1, and 222-2 [17 CFR 275.0-7, 275.203-1, 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-E, Form ADV-H, and Form ADV-NR [17 CFR 279.1, 279.3, and 279.4] under the Advisers Act. The Commission is also rescinding rules 202(a)(11)-1, 203(b)(3)-1, 203(b)(3)-2, and 203A-4 [17 CFR 275.202(a)(11)-1, 275.203(b)(3)-1, 275.203(b)(3)-2, and 275.203A-4] under the Advisers Act.

1
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 203-1, 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 275.203-1; 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 (“CFR”), in which these rules are published.

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. Nationally Recognized Statistical Rating Organizations

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. Public Availability of Reports

4. Updating Requirements

5. Final Reports

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. Custody: Item 9

6. Reporting $1 Billion in Assets: Item 1.O.

7. 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. Effective and Compliance Dates

A. Effective Dates

B. Compliance Dates

1. Transition to State Registration and Form ADV

2. Advisers Previously Exempt Under Section 203(b)(3)

3. Exempt Reporting Advisers

4. Other Amendments

IV. Certain Administrative Law Matters

V. Cost-Benefit Analysis

A. Benefits

B. Costs

VI. Paperwork Reduction Act Analysis

A. Rule 203A-2(d)

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

VII. Final Regulatory Flexibility Analysis

A. Need for and Objectives of the New Rules and Rule Amendments

B. Significant Issues Raised by Public Comment

C. Small Entities Subject to Rules and Rule Amendments

D. Projected Reporting, Recordkeeping and Other Compliance Requirements

E. Agency Action to Minimize Effect on Small Entities

VIII. Effects on Competition, Efficiency and Capital Formation

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

Appendix H: Form ADV-E

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.
2

Title IV of the Dodd-Frank Act (“Title IV”) includes

most of the amendments to the Advisers Act. These amendments include provisions that reallocate primary 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 million and $100 million of assets under management.
3

These provisions 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 on which many advisers, including those to many hedge funds, private equity funds, and venture capital funds, rely in order to avoid registration under the Act.
4

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 such reports “as the Commission determines necessary or appropriate in the public interest.”
5

These provisions in Title IV of the Dodd-Frank Act will be effective on July 21, 2011.
6

2
Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).

3

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 certain responsibility for small investment advisers with less than $25 million in assets under management).

4

See
section 403 of the Dodd-Frank Act. Section 203(b)(3) currently 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 also adopting today 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. 3222 (“Exemptions Adopting Release”).

5

See
section 407 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”).
See also
section 408 of the Dodd-Frank Act. 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 adds 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.

6

See
section 419 of the Dodd-Frank Act. For purposes of this Release, unless indicated otherwise, 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.

On November 19, 2010, we proposed new rules and amendments to existing rules and forms to give effect to these provisions.
7

Specifically, we proposed a new rule and amendments to our rules and forms to facilitate mid-size advisers' transition from Commission to state registration.
8

We also proposed a new rule and rule amendments to require certain advisers to private funds that are exempt from registration under the Advisers Act to submit reports to us.
9

We proposed rule amendments, including amendments to the Commission's “pay to play” rule,
10

to address a number of other changes to the Advisers Act made by the Dodd-Frank Act.
11

Also, in light of our increased responsibility for oversight of private funds, we proposed to require advisers to those funds to provide us with additional information about the operation of those funds.
12

Finally, we proposed additional changes to Form ADV that would enhance our oversight of advisers and also would enable us to identify advisers that are subject to the Dodd-Frank Act's requirements concerning certain incentive-based compensation arrangements.
13

7

See Rules Implementing Amendments to the Investment Advisers Act of 1940,
Investment Advisers Act Release No. 3110 (Nov. 19, 2010) [75 FR 77052 (Dec. 10, 2010)] (“Implementing Proposing Release”).

8

See id.
at section II.A.

9

See id.
at section II.B. Throughout this Release, we refer to advisers exempt from registration under sections 203(l) and 203(m) of the Advisers Act as “exempt reporting advisers.”

10
Rule 206(4)-5.

11

See
Implementing Proposing Release,
supra
note 7, at section II.D.

12

See
sections 403, 407 and 408 of the Dodd-Frank Act; Implementing Proposing Release,
supra
note 7, at section II.C.

13

See
Implementing Proposing Release,
supra
note 7, at section II.C; section 956 of the Dodd-Frank Act.

We received more than 70 comment letters on our proposals, most of which were from advisers, trade or professional organizations, and law firms.
14

Commenters generally supported our approach to facilitate mid-size advisers' transition from Commission to state registration, and our amendments to Form ADV, including those requiring disclosure of additional information about private funds. Many, however, urged us to take a different approach to, among other things, our proposed amendments to the pay to play rule. We are adopting the proposed rules and rule amendments with several modifications to address commenters' concerns. We address these modifications and comments in detail below.

14
Comment letters submitted in File No. S7-36-10 are available on the Commission's Web site at:
http://www.sec.gov/comments/s7-36-10/s73610.shtml.
We also considered those comments submitted in File No. S7-37-10 (
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 (Nov. 19, 2010) [75 FR 77190 (Dec. 10, 2010)] (“Exemptions Proposing Release”)) that addressed the rules and amendments adopted in this Release. Those comments are available at on the Commission's Web site at:
http://www.sec.gov/comments/s7-37-10/s73710.shtml.

II. Discussion

A. Eligibility for Registration With the Commission: Section 410

Section 203A of the Advisers Act, enacted in 1996 as part of the National Securities Markets Improvement Act (“NSMIA”), 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,
15

and preempts certain state laws regulating advisers that are registered with the Commission.
16

This provision makes the states the primary regulators of smaller advisers and the Commission the primary regulator of larger advisers.
17

15
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 if the adviser is eligible for one of six exemptions the Commission has adopted.
See id.;
rule 203A-2;
infra
section II.A.5.

16
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. Advisers Act section 203(a). Investment advisers that are prohibited from registering with the Commission are subject to regulation by the states, but the antifraud 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, require notice filings of documents filed with the Commission, and 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). Section 410 of the Dodd-Frank Act did not amend sections 203A(a)(1) or 203(a) of the Advisers Act.

17

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 category of “mid-sized

advisers” and shifts primary responsibility for their regulatory oversight to the states by prohibiting from Commission registration an investment adviser that is required to be 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.
18

Unlike a small adviser, a mid-sized adviser must register 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; or (ii) if registered with that state, the adviser would not be subject to examination as an investment adviser by that securities commissioner.
19

Section 203A(c) of the Advisers Act, which was not amended by the Dodd-Frank Act, permits the Commission to exempt small and mid-sized advisers from the prohibitions on Commission registration,
20

and we have adopted six exemptions for small advisers pursuant to this authority.
21

18

See
section 410 of the Dodd-Frank Act (adding new section 203A(a)(2) of the Advisers 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”). We are further increasing this threshold to $110 million, pursuant to authority granted to us by Congress.
See
section 410 of the Dodd-Frank Act;
infra
section II.A.4.

19

See
section 410 of the Dodd-Frank Act. A mid-sized adviser also is 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; therefore, mid-sized advisers to registered investment companies and business development companies are not permitted to withdraw their Commission registrations.
Compare
section 410 of the Dodd-Frank Act
with
Advisers Act section 203A(a)(1). Additionally, a mid-sized adviser may register with the Commission if the adviser is required to register in 15 or more states.
See
section 410 of the Dodd-Frank Act. For a discussion of advisers required to register in multiple states, see
infra
section II.A.5.c.

20
For the Commission to permit the registration of small and mid-sized advisers with the Commission, application of the prohibition from registration must be “unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes” of section 203A. Advisers Act section 203A(c). The Commission's exercise of this authority not only would permit registration with the Commission, but also would result in the preemption of state law with respect to the advisers that register with us as a result of an exemption.
See
Advisers Act sections 203(a), 203A(b), and 203A(c).

21

See
rule 203A-2 (permitting the following types of advisers to register with the Commission: (i) Nationally recognized statistical rating organizations (“NRSROs”); (ii) certain 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) certain multi-state investment advisers; and (vi) certain Internet advisers).

As a consequence of section 410 of the Dodd-Frank Act, we estimate that approximately 3,200 SEC-registered advisers will be required to withdraw their registrations and register with one or more state securities authorities.
22

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

22
According to data from the Investment Adviser Registration Depository (“IARD”) as of April 7, 2011, 3,531 SEC-registered advisers either: (i) Had assets under management between $25 million and $90 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 $90 million and are not relying on an exemption from registration. We estimate that 350 of these advisers will not switch to state registration because their principal office and place of business is located in Minnesota, New York, or Wyoming, which did not advise our staff that advisers registered with them are subject to examination.
See infra
note 152 (according to IARD data as of April 7, 2011, there were 63 mid-sized advisers in Minnesota, 286 in New York, and 1 in Wyoming). As a result, we estimate that approximately 3,200 advisers will switch to state registration. 3,531 SEC-registered advisers−350 advisers not switching to state registration = 3,181 advisers. In the Implementing Proposing Release, we estimated that approximately 4,100 SEC-registered advisers would be required to withdraw their registrations and register with one or more state securities authorities, based on IARD data as of September 1, 2010.
See
Implementing Proposing Release,
supra
note 7, at n.15. We have lowered our estimate by 900 advisers to account for the advisers that have between $90 million and $100 million of assets under management that may remain registered with us as a result of the amendments we are adopting to rule 203A-1, the advisers that have withdrawn their registrations with us since that time, and as discussed above, the advisers that will not switch registration because they have a principal office and place of business in Minnesota, New York or Wyoming.
See
section II.A.4. for a discussion of adopted rule 203A-1. Based on IARD data as of April 7, 2011, 244 advisers had assets under management of between $90 million and $100 million and, from September 2, 2010 to April 7, 2011, 405 advisers withdrew their registrations with us and 114 advisers initially registered with us.

1. Transition to State Registration

We are adopting new rule 203A-5 to provide for an orderly transition to state registration for mid-sized advisers that will no longer be eligible to register with the Commission.
23

23
As proposed, we are also amending the instructions to Form ADV to explain this process.
See
amended Form ADV: General Instructions (special one-time instruction for Dodd-Frank transition filing for SEC-registered advisers).

•
Existing Registrants.
Under the rule,
each
adviser registered with us on January 1, 2012 must file an amendment to its Form ADV no later than March 30, 2012.
24

These amendments will respond to new items in Form ADV (discussed below) and will identify mid-sized advisers no longer eligible to remain registered with the Commission.
25

Mid-sized advisers that are no longer eligible for Commission registration must withdraw their registrations with us after filing their Form ADV amendments by filing Form ADV-W
26

no later than June 28, 2012.
27

Mid-sized advisers registered with the Commission as of July 21, 2011 must remain registered with the Commission (unless an exemption from Commission registration is available) until January 1, 2012.
28

24
New rule 203A-5(b). In this filing, advisers will report the current market value of their assets under management determined within 90 days of the filing.

25

See infra
sections II.A.2. and II.C. Advisers will be required to update all of the items in Form ADV, and this filing will serve as the annual updating amendment for most advisers.
See infra
note 48 and accompanying text.

26
17 CFR 279.2 (“Form ADV-W”).

27
New rule 203A-5(c)(1).

28
New rule 203A-5(a). We are using the authority provided to us in section 203A(c) of the Act to require mid-sized advisers to remain registered with the Commission until the programming of the IARD is completed.
See infra
notes 35-41 and accompanying text. For a discussion of section 203A(c) of the Act, see
supra
note 20. We believe that the failure to provide a transition period during the beginning of 2012 would be unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes of section 203A of the Act. We are also adopting, as proposed, a provision that will 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. New rule 203A-5(c)(2). This limitation on withdrawal of an adviser's registration is similar to the one we adopted to implement NSMIA in 1997.
See
NSMIA Adopting Release,
supra
note 17.

•
New Applicants.
Until July 21, 2011, when the amendments to section 203A(a)(2) take effect, advisers applying for registration with the Commission that qualify as mid-sized advisers under section 203A(a)(2) of the Act
29

may register with either the Commission or the appropriate state securities authority.
30

Thereafter, all such advisers

are prohibited from registering with the Commission and must register with the state securities authorities.
31

We also note that advisers that have assets under management of $100 million or more will continue to register with the Commission (unless an exemption from registration with the Commission otherwise is available).
32

29
For a discussion of section 203A(a)(2) of the Act, see
supra
notes 18-19 and accompanying text. As discussed above, the Dodd-Frank Act amendments to this section will be effective on July 21, 2011.
See supra
note 6 and accompanying text.

30
We noted in the Implementing Proposing Release that we would not object if, on or after January 1, 2011 until the end of the transition period, any state-registered or newly-registering adviser is not registered with us, so long as the adviser reports on its Form ADV that it has between $30 million and $100 million of assets under

management, is registered as an investment adviser in the state in which it maintains its principal office and place of business, and has a reasonable belief that it is required to be registered with, and is subject to examination as an investment adviser by, that state.
See
Implementing Proposing Release,
supra
note 7, at section II.A.1. In order to account for the July 21, 2011 effective date of section 410 of the Dodd-Frank Act and the longer transition period that we are adopting (ending on June 28, 2012 instead of October 19, 2011, as proposed), beginning on July 21, 2011, these advisers will no longer be able to choose to register with us; instead, they will be prohibited from registering with us and must instead register with the states.
See infra
note 31. We believe that allowing these advisers to register with the Commission before January 1, 2012 only to require them to withdraw their registrations by June 28, 2012 would be burdensome, and permitting them to choose whether to register with us until the summer of 2012 would be inconsistent with the purposes of Advisers Act section 203A(a)(2), as amended by section 410 of the Dodd-Frank Act.
See supra
note 3 and accompanying text.

31
Once registered, an adviser must remain registered with the Commission (unless an exemption is available) until January 1, 2012, when it may transition to state registration as described above. Until January 1, 2012, we are exempting from section 203A(a)(2) only those mid-sized advisers
already registered
with us on July 21, 2011 that have at least $25 million in assets under management because the IARD will not be able to accept the revised Form ADV by July 21, 2011 and it is our understanding that mid-sized advisers will need additional time to switch to state registration.
See
new rule 203A-5(a);
supra
note 28 and accompanying text. As a result, on or after July 21, 2011, state-registered advisers and newly-registering advisers will be subject to the section 203A(a)(2) prohibition from Commission registration.

32

See
Advisers Act section 203A(a)(2), as amended by the Dodd-Frank Act.
See also
Advisers Act section 203. For a discussion of the threshold requiring larger advisers to register with the Commission, see
infra
section II.A.4.

We have made several changes to these transition provisions in response to comments we received.
33

The proposed rule would have provided mid-sized advisers with a 90-day transitional process with two “grace periods,” the first providing until August 20, 2011 for an adviser to determine whether it is eligible for Commission registration and to file an amended Form ADV, and the second providing until October 19, 2011 for an adviser to register in the states and withdraw its registration with us.
34

We noted in the Implementing Proposing Release, however, that timing of the transition period would be affected by our ability to re-program the IARD, through which advisers file their amendments to Form ADV.
35

33

See
proposed rule 203A-5(a)-(b); Implementing Proposing Release,
supra
note 7, at section II.A.1.

34

See
proposed rule 203A-5(a)-(b); Implementing Proposing Release,
supra
note 7, at section II.A.1.

35

See
Implementing Proposing Release,
supra
note 7, at section II.A.1.

We have worked closely with the Financial Industry Regulatory Authority (“FINRA”), our IARD contractor, to make the needed modifications, but it has informed us that the programming will not be completed by the July 21, 2011 effective date of the Dodd-Frank Act. We understand that beginning in November, the IARD will be updated to reflect the revisions to Form ADV that we are adopting today. We noted in the Implementing Proposing Release that if the IARD is unable to accept filings of revised Form ADV on July 21, 2011, we might consider delaying the transition process until the system could accept electronic filing of the revised form.
36

36

See id.

Commenters, including the North American Securities Administrators Association, Inc. (“NASAA”), agreed with our assessment and supported delaying the transition if the IARD could not accept the revised Form ADV instead of adopting alternative requirements, such as requiring interim paper filings.
37

Many also urged us to provide additional time for mid-sized advisers to complete the switch to state registration,
38

and recommended that the Commission match the current 180-day period
39

provided to SEC-registered advisers that must switch to state registration.
40

We are persuaded by these commenters, and, as described above, we are requiring mid-sized advisers registered with us on July 21, 2011 to remain registered until they switch to state registration after January 1, 2012.
41

As noted above, rule 203A-5 provides until March 30, 2012 for each adviser already registered with the Commission to determine whether it is eligible for Commission registration and to file an amended Form ADV,
42

and provides an additional 90 days (
i.e.,
by June 28, 2012) for an adviser no longer eligible for Commission registration to register with the states and withdraw its registration with us.
43

After the end of

this period, we expect to cancel the registration of advisers no longer eligible to register with us that fail to file an amendment or withdraw their registrations in accordance with the rule.
44

The revised process that we are adopting today allows the Commission and state regulators to manage the transition of mid-sized advisers in an orderly manner.
45

37
Comment letter of the North American Securities Administrators Association, Inc. (Feb. 10, 2011) (“NASAA Letter”) (“the benefits of electronic filing, including easy public access to the documents, are significant and would outweigh any disadvantages imposed by a delay in filing deadlines.”); comment letter of Bill Dezellem, CFA, Tieton Capital Management (Jan. 4, 2011) (“Dezellem Letter”); comment letter of the National Regulatory Services (Jan. 24, 2011) (“NRS Letter”); comment letter of the New York State Bar Association, Business Law Section, Securities Regulation Committee (Apr. 1, 2011) (“NYSBA Committee Letter”).

38
Comment letter of the American Bar Association, Section of Business Law, Committee on Federal Regulation of Securities, Committee on State Regulation of Securities, and the Committee on Private Equity and Venture Capital (Jan. 31, 2011) (“ABA Committees Letter”); comment letter of Altruist Financial Advisors LLC (Dec. 12, 2010) (“Altruist Letter”); comment letter of Capital Markets Compliance, LLC (Feb. 8, 2011) (“CMC Letter”); Dezellem Letter; comment letter of R.H. Dinel Investment Counsel, Inc. (Jan. 20, 2011) (“Dinel Letter”); comment letter of Financial Services Institute (Jan. 24, 2011) (“FSI Letter”); comment letter of Amy Klein (Nov. 30, 2010) (“Klein Letter”); NRS Letter; NYSBA Committee Letter; comment letter of Sadis & Goldberg LLP (Jan. 21, 2011) (“Sadis Letter”); comment letter of L.A. Schnase (Dec. 23, 2010) (“Schnase Letter”); comment letter of Seward & Kissel LLP (Jan. 31, 2011) (“Seward Letter”); comment letter of Shearman & Sterling LLP (Jan. 24, 2011) (“Shearman Letter”). Only one commenter supported the proposed 90-day grace period. Comment letter of Pickard and Djinis LLP (Jan. 21, 2011) (“Pickard Letter”).

39
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).

40
Altruist Letter; Dezellem Letter; FSI Letter; Klein Letter; NYSBA Committee Letter; Schnase Letter; Seward Letter; Shearman Letter.
See also
ABA Committees Letter (recommending December 31 deadline); NRS Letter (recommending rolling state registration process). One commenter stated that based on its almost three decades of experience, it “most strongly supports a defined and longer” transition period. NRS Letter. Another stated that “some states may be unable to process such filings in a timely and efficient manner.” ABA Committees Letter. Several commenters echoed concerns about timely state processing of applications, noting, in particular, additional registration and compliance requirements in many states and expected delays to approve state registrations given the increase in filings as a result of the Dodd-Frank Act.
See
Altruist Letter (noting that it took 122 days for a state to approve its application).
See also
CMC Letter; Dezellem Letter; Klein Letter; NRS Letter; NYSBA Committee Letter; Schnase Letter; Seward Letter. To address potential timing issues, NASAA noted that it is recommending to advisers to file with the states as soon as possible and to the states to conditionally approve the registrations until the re-filing of Form ADV is completed. NASAA Letter.

41

See supra
note 28 and accompanying text.

42
New rule 203A-5(a) and (b). This deadline coincides with the deadline for most advisers' required annual updating amendment (90 days from December 31, 2011), eliminating the requirement that they file an additional amendment to their Form ADV.
See
rule 204-1(a);
infra
note 48. Postponing the beginning of the transition process until January, instead of November or December, also will ensure that the refiling of Form ADV does not interfere with the November state registration and license renewal process and annual system outages for the IARD scheduled in December.

43
New rule 203A-5(c)(1). The rule 203A-5 transition period is the same 180-day transition period for advisers that fall below the $25 million threshold and have to switch to state registration.
See
rule 203A-1(b)(2). Other advisers that will be required to withdraw from registration because they are no longer eligible for Commission registration will include, for example, pension consultants with plan assets of $50 million to $200 million.
See infra
section II.A.5.b.

44

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).

45

See also supra
notes 24-28 and accompanying text.

We are requiring that all advisers registered with us on January 1, 2012—regardless of size—file amendments to Form ADV no later than March 30, 2012. Some commenters argued that advisers unaffected by the statutory changes effected by the Dodd-Frank Act should not have to complete and file all of Form ADV.
46

We believe such a filing is necessary for each adviser to confirm its current eligibility for Commission registration in light of the multiple statutory changes (as well as changes to the rules that we are adopting today) that could affect whether the adviser may register with the Commission.
47

These commenters' concerns also should be allayed by the new March 30, 2012 deadline for filing Form ADV that will coincide with most advisers' required annual updating amendment, eliminating the requirement that they file an additional amendment to their Form ADV.
48

Finally, as recommended by several commenters,
49

we are providing additional flexibility for an adviser to choose the date by which it must calculate its assets under management reported on Form ADV by requiring the calculation within 90 days of the transition filing, rather than 30 days.
50

This is the same amount of time that advisers are afforded to report assets under management after the end of their fiscal year on Form ADV today.
51

46
Comment letter of the Investment Company Institute (Jan. 24, 2011) (“ICI Letter”) (recommending exempting advisers that do not rely on assets under management to register with the SEC); comment letter of the Managed Funds Association (Jan. 24, 2011) (“MFA Letter”) (recommending exempting private fund advisers that file an initial Form ADV by July 7); NYSBA Committee Letter (recommending exempting advisers who will continue to be eligible for Commission registration and advisers relying on the section 203(b)(3) exemption that we proposed would have to register with the Commission by July 21, 2011); Shearman Letter (recommending a more limited filing of Form ADV to determine eligibility). But most commenters supported the proposal.
See
CMC Letter; FSI Letter; NASAA Letter; NRS Letter; Pickard Letter.

47
In addition, we believe that requiring advisers to complete all of the items will provide the Commission and the state regulatory authorities with essential information about the advisers that are transitioning to state registration and the advisers that are remaining registered with the Commission.
See infra
sections II.A.2., II.C.

48
As of April 7, 2011, 10,636 of SEC-registered advisers (approximately 92%) had a fiscal year ending on December 31. These advisers will comply with rule 203A-5(b)'s Form ADV filing requirement by submitting their annual amendment. SEC-registered advisers not required to file an annual updating amendment between January 1, 2012 and March 30, 2012 will file an other-than-annual amendment, but they will complete all of the items on Part 1A of Form ADV (not just the items required to be updated in a typical other-than-annual amendment).

49
Altruist Letter (quarter end); comment letter of Dechert LLP (Jan. 24, 2011) (“Dechert General Letter”) (rolling 12-month average); Dezellem Letter (fiscal year end); Dinel Letter (rolling three-year average); NYSBA Committee Letter (quarter end); Seward Letter (quarter end); Shearman Letter (quarter end). Several commenters argued, for example, that providing for the use of end of quarter numbers precludes an administrate burden for many advisers that value assets on a quarterly basis because most advisers already value assets quarterly to calculate fees. Altruist Letter; NYSBA Committee Letter; Seward Letter; Shearman Letter.

50
New rule 203A-5(b).

51
Form ADV: Instructions for Part 1A, instr. 5.b.(4).

2. Amendments to Form ADV

We are adopting several amendments to Item 2.A. of Part 1A of Form ADV to reflect the new threshold for registration and the revisions we are making to related rules in response to the enactment of the Dodd-Frank Act.
52

Item 2 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. We are adopting the revisions to Item 2.A. substantially as proposed,
53

except that we have revised the instructions and Item 2.A.(1) to reflect our adoption of a “buffer” for advisers with close to $100 million in assets under management, which we discuss below.
54

52
We are adopting conforming amendments to Item 2.A. and the related items in Schedule D to reflect revisions to rule 203A-2, which provides exemptions from the prohibition on registration with the Commission.
See
amended Form ADV Items 2.A.(7), (10) and Section 2.A.(10) of amended Schedule D;
infra
sections II.A.4., II.A.5., II.A.7. Additionally, we are making conforming changes to the instructions for Form ADV.
See
amended Form ADV: Instructions for Part 1A, instr. 2. We also are revising 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
amended rules 203A-1, 203A-2(c) and (d), 203A-3(e); amended Form ADV: Glossary
with
rules 203A-1(b)(1), 203A-2(e)(1), 203A-4; Form ADV: Glossary.
See also
section 410 of the Dodd-Frank Act (amended section 203A(a)(2) of the Advisers Act describes a state securities authority as “the securities commissioner (or any agency or office performing like functions)”).

53
One commenter expressed the view that the item was “sufficiently and clearly written.” NRS Letter.

54

See
amended Form ADV: Instructions for Part 1A, instr. 2.a. For a discussion of the buffer, see
infra
section II.A.4.

To implement the new prohibition on registration for mid-sized advisers, we are amending Item 2.A. to reflect the new statutory threshold for registration. Item 2.A. requires each adviser registered with us (and each applicant for registration) to identify whether it is eligible to register with the Commission because it: (i) Is a large adviser that has $100 million or more of regulatory assets under management (or $90 million or more if an adviser is filing its most recent annual updating amendment and is already registered with us);
55

(ii) is a mid-sized adviser that does not meet the criteria for state registration or is not subject to examination;
56

(iii) has its principal office and place of business in Wyoming (which does not regulate advisers) or outside the United States;
57

(iv) meets the requirements for one or more of the revised exemptive rules under section 203A discussed below;
58

(v) is an adviser (or subadviser) to a registered investment company;
59

(vi) is an adviser to a business development company and has at least $25 million of regulatory assets under management;
60

or (vii) received an order permitting the adviser to register with the Commission.
61

55
Amended Form ADV, Part 1A, Item 2.A.(1). We are revising 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.

56
Amended 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.

57
Amended Form ADV, Part 1A, Items 2.A.(3), 2.A.(4).

58
Amended Form ADV, Part 1A, Items 2.A.(7)-2.A.(11). For a discussion of the exemptive rules, see
infra
section II.A.5.

59
Amended Form ADV, Part 1A, Item 2.A.(5).

60
Amended Form ADV, Part 1A, Item 2.A.(6).

61
Amended Form ADV, Part 1A, Item 2.A.(12). We are also deleting the item for NRSROs to register as investment advisers. For a discussion of NRSROs, see
infra
section II.A.5.a.

Each adviser must check at least one of these items, or indicate that the adviser is no longer eligible to remain registered with the Commission.
62

The IARD will prevent an applicant from registering with us, and an adviser from remaining registered, unless it

represents on Form ADV that it meets at least one of the specific eligibility criteria set forth in the Advisers Act or our rules.

62
Amended Form ADV, Part 1A, Item 2.A.(13). One commenter asked that we clarify whether advisers must check every box in Item 2.A. that they are eligible to check. Schnase Letter. The instructions to the item indicate that an adviser must check “at least one” of the items, but does not require all bases for registration be identified. Amended 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 register with the Commission or one or more 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.”
63

Instructions to Form ADV provide advisers with guidance in applying this provision, and until now have permitted advisers to exclude certain types of assets that otherwise would have to be included.
64

63
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.

64

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.

We are adopting revisions to the instructions to Part 1A of Form ADV to implement a uniform method for advisers to calculate assets under management that will be used under the Act for regulatory purposes in addition to assessing whether an adviser is eligible to register with the Commission.
65

As discussed in more detail below, the amendments improve consistency by eliminating choices the instructions had provided advisers that have enabled some of them to opt in or out of federal or state regulation (by including or excluding a class of assets). We are also amending rule 203A-3 to continue to require that the calculation of “assets under management” for purposes of section 203A of the Act 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.
66

Finally, we are altering 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 “regulatory” purposes of this reporting requirement and to distinguish it from the assets under management disclosure that advisory clients receive in Part 2 of Form ADV.
67

65

See
amended

Form ADV: Instructions for Part 1A, instr. 5.b.
See also
sections 402(a) and 408 of the Dodd-Frank Act (adding section 202(a)(30) of the Act, which defines 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) of the Act, which directs 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); Exemptions Adopting Release,
supra
note 4, at section II.B.

66

See
amended rule 203A-3(d).

67

See
amended 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”). One commenter supported the change of terminology.
See
Schnase Letter (supporting the idea of distinguishing “regulatory assets under management” from “assets under management”).

Many commenters expressed general support for providing a uniform method of calculating assets under management in order to maintain consistency for registration and risk assessment purposes.
68

Others, however, disagreed with or sought changes to one or more of the revisions we are making to the instructions, which we discuss below. We are adopting the amendments as proposed.

68

See, e.g.,
comment letter of the American Federation of Labor and Congress of Industrial Organizations (Jan. 24, 2011) (“AFL-CIO Letter”) (“an adviser's calculation of its assets under management is central to the determination of whether that adviser is required to register with the SEC and be subject to its oversight * * *. The uniform, comprehensive methodology proposed by the SEC will ensure its ability to oversee advisers to funds that may pose a systemic threat.”); comment letter of Americans for Financial Reform (Jan. 24, 2011) (“AFR Letter”) (“Because calculations of the amount of assets under management by each adviser are key to the determination of whether or not they are required to register, the comprehensive and uniform definition of these terms in the proposed rule is particularly important.”).
See also
comment letter of the Alternative Investment Management Association (Jan. 24, 2011) (“AIMA Letter”); Dechert General Letter; comment letter of the Investment Adviser Association (by Valerie M. Baruch) (Jan. 24, 2011) (“IAA General Letter”); NRS Letter; comment letter of O'Melveny & Myers LLP (on behalf of the China Venture Capital and Private Equity Association) (Jan. 25, 2011) (“O'Melveny Letter”); Schnase Letter; NYSBA Committee Letter; Dezellem Letter.

Under the revised instructions, advisers must 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 family or proprietary assets, assets managed without receiving compensation, or assets of foreign clients.
69

We proposed to require advisers to include these assets in light of the new uses of the term “assets under management” in the Advisers Act and the new regulatory requirements related to systemic risk that we anticipated would be triggered by registration with the Commission.
70

Eliminating an adviser's ability to exclude all or some of these assets will prevent advisers from excluding these assets from their regulatory assets under management in order to remain below the new asset threshold for registration and to avoid reporting systemic risk information.
71

This approach will also lead to more consistent reporting of assets under management among advisers.

69

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

70

See supra
note 65. 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.

71

See
Implementing Proposing Release,
supra
note 7, at nn.44-45 and accompanying text;
Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF,
Investment Advisers Act Release No. IA-3145 (Jan. 26, 2011) [76 FR 8,068 (Feb. 11, 2011)] (“Systemic Risk Reporting Release”) (proposing systemic risk reporting).

A number of commenters disagreed with the proposed changes.
72

Some argued that advisers should not be required to include proprietary assets and assets managed without receiving compensation in the calculation because such a requirement would be inconsistent with the statutory definition of “investment adviser.”
73

Although a person is not an “investment adviser” for purposes of the Advisers Act unless it receives compensation for providing advice to others, once a person meets that definition (by receiving compensation from
any
client to which it provides advice), the person is an adviser, and the Act applies to the relationship between the adviser and any of its clients (whether or not the adviser receives compensation from them).
74

Moreover, the management of “proprietary” assets or assets for which the adviser may not be compensated, when combined with other client assets, may suggest that the adviser's activities are of national concern or have implications regarding the reporting for the assessment of systemic risk.
75

We are therefore adopting the amendment to the instruction, as proposed.
76

72

See
AIMA Letter; Dechert General Letter; MFA Letter; Pickard Letter; Seward Letter; NYSBA Committee Letter.

73

See
Dechert General Letter; MFA Letter; Seward Letter; NYSBA Committee Letter.
See also
Pickard Letter. Under Section 202(a)(11) of the Advisers Act, the definition of “investment adviser” includes, among others, “any person who, for compensation, engages in the business of advising others * * * as to the value of securities or as to the advisability of investing in, purchasing, or selling securities * * *.”

74

See
section 202(a)(11); Form ADV: Instructions for Part 1A, Glossary of Terms, Client.

75

See supra
note 70.

76
One commenter objected to the inclusion of assets of foreign clients because it would require domestic advisers that only have a foreign client base to register with the Commission. Comment letter of Katten Muchin Rosenman LLP (on behalf of APG Asset Management US Inc.) (Jan. 21, 2011). However, a domestic adviser dealing exclusively

with foreign clients must register with the Commission if it uses any U.S. jurisdictional means in connection with its advisory business.
See
section 203 of the Advisers Act (requiring registration of
any
investment adviser that uses the United States mails or any other means or instrumentality of interstate commerce in connection with its business as an investment adviser unless the adviser qualifies for an exemption from registration or is prohibited from registering with the Commission).

The revised instructions to Form ADV also clarify that an adviser must calculate its regulatory assets under management on a gross basis, that is, without deduction of “any outstanding indebtedness or other accrued but unpaid liabilities.”
77

Several commenters argued that advisers should determine the amount of regulatory assets under management on a net, rather than gross, basis.
78

They asserted that the use of net assets would better reflect the clients' assets at risk that an adviser manages,
79

and that use of gross assets would confuse advisory clients.
80

However, nothing in the current instructions suggests that liabilities should be deducted from the calculation of an adviser's assets under management. Indeed, since 1997, the instructions have stated that an adviser should not deduct securities purchased on margin when calculating its assets under management.
81

Whether a client has borrowed to purchase a portion of assets managed does not seem to us a relevant consideration in determining the amount of assets an adviser has to manage and the scope and national significance of an adviser's business. Moreover, we are concerned that the use of net assets could permit advisers that utilize investment strategies with highly leveraged positions to avoid registration with the Commission even though the activities of such advisers may have national significance. The use of a net assets test also could allow advisers to large and highly leveraged funds to avoid systemic risk reporting under our proposed systemic risk reporting rules.
82

In addition, there need not be any investor confusion because although an adviser will be required to use gross (rather than net) assets for regulatory purposes, the instruction would not preclude an adviser from holding itself out to its clients as managing a net amount of assets as may be its custom in, for example, its client brochure. We are therefore adopting the instruction, as proposed.
83

77

See
amended

Form ADV: Instructions for Part 1A, instr. 5.b.(2). Accordingly, an adviser cannot deduct accrued fees, expenses, or the amount of any borrowing. Prior to today's amendments, the instructions directed advisers not to “deduct securities purchased on margin.”

78

See, e.g.,
Dechert General Letter; comment letter of Georg Merkl (Jan. 25, 2011) (“Merkl Exemptions Letter”); MFA Letter; Seward Letter; Shearman Letter.
See also
NYSBA Committee Letter.

79

See
Merkl Exemptions Letter; MFA Letter.

80

See
Dechert General Letter; MFA Letter.

81

See
Form ADV: Instructions for Part 1A, instr. 5.b.(2). (“Do not deduct securities purchased on margin.”).

82

See
Systemic Risk Reporting Release,
supra
note 71.

83
Some commenters asked that we clarify how the calculation on a gross basis would apply with respect to, among others, mutual funds, short positions, and leverage.
See
IAA General Letter; MFA Letter. We expect that advisers will continue to calculate their gross assets as they do today, even if they currently only calculate gross assets as an intermediate step to compute their net assets. In the case of pooled investment vehicles with a balance sheet, for instance, an adviser could include in the calculation the total assets of the entity as reported on the balance sheet.

We are also revising the Form ADV instructions, as proposed, to provide guidance regarding how an adviser that advises private funds determines the amount of assets it has under management. We have designed our new 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 adopting today in the Exemptions Adopting Release) and to prevent advisers from understating those assets to avoid registration.

First, an adviser must include in its calculation of 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.
84

A sub-adviser to a private fund would include in its regulatory assets under management only that portion of the value of the portfolio for which it provides continuous and regular supervisory or management services. Advisers that have discretionary authority over fund assets, or a portion of fund assets, and that provide ongoing supervisory or management services over those assets would exercise continuous and regular supervisory or management services.
85

84

See
amended Form ADV: Instructions for Part 1A, instr. 5.b.(1). One commenter specifically addressed this matter, supporting our approach.
See
IAA General Letter.

85

See
amended Form ADV: Instructions for Part 1A, instr. 5.b.(3).

Second, an adviser must include the amount of any uncalled capital commitments made to a private fund managed by the adviser.
86

As we explained in the Implementing Proposing Release, advisers to some private funds (such as private equity funds) typically make investments following capital calls on the funds' investors.
87

One commenter agreed with this approach generally,
88

while another disagreed, asserting that the uncalled capital commitments remain under the management of the fund investor.
89

As we noted in the Implementing Proposing Release, in the early years of a private fund's life, its adviser typically earns fees based on the total amount of capital commitments, which we presume reflects compensation for efforts expended on behalf of the fund in preparation for the investments.
90

We are adopting the instruction, as proposed.

86

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

87
Implementing Proposing Release,
supra
note 7, at n.53 and accompanying text.

88

See
AIMA Letter (supporting including uncalled capital commitments, provided that the adviser has full contractual rights to call that capital and would be given responsibility for management of those assets).

89

See
Merkl Exemptions Letter.

90
Implementing Proposing Release,
supra
note 7, at n.54 and accompanying text.

Third, advisers must use the market value of private fund assets, or the fair value of private fund assets where market value is unavailable.
91

This requirement is designed to make advisers value private fund assets on a more meaningful and consistent basis for regulatory purposes under the Act and it, therefore, should result in a more coherent application of the Act's regulatory requirements and assessment of risk. This instruction would prevent, for example, an adviser electing to value its assets based on their cost, which could be significantly lower than the value of the assets based on their fair value, thus permitting the adviser to avoid registration with or reporting to the Commission. It is designed to prevent inconsistent application of the Advisers Act to advisers managing the same amount of assets.

91

See
amended Form ADV: Instructions for Part 1A, instr. 5.b.(4). This valuation requirement is described in terms similar to the definition of “value” in the Investment Company Act, which looks to market value when quotations are readily available and, if not, then to fair value.
See
Investment Company Act section 2(a)(41) (15 U.S.C. 80a-2(a)(41)). Other standards also may be expressed as requiring that a determination of fair value be based on market quotations where they are readily available.

We received a number of comments regarding the use of fair value, which represents a change from the current instruction that permits an adviser to calculate the value of its assets under management based on whatever method the adviser uses to report its assets to clients or to calculate fees for

investment advisory services.
92

One commenter, for example, supported requiring the use of fair value, noting that it would help achieve more consistent asset calculations and reporting across the investment advisory industry, and that it would enable better application of our staff's risk assessment program.
93

Other commenters, including the Managed Funds Association, however, objected to the use of fair value, asserting that the requirement would cause those advisers that did not use fair value standards to incur additional costs, particularly if the assets are illiquid and therefore difficult to fair value.
94

92

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

93

See
IAA General Letter.
See also
ABA Committees Letter (addressing the requirement within the context of the asset calculation for purposes of the foreign private adviser and the private fund adviser exemptions).

94

See
MFA Letter; Merkl Exemptions Letter; O'Melveny Letter; Seward Letter.

In the Implementing Proposing Release, we noted that we understood that many private funds already value assets in accordance with U.S. generally accepted accounting principles (“GAAP”) or other international accounting standards that require the use of fair value, citing letters we had received in connection with other rulemaking initiatives.
95

We are sensitive to the costs this new requirement will impose. We believe, however, that this approach is warranted in light of the unique regulatory purposes of the calculation under the Advisers Act. We estimated these costs in the Implementing Proposing Release,
96

and have taken several steps to mitigate them.
97

While many advisers will calculate fair value in accordance with GAAP or another international accounting standard,
98

other advisers acting consistently and in good faith may utilize another fair valuation standard.
99

While these other standards may not provide the quality of information in financial reporting (for example, of private fund returns), we expect these calculations will provide sufficient consistency for the purposes that regulatory assets under management serve in our rules (such as applying annual thresholds to determine the registration status of an adviser).
100

95

See
Implementing Proposing Release,
supra
note 7, at n.56 and accompanying text.

96

See
Implementing Proposing Release,
supra
note 7, at n.369 and accompanying text.

97
We recognize that although these steps will provide advisers greater flexibility in calculating the value of their private fund assets, they also will result in valuations that are not as comparable as they could be if we specified a fair value standard (
e.g.,
as specified in GAAP).

98
Several commenters asked that we not require advisers to fair value private fund assets in accordance with GAAP for purposes of calculating regulatory assets under management because many funds, particularly offshore ones, do not use GAAP and such a requirement would be unduly burdensome.
See, e.g.,
comment letter of European Fund and Asset Management Association (Jan. 24, 2011) (“EFAMA Letter”); IAA General Letter; Comment letter of Katten Muchin Rosenman LLP (on behalf of non-U.S. Advisers) (Jan. 24, 2011) (“Katten Foreign Advisers Letter”). We did not propose such a requirement, nor are we adopting one.

99
Consistent with this good faith requirement, we would expect that an adviser that calculates fair value in accordance with GAAP or another basis of accounting for financial reporting purposes will also use that same basis for purposes of determining the fair value of its regulatory assets under management.

100
The fair valuation process need not be the result of a particular mandated procedure and the procedure need not involve the use of a third-party pricing service, appraiser or similar outside expert. An adviser could rely on the procedure for calculating fair value that is specified in a private fund's governing documents. The fund's governing documents may provide, for example, that the fund's general partner determines the fair value of the fund's assets. Advisers are not, however, required to fair value real estate assets only in those limited circumstances where real estate assets are not required to be fair valued for financial reporting purposes under accounting principles that otherwise require fair value for assets of private funds. For example, in those cases, an adviser may instead value the real estate assets as the private fund does for financial reporting purposes. We note that the Financial Accounting Standards Board (“FASB”) has a current project related to investment property entities that may require real estate assets subject to that accounting standard to be measured by the adviser at fair value.
See
FASB Project on
Investment Properties.
We also note that certain international accounting standards currently permit, but do not require, fair valuation of certain real estate assets.
See
International Accounting Standard 40,
Investment Property.
To the extent that an adviser follows GAAP or another accounting standard that requires or in the future requires real estate assets to be fair valued, this limited exception to the use of fair value measurement for real estate assets would not be available.

The alternatives that commenters recommended (
e.g.,
cost basis or any method required by the private fund's governing documents other than fair value) would not meet our objective of having more meaningful and comparable valuation of private fund assets, and could result in a significant understatement of appreciated assets.
101

Moreover, these alternative approaches could permit advisers to circumvent the Advisers Act's registration requirements. Permitting the use of any valuation standard set forth in the governing documents of the private fund other than fair value could effectively yield to the adviser the choice of the most favorable standard for determining its registration obligation as well as the application of other regulatory requirements, and would not provide consistent outcomes from similarly situated advisers. Accordingly, we are adopting the requirement as proposed.

101

See
Merkl Exemptions Letter; MFA Letter; O'Melveny Letter; Seward Letter; NYSBA Committee Letter.

We also requested comment in the Implementing Proposing Release on whether we should require advisers to report their assets under management more frequently than annually. All commenters who responded to our request asked that we continue to require annual reporting, arguing that more frequent reporting would require additional calculations only for purposes of Form ADV disclosure, thus placing an unnecessary burden on advisers.
102

As commenters recommended, we are not changing the frequency of the reporting requirement.

102

See, e.g.,
AIMA Letter; NRS Letter; O'Melveny Letter; NYSBA Committee Letter. Under the Systemic Risk Reporting Release, we proposed to require large advisers with $1 billion or more in assets under management attributable to hedge funds, unregistered money market funds or private equity funds to file systemic risk reports quarterly.
See
Systemic Risk Reporting Release,
supra
note 71.

4. Switching Between State and Commission Registration

Rule 203A-1 is designed to prevent 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. We are amending the rule to eliminate the current buffer for advisers that have assets under management between $25 million and $30 million that permits these advisers to remain regulated by the states, and we are replacing it with a similar buffer for mid-sized advisers.
103

We are also retaining, as proposed, the requirement that eligibility for registration be determined annually as part of an adviser's annual updating amendment, allowing an adviser to avoid the need to change registration status based on fluctuations that occur during the course of the year.
104

103
Amended rule 203A-1(a). Additionally, we are revising the provision in rule 203A-1 that does not require an adviser to withdraw its Commission registration until its assets under management fall below $25 million to reflect the new, $90 million threshold.
See
amended rule 203A-1(a)(1).

104
Amended rule 203A-1(b)(2) (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). We are not renumbering this paragraph as proposed.
Compare
proposed rule 203A-1(a)-(b)
with
amended rule 203A-1(b)(1)-(2).

The amended rule provides a buffer for mid-sized advisers with assets under management close to $100 million to determine whether and when to switch between state and Commission

registration.
105

The rule raises the threshold above which a mid-sized investment adviser must register with the Commission to $110 million; but, once registered with the Commission, an adviser need not withdraw its registration until it has less than $90 million of assets under management.
106

105
Amended rule 203A-1(a).

106
Amended rule 203A-1(a)(1). Mid-sized advisers eligible for a rule 203A-2 exemption and advisers to a registered investment company or business development company under the Investment Company Act will not be able to rely on the buffer because they are required to register with us regardless of whether they have $100 million of assets under management. Amended rule 203A-1(a)(2). In addition, advisers that rely on amended rule 203A-2(c) to register with the Commission because they expect to be eligible for registration within 120 days cannot rely on the buffer—they must have $100 million of assets under management within 120 days to remain registered with the Commission.
See
Form ADV: Instructions for Part 1A, instrs. 2.a., 2.g.
See also
amended rule 203A-1(a)(2)(ii); amended rule 203A-2(c).

Although commenters did not object to elimination of the current buffer, several argued that we need to include a new buffer for mid-sized advisers that have close to $100 million of assets under management.
107

Some commenters, for example, asserted that the current $5 million buffer was effective in preventing frequent switching of registration attributable to market fluctuations,
108

while another called the buffer an important element of regulatory flexibility.
109

Several advisers with close to $100 million of assets under management asserted that a buffer is necessary to prevent them from switching to and from Commission registration.
110

Commenters recommended several different buffers, including one for advisers with between $100 million and $120 million (to retain the current buffer's 20 percent increase in assets under management),
111

one that would fall below $100 million,
112

and a buffer that straddled above and below $100 million.
113

107
Altruist Letter; Dezellem Letter; Dinel Letter; FSI Letter; comment letter of Intelligent Capitalworks Investment Advisors (Jan. 24, 2011) (“ICW Letter”); comment letter of JVL Associates, LLC (Jan. 13, 2011) (“JVL Associates Letter”); comment letter of Georg Merkl (Jan. 25, 2011) (“Merkl Implementing Letter”); NASAA Letter; NRS Letter; NYSBA Committee Letter; comment letter of The Wealth Coach, LLC (by Jeffrey W. McClure) (Dec. 31, 2010) (“Wealth Coach Letter”); and comment letter of WJM Financial, LLC (Jan. 4, 2011) (“WJM Letter”). To prevent an adviser from switching frequently between state and Commission registration, we proposed to retain an adviser's ability to rely on the reporting on Form ADV of assets under management in the annual updating amendment for purposes of determining its eligibility to register.
See
proposed rule 203A-1(b).

108

See, e.g.,
Altruist Letter; NRS Letter.

109
NASAA Letter.

110
ICW Letter (for 3 years, adviser's assets under management have been greater than $100 million by a few million dollars and at various times throughout the year has been reduced to under $100 million by just a few days of downside market volatility); JVL Associates Letter (adviser's assets under management have fluctuated around $100 million since 2007).
See also
Wealth Coach Letter (from October 2008 through March 2009, adviser's total assets under management fell over 25%).

111
Altruist Letter; FSI Letter; NASAA Letter; WJM Letter.
See also
ICW Letter; Merkl Implementing Letter; NYSBA Committee Letter.

112
Dezellem Letter ($80-$100 million); Dinel Letter ($80-$100 million); JVL Associates Letter ($90-$100 million); NRS Letter ($90-$100 million).

113
Wealth Coach Letter ($85-$115 million).

We are persuaded by these comments that a buffer may prevent costs and disruption to advisers that otherwise may have to switch between federal and state registration frequently because of, for example, the volatility of the market values of the assets they manage. Rule 203A-1(a), as amended, raises the threshold above which a mid-sized investment adviser must register with the Commission to $110 million.
114

Once registered with the Commission, an adviser need not withdraw its registration until it has less than $90 million of assets under management.
115

The amendment operates to provide a buffer of 20 percent of the $100 million statutory threshold for registration with the Commission, which is the same percentage as the current buffer.
116

We believe a 20 percent buffer is appropriate because it is large enough to accommodate market fluctuations or the departure of one or more clients, and does not substantially increase or decrease the $100 million threshold set by Congress in the Dodd-Frank Act.
117

114
We find that raising the threshold for mid-sized advisers to register with the Commission is appropriate in accordance with the purposes of the Advisers Act. Advisers Act section 203A(a)(2)(B)(ii), as amended by the Dodd-Frank Act.

115
Amended rule 203A-1(a)(1). We find that not providing this buffer and requiring advisers with assets under management of between $90 million and $100 million to register with the states would be unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes of section 203A of the Advisers Act. Advisers Act section 203A(c). Advisers Act section 203A(c) 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.
See supra
note 20 for a discussion of section 203A(c).

116
Commenters said the current $5 million buffer, which is 20 percent of the $25 million statutory threshold, effectively limits advisers having to switch registrations due to market changes in their assets under management.
See, e.g.,
Altruist Letter (current $5 million buffer “was useful in lessening the need to switch back and forth between state and Federal regulation as an IA's AUM grew or fell”).
See also
Advisers Act section 203A(a)(1); rule 203A-1(a). The amendment we are adopting provides a $20 million buffer, which is 20 percent of the $100 million statutory threshold.
See
Advisers Act section 203A(a)(2), as amended by the Dodd-Frank Act; amended rule 203A-1(a)(1).

117
An adviser must register if its assets under management are $110 million or more, which is $10 million higher than the $100 million statutory threshold.
See
Advisers Act section 203A(a)(2), as amended by the Dodd-Frank Act; amended rule 203A-1(a)(1).
See also supra
note 108 (citing commenters discussing market fluctuations); Senate Committee Report,
supra
note 18, at 76 (stating that this amendment increases the threshold above which all investment advisers must register with the Commission from $25 million to $100 million).

5. Exemptions From the Prohibition on Registration With the Commission

Using the authority provided by section 203A(c) of the Advisers Act, we are adopting, as proposed, amendments to three of the exemptions in rule 203A-2 from the prohibition on Commission registration in section 203A to reflect developments since their original adoption, including the enactment of the Dodd-Frank Act, which we discuss below.
118

Each of the exemptions (including those we are not amending) also applies to mid-sized advisers, exempting them from the prohibitions on registering with the Commission if they meet the requirements of rule 203A-2.
119

118
Using the authority provided in section 203A(c) of the Advisers Act, the Commission has permitted six types of investment advisers to register with the Commission under rule 203A-2: (i) NRSROs; (ii) certain pension consultants; (iii) certain 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) certain multi-state investment advisers; and (vi) certain Internet advisers.
See supra
notes 20-21 and accompanying text. 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, respectively.
See
amended rule 203A-2(b), (c), and (e). We are requiring advisers to comply with amended rule 203A-2 60 days after publication in the
Federal Register.

See infra
section III.

119
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,
supra
note 17, at section II.D. 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 are eligible to register with us.
See
section 410 of the Dodd-Frank Act; amended rule 203A-2. We asked, but did not receive comment on, whether we should limit rule 203A-2's application to small advisers; however, one commenter agreed that these exemptions should apply to all advisers, including mid-sized advisers. NRS Letter (strongly supporting that the exemptions be applicable to all advisers no matter their assets under management as it “promotes uniformity, clarity and a consistent standard for all.”). We are leaving rule 203A-2 unchanged in this regard.

a. Nationally Recognized Statistical Rating Organizations

We are eliminating, as proposed, the exemption in rule 203A-2(a) from the prohibition on Commission registration for nationally recognized statistical rating organizations (“NRSROs”).
120

Since we adopted this exemption, Congress amended the Act to exclude certain NRSROs from the Act's definition of “investment adviser”
121

and provided for a separate regulatory regime for NRSROs under the Securities Exchange Act of 1934 (“Exchange Act”).
122

Commenters supported the elimination of this provision.
123

120

See
rule 203A-2(a).

121
Credit Rating Agency Reform Act of 2006, P.L. 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 on behalf of others).

122
Credit Rating Agency Reform Act,
supra
note 121, at sections 4(a), 5.

123
NRS Letter (asserting that the proposal is consistent with the Credit Rating Agency Reform Act, which amended the Advisers Act to exclude NRSROs and to provide for a separate regulatory regime for them under the Exchange Act); Pickard Letter (asserting that continued availability of the NRSRO exemption is causing confusion among advisers).

b. Pension Consultants

We are amending rule 203A-2(b), the exemption available to pension consultants, to increase the minimum value of plan assets required to rely on the exemption from $50 million to $200 million.
124

As discussed in the Implementing Proposing Release, 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.
125

As a result of this amendment, advisers currently relying on the pension consultant exemption advising plan assets of less than $200 million may be required to withdraw from Commission registration and register with one or more states.
126

124
Amended rule 203A-2(a). 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,
supra
note 17, at section II.D.2. The exemption does not apply to pension consultants that solely provide services to plan participants.
See
NSMIA Adopting Release,
supra
note 17, at section II.D.2. 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 provides investment advice. Rule 203A-2(b)(3).

125

See
Implementing Proposing Release,
supra
note 7, at section II.A.5.b.; NSMIA Adopting Release,
supra
note 17, at section II.D.2.;
Rules Implementing Amendments to the Investment Advisers Act of 1940,
Investment Advisers Act Release No. 1601, section II.D.2. (Dec. 20, 1996) [61 FR 68480 (Dec. 27, 1996)].

126
An adviser currently relying on the exemption, but that advises plan assets of less than $200 million and files an annual updating amendment to its Form ADV following the compliance date of the amended rule, will be required to withdraw from Commission registration within 180 days of the adviser's fiscal year end (unless the adviser is otherwise eligible for SEC registration).
See
rule 203A-1(b)(2);
supra
note 118.

We proposed to increase the 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, and to maintain the same ratio as today of plan assets to the statutory threshold for registration.
127

Commenters supported our proposal.
128

One agreed that the new $200 million threshold would continue to ensure that the activities of a pension consultant registered with the Commission are significant enough to have an impact on national markets.
129

We are adopting the amendment, as proposed.

127
Proposed rule 203A-2(a).

128

See
NRS Letter; Pickard Letter.

129
NRS Letter.
See also
NSMIA Adopting Release,
supra
note 17, 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.

c. Multi-State Advisers

We are adopting, as proposed, amendments to the multi-state adviser exemption to align the rule with the multi-state exemption that Congress provided for mid-sized advisers in section 410 of the Dodd-Frank Act.
130

Amended rule 203A-2(d) permits all investment advisers who are required to register as an investment adviser with 15 or more states to register with the Commission, rather than 30 states, as currently required.
131

An adviser relying on the rule must withdraw from registration with the Commission when it is no longer required to be registered with 15 states.
132

We are also rescinding, as proposed, the provision in the current 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 adopting a similar cushion for the 15-state threshold.
133

130
Amended rule 203A-2(d). Form ADV will not be amended to reflect the changes to the multi-state adviser exemption until the end of the calendar year.
See supra
section II.A.1. Until that time, both a mid-sized adviser eligible for the statutory multi-state exemption and a small adviser eligible for the exemption under amended rule 203A-2(d) because it is required to register as an adviser in 15 or more states may register or remain registered (as the case may be) with the Commission by checking the boxes (Item 2.A.(9) and the relevant section of Schedule D) indicating that it is exempt because it is required to register in 30 or more states.
See supra
note 118. Upon making its next amendments to Form ADV, the adviser should revise its filing to report reliance on the new multi-state adviser exemption.

131
We note that amended rule 203A-2(d) permits an adviser otherwise eligible to rely on the exemption to choose to maintain its state registrations and not switch to SEC registration.
See
amended rule 203A-2(d)(2) (adviser elects to rely on the exemption by making the required representations on Form ADV).

132

See
amended rule 203A-2(d). To rely on this exemption, an adviser also must continue to: (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 15 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. Amended rule 203A-2(d)(2)-(3). The adviser may not include in the number of states those in which it is 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)].

133

See
rule 203A-2(e)(1). Eliminating this buffer simplifies the requirements of the exemption.
See
NRS Letter (“The Dodd-Frank Act has addressed the multi-state adviser exemption to simplify the requirements of this exemption.”)

Commenters generally agreed with our proposal to align our multi-state exemption for small advisers with the statutory exemption for mid-sized advisers.
134

A few, however, recommended a lower threshold of required state registrations for eligibility for the multi-state exemption.
135

In light of Congressional determination to set the threshold at 15 states and our stated purpose in amending the rule to align it with the Dodd-Frank Act, we have determined not to lower the threshold further.
136

We also note that the

requirement that advisers annually assess their eligibility for registration and the grace periods provided to switch to and from state registration should further mitigate the frequency with which an investment adviser required to register in 15 states will have to switch between state and federal registration.
137

134

See
NASAA Letter; comment letter of the National Education Association Member Benefits Corporation (Jan. 21, 2011) (“NEA Letter”); NRS Letter; Pickard Letter; Seward Letter; Shearman Letter.

135

See
Seward Letter and Shearman Letter (in each case supporting the 15-state threshold we proposed, and suggesting the burdens of maintaining multiple state registrations can be significant).
See also
NEA Letter. One of these commenters also would support further decreasing the number of states to five and requiring advisers relying on the exemption to have at least $25 million of assets under management. Seward Letter. Another “would support an even lower threshold.” Shearman Letter.

136

See
section 410 of the Dodd-Frank Act (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); H. Rep. No. 111-517, at 867 (2010) (“Conference Committee

Report”) (“Those advisers who qualify to register with their home state must register with the SEC should the adviser operate in more than 15 states.”).

137

See supra
section II.A.4.

6. Elimination of Safe Harbor

We are rescinding, as proposed, rule 203A-4, which has provided 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.
138

One commenter argued that the safe harbor should be retained for mid-sized advisers because advisers calculating regulatory assets under management face similar challenges today as when the safe harbor was adopted.
139

We disagree. As stated in the Implementing Proposing Release, the safe harbor 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.
140

We also believe that the revisions we are adopting to the Form ADV instructions to implement a uniform method for advisers to calculate assets under management will clarify the requirements and reduce confusion among advisers.
141

Moreover, the rule is a safe harbor only from our enforcement actions, and to our knowledge few, if any, advisers have relied upon it in the 14 years since it was adopted.
142

Accordingly, we are rescinding the rule.

138
Rule 203A-4.

139
NYSBA Committee Letter. Another commenter asserted that there has been and continues to be confusion among smaller advisers in calculating assets under management. NRS Letter.

140
Implementing Proposing Release,
supra
note 7, at section II.A.6. (
citing
rule 203A-4; NSMIA Adopting Release,
supra
note 17, at section II.B.3.).

141

See supra
section II.A.3.

142

See
NRS Letter (noting a belief that the safe harbor has been little used by small advisers based upon the commenter's years of consulting for such advisers).

7. Mid-Sized Advisers

We are amending Form ADV to require a mid-sized adviser registering with us to affirm, upon application and annually thereafter, that it is either: (i) 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; or (ii) is not subject to examination as an adviser by that state.
143

These form revisions implement the Dodd-Frank Act amendment to section 203A of the Advisers Act that prohibits mid-sized advisers from registering with the Commission, but only: (i) If 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.
144

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.
145

We are therefore providing an explanation of these provisions in instructions to Form ADV.
146

143

See
amended Form ADV, Part 1A, Item 2.A.(2). For a discussion of changes to Form ADV, Part 1A, Item 2.A., see
supra
section II.A.2.

144

See
section 410 of the Dodd-Frank Act. An adviser reporting that it is no longer able to make this affirmation will have 180 days from its fiscal year end to withdraw from Commission registration.
See
amended rule 203A-1(b)(2). Thus, the rule will 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.

145
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 changing this definition.
See
amended rule 203A-3(c). For a discussion of amendments we are making to the calculation of assets under management, see
supra
section II.A.3.

146

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

a. Required To Be Registered

The Form ADV instructions we are adopting reflect that the “required to be registered” standard that Congress included in new section 203A(a)(2) of the Advisers Act for mid-sized advisers is different from the “regulated or required to be regulated” standard set forth in section 203A(a)(1) for small advisers.
147

The instruction explains that a mid-sized adviser “is not required to be registered” with the state securities authority and must register with the Commission (unless an exemption from registration with the Commission otherwise is available)
148

if the adviser is exempt from registration under the law of the state in which it has its principal office and place of business, or is excluded from the definition of investment adviser in that state.
149

Thus, for example, an adviser with $75 million of assets under management that is exempt from registration in the state in which its principal office and place of business is located will have to register with the Commission (unless an exemption from Commission registration is available). None of the commenters disputed our interpretation or suggested an alternative interpretation of the “required to be registered” element,
150

and we are adopting the instructions, as proposed.
151

147

See
amended Form ADV: Instructions for Part 1A, instr. 2.b. 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. Advisers Act section 203A(a)(1).
See also
Advisers Act section 203(a). 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.
See
NSMIA Adopting Release,
supra
note 17, at section II.E.1. 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).
See
The Wall Street Reform and Consumer Protection Act of 2009, H.R. 4173, 111th Cong. § 7418 (2009); Restoring American Financial Stability Act of 2010, S. 3217, 111th Cong. § 410 (2010). But the final version of the Dodd-Frank Act prohibits 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.
See
section 410 of the Dodd-Frank Act.

148

See, e.g.,
Advisers Act sections 203(a) and (b), 203A(b); rule 203A-2.

149

See, e.g.,
Uniform Securities Act §§ 102(15), 403(b) (2002). An adviser not registered under a state adviser statute in contravention of such statute, however, is not eligible for registration with the Commission. Similarly, an adviser could not voluntarily register with the Commission to avoid state registration.

150
One commenter suggested that we clarify whether mid-sized advisers that are exempt from registration in their home states may or are required to register with us. Sadis Letter. As discussed above and in the Form ADV instructions, if a mid-sized adviser is not required to be registered in the state where it has its principal office and place of business, the adviser must register with the Commission (unless an exemption from Commission registration is available).
See supra
notes 148-149 and accompanying text; amended Form ADV: Instructions for Part 1A, instr. 2.b.

151

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

b. Subject to Examination

As we discussed in the Implementing Proposing Release, our staff contacted the state securities authority for each state and, based upon information they have provided us, identified those states that do not subject advisers registered with them to examination.
152

We have posted this list on our Web site,
153

and it also will be available to advisers using the IARD to register or amend their registration forms.
154

Based on those responses, advisers with their principal office and place of business in Minnesota, New York and Wyoming with assets under management between $25 million and $100 million must register with the Commission.
155

152
All state securities authorities other than Minnesota, New York and Wyoming have advised our staff that advisers registered with them are subject to examination. According to IARD data as of April 7, 2011, there were 63 advisers with assets under management between $25 million and $90 million and a principal office and place of business in Minnesota, 286 in New York, and 1 in Wyoming.

153

See http://www.sec.gov/divisions/investment/midsizedadviserinfo.htm
.

154

See
amended Form ADV, Part 1A, Item 2.A.(2)(b); amended Form ADV: Instructions for Part 1A, instr. 2.b. The staff also requested that each state notify us promptly if advisers in the state will begin to be subject to examination or will no longer be subject to examination, and we will update the list on the IARD and our Web site accordingly.

155

See supra
note 152. The requirement for such an adviser to register with the Commission, as opposed to one of these states, will be effective on July 21, 2011.

Several commenters agreed with our approach of relying on responses from the state regulators rather than determinations by the Commission to identify whether an adviser is “subject to examination” by a state.
156

Two commenters, however, suggested that we should instead establish our own criteria for whether an adviser is “subject to examination,” and one further recommended that we should engage in an evaluation of each state's adviser examination program.
157

We do not believe that the alternatives suggested are practical or appropriate. As we explained in the Implementing Proposing Release, the states are the most familiar with their own circumstances and are in the best position to determine whether advisers in their states are subject to examination.
158

156

See
NASAA Letter (proposed approach “complies with the clear and unambiguous language of the statute” and “attempting to define or otherwise interpret terms that are plain and direct is contrary to long-established rules of statutory construction.”); NRS Letter; Pickard Letter.
See also
Sadis Letter (recommending the Commission clarify whether an adviser in a particular state is required to register with the Commission).

157
ABA Committees Letter (recommending the Commission construe “examination” to indicate a “structured adviser examination program, rather than one conducted on an occasional, sporadic or informal basis,” and require an annual affirmation from each state that it subjects advisers to examination); FSI Letter (recommending the Commission engage in a stringent evaluation of each state's adviser examination program and expressly define “subject to examination” to, at a minimum, include a “uniform or risk based routine examination process” and that it “mirrors the frequency of broker-dealer examination by FINRA and the SEC”).

158

See
Implementing Proposing Release,
supra
note 7, at section II.A.7.b.

B. Exempt Reporting Advisers: Sections 407 and 408

To implement new sections 203(l) and 203(m) of the Advisers Act, we are adopting a new rule, as proposed, that requires advisers relying on those exemptions from registration to submit to us, and to periodically update, reports that consist of a limited subset of items on Form ADV.
159

We are also adopting the amendments we proposed to Form ADV to permit the form to serve as both a reporting and registration form and to specify the seven items these “exempt reporting advisers” must complete.
160

159
We refer to advisers that rely on the exemptions from registration provided in either new section 203(l) or new section 203(m) of the Advisers Act as “exempt reporting advisers.” For a brief discussion of these exemptions, see
infra
note 162 and accompanying text; for a more in-depth discussion, see Exemptions Adopting Release,
supra
note 4.

160
For a discussion of additional amendments we are proposing to Part 1 of Form ADV, see
infra
section II.C.

As discussed above, the Dodd-Frank Act amends the Advisers Act, as of July 21, 2011, to create two new exemptions from registration for advisers to certain types of “private funds” and to repeal the private adviser exemption contained in section 203(b)(3) of the Advisers Act on which advisers to many hedge and other private funds relied in order to avoid registration.
161

Both section 203(l) (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 and to submit such reports “as the Commission determines necessary or appropriate in the public interest.”
162

The rules and amendments to Form ADV that we are adopting today are designed to address the reporting aspects of these two exemptions.
163

161
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-54).
See supra
note 4; Implementing Proposing Release,
supra
note 7, at n.112 and accompanying text.

162

See
sections 407 and 408 of the Dodd-Frank Act, adding Advisers Act sections 203(l) and (m). See
supra
note 5.
See also
Exemptions Adopting Release,
supra
note 4, at section II.; section 204(a) of the Advisers Act and section 204(b)(5), as added by section 404 of the Dodd-Frank Act.

163
Recordkeeping requirements for exempt reporting advisers will be addressed in a future release.
See
sections 407 and 408 of the Dodd-Frank Act (providing that the Commission shall require investment advisers exempt from registration under either section 407 or 408 of the Dodd-Frank Act to maintain such records as the Commission determines necessary or appropriate in the public interest or for the protection of investors.).

1. Reporting Required

Rule 204-4 requires exempt reporting advisers to file reports with the Commission electronically on Form ADV through the IARD using the same process used by registered investment advisers.
164

An exempt reporting adviser must submit its initial Form ADV within 60 days of relying on the exemption from registration under either section 203(l) or section 203(m) of the Advisers Act.
165

Each Form ADV is considered filed with the Commission upon acceptance by the IARD.
166

An exempt reporting adviser unable to file electronically as a result of unanticipated technical difficulties may, like a registered adviser, request a temporary hardship exemption of up to seven business days after the filing was due.
167

Advisers filing the form must

pay a filing fee designed to pay the reasonable costs associated with the filing and maintenance of the system.
168

We anticipate that filing fees, which the Commission will consider separately, will be the same as those for registered investment advisers, which currently range from $40 to $225 based on the amount of assets an adviser has under management.
169

164
New rule 204-4.
See
amended Form ADV: General Instructions 6, 7, 8 and 9 (providing guidance about the IARD entitlement process, signing the form, and submitting it for filing). We are also adopting technical amendments, as proposed, to Form ADV-NR, to enable exempt reporting advisers to appoint the Secretary of the Commission as an agent for service of process for certain non-resident advisers.
See
amended Form ADV-NR; amended Form ADV: General Instruction 19.

165

See
amended Form ADV: General Instruction 13. An adviser may not be both registered with us and filing as an exempt reporting adviser at the same time. An SEC registered adviser switching from being registered to being an exempt reporting adviser must first file a Form ADV-W to withdraw its SEC registration before submitting its first report as an exempt reporting adviser. We have modified General Instruction 13 from the proposal to reflect IARD system functionality, which we continue to develop.

166
New 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.”).

167

See
new rule 204-4(e) (providing a temporary hardship exemption for an adviser having unanticipated technical difficulties that prevent submission of a filing to IARD); amended Form

ADV-H; amended Form ADV: General Instruction 17.

168
New rule 204-4(d).

169
The current fee schedule applicable to advisers applying for registration may be found on our Web site at
http://www.sec.gov/divisions/investment/iard/iardfee.shtml.

Several commenters expressed the view that use of Form ADV and the IARD for exempt reporting advisers would be efficient, because the system is familiar to many advisers and because it would integrate the process of filing with the Commission with any parallel filing the adviser may be obligated to make with state securities authorities.
170

Commenters agreed with our expectation that use of Form ADV and the IARD would facilitate a transition from filing reports with us to applying for registration with us.
171

Two commenters urged that we create a separate reporting system.
172

One recommended a new, more interactive system; and the other suggested a separate filing system to avoid confusion among investors who might mistakenly assume that an exempt reporting adviser is registered if its information comes up in an IARD search. We share these commenters' general goals of innovation and the avoidance of investor confusion as our staff works with FINRA (our IARD contractor) to continue improving the IARD.
173

However, the expense and delay of initiating and developing a new system with adequate functionality, which neither commenter addressed, argues against these commenters' recommendations. We are adopting rule 204-4 as proposed.

170
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
amended Form ADV: General Instruction 14 (noting that exempt reporting advisers who file reports with the SEC may continue to be subject to state registration, reporting, or other obligations).

171
ABA Committees Letter; comment letter of Better Markets, Inc. (Jan. 24, 2011) (“Better Markets Letter”); NRS Letter; NASAA Letter. Form ADV, as amended, permits 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.
See
amended Form ADV: General Instruction 15 (providing procedural guidance to advisers that no longer meet the definition of exempt reporting adviser).

172
Merkl Implementing Letter; Seward Letter.
See also
Shearman Letter (making similar arguments regarding the potential for investor confusion, but not advocating use of a different form or reporting system).

173
Our staff, for example, recently completed a study mandated by section 919B of the Dodd-Frank Act on ways to improve investor access to information about certain financial service providers, including data contained in the IARD.
See
Staff of the Office of Investor Education and Advocacy of the U.S. Securities and Exchange Commission,
Study and Recommendations on Improved Investor Access to Registration Information about Investment Advisers and Broker-Dealers,
Jan. 2011, available at
http://www.sec.gov/news/studies/2011/919bstudy.pdf.

2. Information in Reports

We are also amending Form ADV to accommodate its use by exempt reporting advisers. First, we are re-titling 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 revising the cover page to require exempt reporting advisers to indicate the type of report they are filing.
174

Finally, we are amending Item 2 of Part 1A, which today requires advisers to indicate their eligibility for SEC registration, to add a new subsection B that requires an exempt reporting adviser to identify the exemption(s) on which it is relying to report, rather than register, with the Commission.
175

174
An exempt reporting adviser must indicate whether it is submitting an initial report, an annual updating amendment, an other-than-annual amendment, or a final report. We are also adopting corresponding changes to General Instruction 2.

175
An exempt reporting adviser must 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
amended Form ADV, Part 1A, Item 2.B, questions 1 and 2. An exempt reporting adviser relying on the latter exemption, for private fund advisers, must also indicate the amount of private fund assets it manages in Section 2.B. 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, need only include private fund assets that they manage at a place of business in the United States.
See
Exemptions Adopting Release,
supra
note 4, at section II.B.3. An adviser that acts solely as an adviser to private funds but is no longer eligible to check box 2.B.(2) because it has assets under management in the United States of $150 million or more may, subject to certain conditions, check a separate box to continue filing as an exempt reporting adviser during the safe harbor transition period described below.
See infra
note 211 and accompanying text.
See also
amended Form ADV, Part 1A, Item 2.B, question 3; Form ADV: General Instruction 15.

Some commenters asserted that it would be inconsistent with these new exemptions to require exempt reporting advisers to submit reports to the Commission,
176

while others argued that we proposed to require too much information.
177

Congress, however, 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.
178

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

176
Comment letter of Avoca Capital Holdings (Dec. 21, 2011) (“Avoca Letter”); AIMA Letter; comment letter of AustinVentures (Jan. 21, 2011) (“AV Letter”).

177
Comment letter of Berkeley Center for Law, Business and the Economy (Jan. 31, 2011) (“BCLBE Letter”); Shearman Letter; comment letter of Village Ventures, Inc. (Jan. 24, 2011) (“Village Ventures Letter”).

178

See
sections 407 and 408 of the Dodd-Frank Act.

We are adopting, as proposed, a requirement that exempt reporting advisers complete the following items of Part 1A of Form ADV: Items 1 (Identifying Information), 2.B. (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).
179

In addition, we are requiring, as proposed, that exempt reporting advisers also complete corresponding sections of Schedules A, B, C, and D.
180

Responses to these items will assist us to identify exempt reporting advisers, their owners, and their business models. The information we collect will provide us with information as to whether these advisers or their activities might present sufficient concerns to warrant our further attention in order to protect their clients, investors, and other market participants.
181

The reports will also provide the public with some basic information about these advisers and their businesses.

179

See
amended Form ADV: General Instruction 3. We will continue to monitor whether we should also require exempt reporting advisers to complete other items on Form ADV (
e.g.,
Part 2).

180

See id.;
Implementing Proposing Release,
supra
note 7, at section II.B.2.

181
One commenter agreed.
See
ABA Committees Letter (stating that most of the information exempt reporting advisers would have to provide is of a nature that will assist the Commission to identify compliance risks posed by exempt reporting advisers and thus such disclosure responds to the mandate set forth in the Dodd-Frank Act).

Items 1, 3, and 10 elicit basic identification details such as name, address, contact information, form of organization, and who controls the adviser. Items 6 and 7.A. provide us with details regarding other business activities in which the adviser and its

affiliates are engaged, 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 requires advisers to disclose the disciplinary history of the adviser and its employees and to complete a separate schedule containing details of each disciplinary event.
182

Item 7.B. and Section 7.B. of Schedule D require advisers to private funds, which these advisers manage by terms of the exemptions, to disclose information regarding each private fund they advise. As discussed in more detail in Section II.C. of this Release, we are adopting significant amendments to Section 7.B. of Schedule D that are designed to provide us with a comprehensive overview, or census, of private funds.
183

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

182

See
amended Form ADV, Part 1A, Disclosure Reporting Pages.

183
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 service providers and its gross assets.
See
amended Form ADV, Part 1A, Schedule D, Section 7.B.(1).
See also infra
Section II.C.1.

Several commenters expressed general support for the Commission's proposed reporting requirement.
184

One commenter urged us not to require exempt reporting advisers to report information about their other business activities in response to Item 6, their related persons in response to Item 7.A., their private funds in response to Item 7.B., and their control persons in response to Item 10 because, among other reasons, such information “would not add to the Commission's ability to protect the public interest or investors.”
185

We disagree. Without this information, the reports would contain little more than basic identifying data, which would be inadequate to help us to meaningfully identify significant risks to an exempt reporting adviser's clients, investors, or other market participants. Moreover, to require such limited information to be reported would deny investors an opportunity to verify disclosures they receive directly from the adviser.

184

See, e.g.,
AFL-C

[Text truncated at 120,000 characters. The full text is on the page linked above.]

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2011-16318. Public record. Not legal advice.