California Proposes Exemption from Registration for Certain Advisers to Private Funds

On December 21, 2011, the California Corporations Commissioner released a notice of proposed rulemaking to create an exemption from the investment adviser registration requirements for advisers to certain private funds. California’s proposed exemption is in response to changes made by the Dodd-Frank Act, and is based on the proposed Model Rule for Exempt Reporting Advisers released last year by the North American Securities Administrators Association (NASAA). Prior to the enactment of Dodd-Frank in July 2010, many advisers to hedge funds, private-equity funds, and venture capital funds relied on the “private adviser” exemption set forth in Section 203(b)(3) of the Advisers Act and a corollary exemption in California set forth in Section 260.204.9 of the California Code of Regulations. In order to conform to the elimination of the “private adviser” exemption and the creation of a new regulatory regime for private fund advisers imposed by Dodd-Frank, California has proposed a successor exemption that is predicated on the high net worth of investors in private funds. The proposed exemption includes certain requirements and safeguards designed to ensure adequate investor protection.

Under the proposed exemption, private fund advisers would be exempt from registration as an investment adviser in California if the following conditions are met:

  • the adviser is not subject to certain statutory disqualifications or “bad boy” provisions;
  • the adviser files periodic reports on Form ADV containing the information required by exempt reporting advisers under SEC Rule 204-4; and
  • the adviser pays the standard investment adviser annual registration fee of $125.

In addition, advisers to one or more funds relying on Section 3(c)(1) of the Investment Company Act that do not fall within the definition of “venture capital company” would be required to comply with the following additional requirements: (1) only “accredited investors” are permitted to invest in the fund; (2) the adviser provides certain disclosures to investors at the time of purchase pertaining to an investment in the fund and the services to be provided by the adviser; (3) the fund is subject to annual audit and the audited financial statements are distributed to each investor in the fund; and (4) performance fees are only charged to investors that meet the definition of “qualified client.”

The Commissioner has released an Initial Statement of Reasons, setting forth the rationale for the new exemption and the comment period for the proposed amendments is open until February 20, 2012. For additional information on the proposed exemption, please contact Zac Rosenberg, Compliance Consultant by email at zachary.rosenberg@corecls.com or by phone at (619) 278-0020.