California Private Fund Adviser Exemption
As a general matter, California law requires that investment advisers register with the state if they are providing investment advice for compensation. There are exemptions to the registration requirement for certain advisers to private funds - i.e., hedge funds, venture capital funds and private-equity funds. These laws have changed in recent years following changes to comparable federal regulations.
Historically, most private advisers in California relied on an exemption from state investment adviser licensing requirements that corresponded to a similar exemption from the federal registration pursuant to Section 203(b)(3) of the Investment Advisers Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act eliminated the so-called “private-adviser exemption” at the federal level and replaced it with certain narrower exemptions. Generally, private fund advisers are exempt from Securities and Exchange Commission registration if they exclusively advise venture capital funds, or have less than $150 million in assets under management.
In 2012, California adopted analogous changes at the state level. The California exemptions are available to investment advisers who provide advice solely to one or more “qualifying private funds,” which are defined as an issuer that that qualifies for the exclusion from the definition of an investment company under Section 3(c)(1), 3(c)(5) or 3(c)(7) of the Investment Company Act of 1940. (Typically, most venture capital, private equity and hedge funds are considered qualifying private funds).
In order to qualify for the California exemption, advisers are required to:
- Not be subject to statutory disqualifications (often referred to as “bad boy” provisions);
- File periodic notices regarding the characteristics of the adviser and associated private funds; and
- Pay the standard investment adviser annual registration fee.
Retail Buyer Funds
There are additional requirements for private fund advisers to what are known as retail buyer funds - those organized under sections 3(c)(1) or 3(c)(5) that don’t fall under the definition of a “Venture Capital Company” as defined in the rule. These heightened requirements include:
- The private fund adviser shall advise only retail buyer funds whose outstanding securities are beneficially owned entirely by: (A) persons who, at the time the securities were sold, either (i) met the definition of “accredited investor” in Rule 501(a) of Regulation D adopted by the SEC under the Securities Act of 1933, or (ii) were managers, directors, officers, or employees of the private fund adviser; or (B) any person that obtains the securities through a transfer not involving a sale of that security.
- At or before the time of purchase of any ownership interest in a retail buyer fund, the private fund adviser shall disclose to the purchaser of such ownership interest all material facts regarding all services to be provided by the investment adviser to a beneficial owner of the fund, and to the fund itself; and all duties the investment adviser owes to a beneficial owner of the fund, and to the fund itself.
- The private fund adviser shall obtain, on an annual basis, financial statements of each retail buyer fund advised by the private fund adviser, audited by an independent certified public accountant that is registered with, and subject to regular examination by, the Public Company Accounting Oversight Board, and shall deliver a copy of such audited financial statements to each beneficial owner of the retail buyer fund within 120 days after the end of each fiscal year (or within 180 days if the retail buyer fund is a fund of funds).
- A private fund adviser may not enter into, perform, renew or extend an investment advisory contract that provides for compensation to the investment adviser on the basis of a share of the capital gains upon, or the capital appreciation of, the funds, or any portion of the funds of an investor that is not a “qualified client” as defined in Rule 205-3(d) under the Advisers Act.
The 2012 revisions to the exemption from investment adviser regulations provided some consistency between the California regulations and SEC regulations implemented after Dodd-Frank was signed in 2010. Still, this remains a highly complex and technical area of the law, and advisers who provide investment advice in California must carefully analyze whether the they must register with California Department of Corporations or the SEC.