77190 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

1Unless otherwise noted, all references to rules 

under the Advisers Act will be to title 17, part 275 

of the Code of Federal Regulations (17 CFR 275). 

2 Dodd-Frank Wall Street Reform and Consumer 

Protection Act, Public Law 111–203, 124 Stat. 1376 

(2010). 

3 In this Release, when we refer to the ‘‘Advisers 

Act,’’ we refer to the Advisers Act as in effect on 

July 21, 2011. 

4Section 419 of the Dodd-Frank Act. 

5 15 U.S.C. 80b-3(b)(3) as in effect before July 21, 

2011. 

6See section 204(a) of the Advisers Act. See also 

infra note 30. 

7See S. Rep. No. 111–176, at 71–3 (2010) (‘‘S. 

Rep. No. 111–176’’); H. Rep. No. 111–517, at 866 

[FR Doc. 2010–29956 Filed 12–9–10; 8:45 am] 

BILLING CODE C 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 275 

[Release No. IA–3111; File No. S7–37–10] 

RIN 3235–AK81 

Exemptions for Advisers to Venture 

Capital Funds, Private Fund Advisers 

With Less Than $150 Million in Assets 

Under Management, and Foreign 

Private Advisers 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule. 

SUMMARY: The Securities and Exchange 

Commission (the ‘‘Commission’’) is 

proposing rules that would implement 

new exemptions from the registration 

requirements of the Investment Advisers 

Act of 1940 for advisers to certain 

privately offered investment funds that 

were enacted as part of the Dodd-Frank 

Wall Street Reform and Consumer 

Protection Act (the ‘‘Dodd-Frank Act’’). 

As required by Title IV of the DoddFrank Act—the Private Fund Investment 

Advisers Registration Act of 2010, the 

new rules would define ‘‘venture capital 

fund’’ and provide for an exemption for 

advisers with less than $150 million in 

private fund assets under management 

in the United States. The new rules 

would also clarify the meaning of 

certain terms included in a new 

exemption for foreign private advisers. 

DATES: Comments should be received on 

or before January 24, 2011. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/proposed.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number S7–37–10 on the subject line; 

or 

• Use the Federal eRulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090. 

All submissions should refer to File 

Number S7–37–10. This file number 

should be included on the subject line 

if e-mail is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/ 

proposed.shtml). Comments are also 

available for Web site viewing and 

printing in the Commission’s Public 

Reference Room, 100 F Street, NE., 

Washington, DC 20549, on official 

business days between the hours of 10 

a.m. and 3 p.m. All comments received 

will be posted without change; we do 

not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly. 

FOR FURTHER INFORMATION CONTACT: 

Tram N. Nguyen, Daniele Marchesani, 

or David A. Vaughan, at (202) 551–6787 

or (IArules@sec.gov), Division of 

Investment Management, U.S. Securities 

and Exchange Commission, 100 F 

Street, NE., Washington, DC 20549– 

8549. 

SUPPLEMENTARY INFORMATION: The 

Commission is requesting public 

comment on proposed rules 203(l)–1, 

203(m)–1 and 202(a)(30)–1 (17 CFR 

275.203(l)–1, 275.203(m)–1 and 

275.202(a)(30)–1) under the Investment 

Advisers Act of 1940 (15 U.S.C. 80b) 

(‘‘Advisers Act’’).1

Table of Contents 

I. Background 

II. Discussion 

A. Definition of Venture Capital Fund 

1. Qualifying Portfolio Companies 

2. Management Involvement 

3. Limitation on Leverage 

4. No Redemption Rights 

5. Represents Itself as a Venture Capital 

Fund 

6. Is a Private Fund 

7. Other Factors 

8. Application to Non-U.S. Advisers 

9. Grandfathering Provision 

B. Exemption for Investment Advisers 

Solely to Private Funds With Less Than 

$150 million in Assets Under 

Management 

1. Advises Solely Private Funds 

2. Private Fund Assets 

3. Assets Managed in the United States 

4. United States Person 

5. Transition Rule 

C. Foreign Private Advisers 

1. Clients 

2. Private Fund Investor 

3. In the United States 

4. Place of Business 

5. Assets Under Management 

D. Subadvisory Relationships and 

Advisory Affiliates 

III. Request for Comment 

IV. Paperwork Reduction Act Analysis 

V. Cost-Benefit Analysis 

VI. Regulatory Flexibility Act Certification 

VII. Statutory Authority 

Text of Proposed Rules 

I. Background 

On July 21, 2010, President Obama 

signed into law the Dodd-Frank Act,2

which amends various provisions of the 

Advisers Act and requires or authorizes 

the Commission to adopt several new 

rules and revise existing rules.3 Unless 

otherwise provided for in the DoddFrank Act, the amendments become 

effective on July 21, 2011.4

The amendments include the repeal 

of section 203(b)(3) of the Advisers Act, 

which exempts any investment adviser 

from registration if the investment 

adviser (i) Has had fewer than 15 clients 

in the preceding 12 months, (ii) does not 

hold itself out to the public as an 

investment adviser and (iii) does not act 

as an investment adviser to a registered 

investment company or a company that 

has elected to be a business 

development company (the ‘‘private 

adviser exemption’’).5 Advisers 

specifically exempt under section 203(b) 

are not subject to reporting or 

recordkeeping provisions under the 

Advisers Act, and are not subject to 

examination by our staff.6

The primary purpose of Congress in 

repealing section 203(b)(3) was to 

require advisers to ‘‘private funds’’ to 

register under the Advisers Act.7 Private 


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Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 77191 

(2010) (‘‘H. Rep. No. 111–517’’). H. Rep. No. 111– 

517 contains the conference report accompanying 

the version of H.R. 4173 that was debated in 

conference, infra note 39. 

8 15 U.S.C. 80a. 

9Section 202(a)(29) of the Advisers Act defines 

the term ‘‘private fund’’ as ‘‘an issuer that would be 

an investment company, as defined in section 3 of 

the Investment Company Act of 1940 (15 U.S.C. 

80a-3), but for section 3(c)(1) or 3(c)(7) of that Act.’’ 

10 Interests in a private fund may be offered 

pursuant to an exemption from registration under 

the Securities Act of 1933 (15 U.S.C. 77a) 

(‘‘Securities Act’’). Notwithstanding these 

exemptions, the persons who market interests in a 

private fund may be subject to the registration 

requirements of section 15(a) under the Securities 

Exchange Act of 1934 (‘‘Exchange Act’’) (15 U.S.C. 

78o(a)). The Exchange Act generally defines a 

‘‘broker’’ as any person engaged in the business of 

effecting transactions in securities for the account 

of others. Section 3(a)(4)(A) of the Exchange Act (15 

U.S.C. 78c(a)(4)(A)). See also Definition of Terms in 

and Specific Exemptions for Banks, Savings 

Associations, and Savings Banks Under Sections 

3(a)(4) and 3(a)(5) of the Securities Exchange Act 

of 1934, Exchange Act Release No. 44291 (May 11, 

2001) [66 FR 27759 (May 18, 2001)], at n.124 

(‘‘Solicitation is one of the most relevant factors in 

determining whether a person is effecting 

transactions.’’); Political Contributions by Certain 

Investment Advisers, Investment Advisers Act 

Release No. 3043 (July 1, 2010) [75 FR 41018 (July 

14, 2010)], n.326 (‘‘Pay to Play Release’’). 

11See section 3(c)(1) of the Investment Company 

Act (providing an exclusion from the definition of 

‘‘investment company’’ for any ‘‘issuer whose 

outstanding securities (other than short-term paper) 

are beneficially owned by not more than one 

hundred persons and which is not making and does 

not presently propose to make a public offering of 

its securities.’’). 

12See supra note 10. 

13See section 3(c)(7) of the Investment Company 

Act (providing an exclusion from the definition of 

‘‘investment company’’ for any ‘‘issuer, the 

outstanding securities of which are owned 

exclusively by persons who, at the time of 

acquisition of such securities, are qualified 

purchasers, and which is not making and does not 

at that time propose to make a public offering of 

such securities.’’). The term ‘‘qualified purchaser’’ is 

defined in section 2(a)(51) of the Investment 

Company Act. 

14See rule 203(b)(3)-1(a)(2). 

15See Staff Report to the united states securities 

and exchange Commission, Implications of the 

Growth of Hedge Funds, at 21 (2003), http:// 

www.sec.gov/news/studies/hedgefunds0903.pdf 

(discussing section 203(b)(3) of the Advisers Act as 

in effect before July 21, 2011). 

16See generally id. (noting that the private 

adviser exemption contributed to growth in the 

number and size of, and investor participation in, 

hedge funds). 17See Registration Under the Advisers Act of 

Certain Hedge Fund Advisers, Investment Advisers 

Act Release No. 2333 (Dec. 2, 2004) [69 FR 72054 

(Dec. 10, 2004)] (‘‘Hedge Fund Adviser Registration 

Release’’). 

18 Goldstein v. Securities and Exchange 

Commission, 451 F.3d 873 (D.C. Cir. 2006) 

(‘‘Goldstein’’). 

19Section 403 of the Dodd-Frank Act amends 

existing section 203(b)(3) of the Advisers Act by 

repealing the current private adviser exemption and 

inserting the foreign private adviser exemption. See 

infra Section II.C. Unlike our 2004 rule, which 

sought to apply only to advisers of ‘‘hedge funds,’’ 

the Dodd-Frank Act requires that, unless another 

exemption applies, all advisers previously eligible 

for the private adviser exemption register with us 

regardless of the type of private funds or other 

clients the adviser has. 

20Title IV also created exemptions and exclusions 

in addition to the three discussed at length in this 

Release. See, e.g., sections 403 and 409 of the DoddFrank Act (exempting advisers to licensed small 

business investment companies from registration 

under the Advisers Act and excluding family offices 

from the definition of ‘‘investment adviser’’ under 

the Advisers Act). We proposed a rule defining 

‘‘family office’’ in a prior release (Family Offices, 

Investment Advisers Act Release No. 3098 (Oct. 12, 

2010) [75 FR 63753 (Oct. 18, 2010)]). 

21See section 407 of the Dodd-Frank Act 

(exempting advisers solely to ‘‘venture capital 

funds,’’ as defined by the Commission). 

22See section 408 of the Dodd-Frank Act 

(directing the Commission to exempt private fund 

advisers with less than $150 million in aggregate 

assets under management in the United States). 

23See section 402 of the Dodd-Frank Act 

(defining ‘‘foreign private adviser’’ as ‘‘any 

investment adviser who—(A) Has no place of 

business in the United States; (B) has, in total, fewer 

than 15 clients and investors in the United States 

in private funds advised by the investment adviser; 

(C) has aggregate assets under management 

attributable to clients in the United States and 

investors in the United States in private funds 

advised by the investment adviser of less than 

$25,000,000, or such higher amount as the 

Commission may, by rule, deem appropriate in 

accordance with the purposes of this title; and (D) 

neither—(i) Holds itself out generally to the public 

in the United States as an investment adviser; nor 

(ii) acts as—(I) an investment adviser to any 

investment company registered under the 

Investment Company Act of 1940 [15 U.S.C. 80a]; 

or a company that has elected to be a business 

development company pursuant to section 54 of the 

Investment Company Act of 1940 (15 U.S.C. 80a53), and has not withdrawn its election.’’). 

24The Commission provided the public with an 

opportunity to present its views on various 

rulemaking and other initiatives that the DoddFrank Act required the Commission to undertake. 

Public views relating to our rulemaking in 

connection with the exemptions for certain advisers 

addressed in this Release are available at http:// 

www.sec.gov/comments/df-title-iv/exemptions/ 

exemptions.shtml. 

25Rules Implementing Amendments to the 

Investment Advisers Act of 1940, Investment 

Advisers Act Release No. 3110 (Nov. 19, 2010). 

26See infra note 30 and accompanying and 

following text. 

27See supra note 21. 

funds include hedge funds, private 

equity funds and other types of pooled 

investment vehicles that are excluded 

from the definition of ‘‘investment 

company’’ under the Investment 

Company Act of 1940 8 (‘‘Investment 

Company Act’’) by reason of sections 

3(c)(1) or 3(c)(7) of such Act.9 Section 

3(c)(1) is available to a fund that does 

not publicly offer the securities it 

issues 10 and has 100 or fewer beneficial 

owners of its outstanding securities.11 A 

fund relying on section 3(c)(7) cannot 

publicly offer the securities it issues 12

and generally must limit the owners of 

its outstanding securities to ‘‘qualified 

purchasers.’’ 13

Each of these types of private funds 

advised by an adviser typically qualifies 

as a single client for purposes of the 

private adviser exemption.14 As a result, 

investment advisers could form up to 14 

private funds, regardless of the total 

number of investors investing in the 

funds, without the need to register with 

us.15 This has permitted the growth of 

unregistered investment advisers with 

large amounts of assets under 

management and significant numbers of 

investors but without the Commission 

oversight that registration under the 

Advisers Act provides.16 Concern about 

this lack of Commission oversight led us 

to adopt a rule in 2004 extending 

registration to hedge fund advisers,17

which was vacated by a federal court in 

2006.18 In Title IV of the Dodd-Frank 

Act (‘‘Title IV’’), Congress has now 

generally extended Advisers Act 

registration to advisers to hedge funds 

and many other private funds by 

eliminating the current private adviser 

exemption.19

In addition to removing the broad 

exemption provided by section 

203(b)(3), Congress created three 

exemptions from registration under the 

Advisers Act.20 These new exemptions 

apply to: (i) Advisers solely to venture 

capital funds, without regard to the 

number of such funds advised by the 

adviser or the size of such funds; 21 (ii) 

advisers solely to private funds with 

less than $150 million in assets under 

management in the United States, 

without regard to the number or type of 

private funds advised; 22 and (iii) nonU.S. advisers with less than $25 million 

in aggregate assets under management 

from U.S. clients and private fund 

investors and fewer than 15 such clients 

and investors.23

II. Discussion 

Today we are proposing three rules 

that would implement these 

exemptions.24 In a separate companion 

release (the ‘‘Implementing Release’’),25

we are proposing rules to implement 

other amendments made to the Advisers 

Act by the Dodd-Frank Act, some of 

which also concern certain advisers that 

qualify for the exemptions discussed in 

this Release.26

New section 203(l) of the Advisers 

Act provides that an investment adviser 

that solely advises venture capital funds 

is exempt from registration under the 

Advisers Act and directs the 

Commission to define ‘‘venture capital 

fund’’ within one year of enactment.27

We are proposing new rule 203(l)-1 to 

provide such a definition, which we 

discuss below in Section II.A of this 

Release. 

New section 203(m) of the Advisers 

Act directs the Commission to provide 

an exemption from registration to any 

investment adviser that solely advises 

private funds if the adviser has assets 


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77192 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

28See supra note 22. 

29See supra notes 21 and 22. 

30Under section 204(a) of the Advisers Act, the 

Commission has the authority to require an 

investment adviser to maintain records and provide 

reports, as well as the authority to examine such 

adviser’s records, unless the adviser is ‘‘specifically 

exempted’’ from the requirement to register 

pursuant to section 203(b) of the Advisers Act. 

Investment advisers that are exempt from 

registration in reliance on section 203(l) or 203(m) 

of the Advisers Act are not ‘‘specifically exempted’’ 

from the requirement to register pursuant to section 

203(b), and thus the Commission has authority 

under section 204(a) of the Advisers Act to require 

those advisers to maintain records and provide 

reports and has authority to examine such advisers’ 

records. 

31See Implementing Release, supra note 25, at 

section II.B. 

32Subparagraph (B) of section 202(a)(30) refers to 

number of ‘‘clients and investors in the United 

States in private funds,’’ while subparagraph (C) 

refers to the assets of ‘‘clients in the United States 

and investors in the United States in private funds’’ 

(emphasis added). We interpret these provisions 

consistently so that only clients in the United States 

and investors in the United States should be 

included for purposes of determining eligibility for 

the exemption under subparagraph (B). 

33The exemption is not available to an adviser 

that ‘‘acts as (I) an investment adviser to any 

investment company registered under the 

[Investment Company Act]; or (II) a company that 

has elected to be a business development company 

pursuant to section 54 of [that Act] and has not 

withdrawn its election.’’ Section 202(a)(30)(D)(ii). 

We interpret subparagraph (II) to prevent an adviser 

that advises a business development company from 

relying on the exemption. 

34Proposed rule 202(a)(30)-1 would define the 

following terms: (i) ‘‘client;’’ (ii) ‘‘investor;’’ (iii) ‘‘in 

the United States;’’ (iv) ‘‘place of business;’’ and (v) 

‘‘assets under management.’’ See discussion infra in 

section II.C of this Release. We are proposing rule 

202(a)(30)-1 pursuant to section 211(a) of the 

Advisers Act, which Congress amended to 

explicitly provide us with the authority to define 

technical, trade, and other terms used in the 

Advisers Act. See section 406 of the Dodd-Frank 

Act. 

35Section 203A(a)(1) of the Advisers Act 

generally prohibits an investment adviser regulated 

by the state in which it maintains its principal 

office and place of business from registering with 

the Commission unless it has at least $25 million 

of assets under management, and preempts certain 

state laws regulating advisers that are registered 

with the Commission. Section 410 of the DoddFrank Act amended section 203A(a) to also prohibit 

generally from registering with the Commission an 

investment adviser that has assets under 

management between $25 million and $100 million 

if the adviser is required to be registered with, and 

if registered, would be subject to examination by, 

the state security authority where it maintains its 

principal office and place of business. See section 

203A(a)(2) of the Advisers Act. In each of 

subparagraphs (1) and (2) of section 203A(a), 

additional conditions also may apply. See 

Implementing Release, supra note 25, at section 

II.A. 

36See section 203A(b)(1) of the Advisers Act 

(exempting from state regulatory requirements only 

advisers registered with the Commission). See also 

infra note 265 (discussing the application of section 

222 of the Advisers Act). 

37See proposed rule 203(l)–1. 

38See infra notes 94, 123, 125 (discussing the 

history of and regulatory framework applicable to 

business development companies under federal 

securities laws). 

39While the Senate voted to exempt private 

equity fund advisers in addition to venture capital 

fund advisers, the final Dodd-Frank Act only 

exempts venture capital fund advisers. Compare 

Restoring American Financial Stability Act of 2010, 

S. 3217, 111th Cong. § 408 (2010) (as passed by the 

Senate) with Dodd-Frank Wall Street Reform and 

Consumer Protection Act of 2009, H.R. 4173, 111th 

Cong. (2009) (as passed by the House) (‘‘H.R. 4173’’) 

and Dodd-Frank Act. 

40See Testimony of Trevor Loy, Flywheel 

Ventures, before the Senate Banking Subcommittee 

on Securities, Insurance and Investment Hearing, 

July 15, 2009 (‘‘Loy Testimony’’), at 3; Testimony of 

James Chanos, Chairman, Coalition of Private 

Investment Companies, July 15, 2009, at 4 (‘‘Chanos 

Testimony’’) (‘‘Private investment companies play 

significant, diverse roles in the financial markets 

and in the economy as a whole. For example, 

venture capital funds are an important source of 

funding for start-up companies or turnaround 

ventures. Other private equity funds provide growth 

capital to established small-sized companies, while 

still others pursue ‘buyout’ strategies by investing 

in underperforming companies and providing them 

with capital and/or expertise to improve results.’’); 

Testimony of Mark Tresnowksi, General Counsel, 

Madison Dearborn Partners, LLC, on behalf of the 

Private Equity Council, before the Senate Banking 

Subcommittee on Securities, Insurance and 

Investment, July 15, 2009, at 2 (‘‘Tresnowski 

Testimony’’) (stating that private equity firms invest 

in broad categories of companies, including 

‘‘struggling and underperforming businesses’’ and ’’ 

promising or strong companies’’). See also Preqin, 

Private Equity and Alternative Asset Glossary, 

http://www.preqin.com/ 

itemGlossary.aspx?pnl=UtoZ (defining venture 

capital as ‘‘a type of private equity investment that 

provides capital to new or growing businesses. 

Venture funds invest in start-up firms and small 

businesses with perceived, long-term growth 

potential.’’). 

41Loy Testimony, supra note 40, at 3; Testimony 

of Terry McGuire, General Partner, Polaris Venture 

Partners, and Chairman, National Venture Capital 

Association, before the U.S. House of 

Representatives Committee on Financial Services, 

October 6, 2009, at 3 (‘‘McGuire Testimony’’) (‘‘Our 

under management in the United States 

of less than $150 million.28 We are 

proposing such an exemption in a new 

rule 203(m)–1, which we discuss below 

in Section II.B of this Release. Proposed 

rule 203(m)–1 includes provisions for 

determining the amount of an adviser’s 

private fund assets for purposes of the 

exemption and when those assets are 

deemed managed in the United States. 

The new exemptions under sections 

203(l) and 203(m) provide that the 

Commission shall require advisers 

relying on them to provide the 

Commission with reports and keep 

records as the Commission determines 

necessary or appropriate in the public 

interest or for the protection of 

investors.29 These new exemptions do 

not limit our statutory authority to 

examine the books and records of 

advisers relying upon these 

exemptions.30 For purposes of this 

Release we will refer to these advisers 

as ‘‘exempt reporting advisers.’’ In the 

Implementing Release, we are proposing 

reporting requirements for exempt 

reporting advisers.31

The third exemption, set forth in 

amended section 203(b)(3) of the 

Advisers Act, provides an exemption 

from registration for certain foreign 

private advisers. New section 202(a)(30) 

of the Advisers Act defines ‘‘foreign 

private adviser’’ as an investment 

adviser that has no place of business in 

the United States, has fewer than 15 

clients in the United States and 

investors in the United States in private 

funds advised by the adviser,32 and less 

than $25 million in aggregate assets 

under management from such clients 

and investors.33 As discussed in Section 

II.C of this Release, in order to clarify 

the application of this new exemption, 

we are proposing a new rule 202(a)(30)- 

1, which would define a number of 

terms included in the statutory 

definition of foreign private adviser.34

These exemptions are not mandatory. 

Thus, an adviser that qualifies for any 

of the exemptions could choose to 

register (or remain registered) with the 

Commission, subject to section 203A of 

the Advisers Act, which generally 

prohibits from registering with the 

Commission most advisers that do not 

have at least $100 million in assets 

under management.35 An adviser 

choosing to avail itself of the 

exemptions under sections 203(l), 

203(m) or 203(b)(3), however, may be 

subject to registration by one or more 

state securities authorities.36

A. Definition of Venture Capital Fund 

We are proposing a definition of 

‘‘venture capital fund’’ for purposes of 

the new exemption for investment 

advisers that advise solely venture 

capital funds.37 Proposed rule 203(l)-1 

would define the term venture capital 

fund consistently with what we believe 

Congress understood venture capital 

funds to be, and in light of other 

provisions of the federal securities laws 

that seek to achieve similar objectives.38

We understand that Congress sought 

to distinguish advisers to ‘‘venture 

capital funds’’ from the larger category 

of advisers to ‘‘private equity funds’’ for 

which Congress considered, but 

ultimately did not provide, an 

exemption.39 As a general matter, 

venture capital funds are long-term 

investors in early-stage or small 

companies that are privately held, as 

distinguished from other types of 

private equity funds, which may invest 

in businesses at various stages of 

development including mature, publicly 

held companies.40 Testimony received 

by Congress characterized venture 

capital funds as typically contributing 

substantial capital to early-stage 

companies 41 and generally not 


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Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 77193 

job is to find the most promising, innovative ideas, 

entrepreneurs, and companies that have the 

potential to grow exponentially with the 

application of our expertise and venture capital 

investment. Often these companies are formed from 

ideas and entrepreneurs that come out of university 

and government laboratories—or even someone’s 

garage.’’). See also National Venture Capital 

Association Yearbook 2010, at 7–8 (noting that 

venture capital is a ‘‘long-term investment’’ and the 

‘‘payoff [to the venture capital firm] comes after the 

company is acquired or goes public’’) (‘‘NVCA 

Yearbook 2010’’); Private Equity Growth Capital 

Council, Private Equity: Frequently Asked 

Questions, http://www.privateequitycouncil.org/ 

just-the-facts/private-equity-frequently-askedquestions/ (noting that venture capital funds focus 

on ‘‘start-up and young companies with little or no 

track record,’’ whereas buyout and growth funds 

focus on more mature businesses). 

42Loy Testimony, supra note 40, at 3. See also 

McGuire Testimony, supra note 41, at 3–4 (‘‘most 

limited partnership agreements [of venture capital 

funds] * * * prohibit [the venture capital fund] 

from any type of long term borrowing. * * * 

Leverage is not part of the equation because startups do not typically have the ability to sustain debt 

interest payments and often do not have collateral 

that lenders desire. In fact most of our companies 

are not profitable and require our equity to fund 

their losses through their initial growth period.’’). 

43See S. Rep. No. 111–176, supra note 7, at 74– 

5 (noting that venture capital funds ‘‘do not present 

the same risks as the large private funds whose 

advisers are required to register with the SEC under 

this title [IV]. Their activities are not interconnected 

with the global financial system, and they generally 

rely on equity funding, so that losses that may occur 

do not ripple throughout world markets but are 

borne by fund investors alone. Terry McGuire, 

Chairman of the National Venture Capital 

Association, wrote in congressional testimony that 

‘venture capital did not contribute to the implosion 

that occurred in the financial system in the last 

year, nor does it pose a future systemic risk to our 

world financial markets or retail investors.’’’). See 

also Loy Testimony, supra note 40, at 7 (noting the 

factors by which the venture capital industry is 

exposed to ‘‘entrepreneurial and technological risk 

not systemic financial risk’’). 

44See H. Rep. No. 96–1341, at 21–22 (1980) 

(‘‘1980 House Report’’). 

45See infra note 123 for a discussion of these 

definitions. 

46See 1980 House Report, supra note 44, at 22. 

47See id., at 21. 

48Proposed rule 203(l)–1(a). 

49Proposed rule 203(l)–1(b). 

50Proposed rule 203(l)–1(c)(4). 

51Proposed rule 203(l)–1(a)(2). 

52See infra sections II.A.1.a–II.A.1.e of this 

Release. 

53Proposed rule 203(l)–1(a)(2). 

54Proposed rule 203(l)–1(c)(4)(i); proposed rule 

203(l)–1(c)(3) (defining a ‘‘publicly traded’’ 

company as one that is subject to the reporting 

requirements under section 13 or 15(d) of the 

Exchange Act, or has a security listed or traded on 

any exchange or organized market operating in a 

foreign jurisdiction). This definition is similar to 

rule 2a51–1 under the Investment Company Act 

(defining ‘‘public company,’’ for purposes of the 

qualified purchaser standard, as ‘‘a company that 

files reports pursuant to section 13 or 15(d) of the 

Securities Exchange Act of 1934’’) and rule 12g3– 

2 under the Exchange Act (conditioning a foreign 

private issuer’s exemption from registering 

securities under section 12(g) of the Exchange Act 

if, among other conditions, the ‘‘issuer is not 

required to file or furnish reports’’ pursuant to 

section 13(a) or section 15(d) of the Exchange Act). 

Under the proposed rule, securities of a publicly 

traded company, as defined, would include 

securities of non-U.S. companies that are listed on 

a non-U.S. market or non-U.S. exchange. Some 

securities that are ‘‘pink sheets’’ (i.e., generally overthe-counter securities that are quoted on an 

electronic quotation system operated by Pink OTC 

Markets) are not subject to the reporting 

requirements under sections 13 and 15(d) of the 

Exchange Act and would not be publicly traded for 

purposes of the proposed rule. 

55See Chanos Testimony, supra note 40, at 4 

(‘‘[V]enture capital funds are an important source of 

funding for start-up companies or turnaround 

ventures.’’); NVCA Yearbook 2010, supra note 41, at 

7–8 (noting that venture capital is a ‘‘long-term 

Continued 

leveraged,42 and thus not contributing to 

systemic risk, a factor that appears 

significant to Congress’ determination to 

exempt these advisers.43 In drafting the 

proposed rule, we have sought to 

incorporate this Congressional 

understanding of the nature of 

investments of a venture capital fund, 

and these principles guided our 

consideration of the proposed venture 

capital fund definition. 

This is not the first time that Congress 

has included special provisions to the 

federal securities laws for these types of 

private funds and the advisers that 

advise them. In 1980, in an effort to 

promote capital raising by small 

businesses,44 Congress provided 

exemptions from various requirements 

in the Investment Company Act and 

Advisers Act for ‘‘business development 

companies’’ (or ‘‘BDCs’’).45 Congress 

adopted the term BDC to avoid 

‘‘semantical disagreements’’ over what 

constituted a venture capital or small 

business company,46 but acknowledged 

that the purpose of the BDC provisions 

was to support ‘‘venture capital’’ activity 

in capital formation for small 

businesses.47 The BDC provisions and 

venture capital exemption reflect many 

similar policy considerations, and thus 

in drafting the definition of ‘‘venture 

capital fund,’’ we have looked, in part, 

to language Congress previously used to 

describe these types of funds. 

As described in more detail below, we 

propose to define a venture capital fund 

as a private fund that: (i) Invests in 

equity securities of private companies in 

order to provide operating and business 

expansion capital (i.e., ‘‘qualifying 

portfolio companies,’’ which are 

discussed below) and at least 80 percent 

of each company’s securities owned by 

the fund were acquired directly from the 

qualifying portfolio company; (ii) 

directly, or through its investment 

advisers, offers or provides significant 

managerial assistance to, or controls, the 

qualifying portfolio company; (iii) does 

not borrow or otherwise incur leverage 

(other than limited short-term 

borrowing); (iv) does not offer its 

investors redemption or other similar 

liquidity rights except in extraordinary 

circumstances; (v) represents itself as a 

venture capital fund to investors; and 

(vi) is not registered under the 

Investment Company Act and has not 

elected to be treated as a BDC.48 We also 

propose to grandfather an existing fund 

as a venture capital fund if it satisfies 

certain criteria under the grandfathering 

provision.49 An adviser would be 

eligible to rely on the exemption under 

section 203(l) of the Advisers Act (the 

‘‘venture capital exemption’’) only if it 

solely advised venture capital funds that 

met all of the elements of the proposed 

definition or if it were grandfathered. 

1. Qualifying Portfolio Companies 

We propose to define a venture 

capital fund for the purposes of the 

exemption as a fund that invests in 

equity securities issued by ‘‘qualifying 

portfolio companies,’’ which we define 

generally as any company that: (i) Is not 

publicly traded; (ii) does not incur 

leverage in connection with the 

investment by the private fund; (iii) uses 

the capital provided by the fund for 

operating or business expansion 

purposes rather than to buy out other 

investors; and (iv) is not itself a fund 

(i.e., is an operating company).50 In 

addition to equity securities, the venture 

capital fund may also hold cash (and 

cash equivalents) and U.S. Treasuries 

with a remaining maturity of 60 days or 

less.51 We understand each of the 

criteria to be characteristic of issuers of 

portfolio securities held by venture 

capital funds.52 Moreover, collectively, 

these criteria would operate to exclude 

most other private equity funds and 

hedge funds from the definition. We 

describe each element of a qualifying 

portfolio company below. 

a. Private Companies 

We propose to define a venture 

capital fund as a fund that invests in 

equity securities of qualifying portfolio 

companies and cash and cash 

equivalents and U.S. Treasuries with a 

remaining maturity of 60 days or less.53

At the time of each investment by the 

venture capital fund, the portfolio 

company could not be publicly traded 

nor could it control, be controlled by, or 

be under common control with, a 

publicly traded company.54 Under the 

proposed definition, a venture capital 

fund could continue to hold securities 

of a portfolio company that 

subsequently becomes public. 

Venture capital funds provide 

operating capital to companies in the 

early stages of their development with 

the goal of eventually either selling the 

company or taking it public.55 Unlike 


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77194 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

investment’’ and the ‘‘payoff [to the venture capital 

firm] comes after the company is acquired or goes 

public.’’); George W. Fenn, Nellie Liang and 

Stephen Prowse, The Economics of the Private 

Equity Market, December 1995, 22, n.61 and 

accompanying text (‘‘Fenn et al.’’) (‘‘Private sales’’ 

are not normally the most important type of exit 

strategy as compared to IPOs, yet of the 635 

successful portfolio company exits by venture 

capitalists between 1991–1993 ‘‘merger and 

acquisition transactions accounted for 191 deals 

and IPOs for 444 deals.’’ Furthermore, between 1983 

and 1994, of the 2,200 venture capital fund exits, 

1,104 (approximately 50%) were attributed to 

mergers and acquisitions of venture-backed firms.). 

See also Jack S. Levin, Structuring Venture Capital, 

Private Equity and Entrepreneurial Transactions, 

2000 (‘‘Levin’’) at 1–2 to 1–7 (describing the various 

types of venture capital and private equity 

investment business but stating that ‘‘the phrase 

‘venture capital’ is sometimes used narrowly to 

refer only to financing the start-up of a new 

business’’); Anna T. Pinedo & James R. Tanenbaum, 

Exempt and Hybrid Securities Offerings (2009), Vol. 

1 at 12–2 (‘‘Pinedo’’) (discussing the role initial 

public offerings play in providing venture capital 

investors with liquidity). 

56See Loy Testimony, supra note 40, at 5 (‘‘We 

do not trade in the public markets.’’). See also 

McGuire Testimony, supra note 41, at 11 

(‘‘[V]enture capital funds do not typically trade in 

the public markets and generally limit advisory 

activities to the purchase and sale of securities of 

private operating companies in private 

transactions’’); Levin, supra note 55, at 1–4 (‘‘A third 

distinguishing feature of venture capital/private 

equity investing is that the securities purchased are 

generally privately held as opposed to publicly 

traded * * * a venture capital/private equity 

investment is normally made in a privately-held 

company, and in the relatively infrequent cases 

where the investment is into a publicly-held 

company, the [venture capital fund] generally holds 

non-public securities.’’) (emphasis in original). 

57NVCA Yearbook 2010, supra note 41, at 9. 

58Bloomberg Terminal Database, WCAUUS 

(Bloomberg United States Exchange Market 

Capitalization). 

59See Saijel Kishan, Hedge Funds Hold Investors 

‘‘Hostage’’ After Decade’s Best Year, Bloomberg 

Businessweek, Jan. 20, 2010, available at http:// 

www.businessweek.com/news/2010–01–20/hedgefunds-hold-investors-hostage-after-decade-s-bestyear.html. 

60See supra note 43; McGuire Testimony, supra 

note 41, at 6 (noting that the ‘‘venture capital 

industry’s activities are not interwoven with U.S. 

financial markets.’’). See also Group of Thirty, 

Financial Reform: A Framework for Financial 

Stability, January 15, 2009, at 9 (discussing the need 

for registration of managers of ‘‘private pools of 

capital that employ substantial borrowed funds’’ yet 

recognizing the need to exempt venture capital from 

registration). 

61See supra note 43. 

62See S. Rep. No. 111–176, supra note 7, at 74 

(describing venture capital funds as a subset of 

private investment companies, specializing in longterm equity investments in ‘‘small or start-up 

businesses’’). 

63There is no generally accepted definition of a 

‘‘start-up’’ entity although it is generally used to 

refer to new business ventures. See, e.g., U.S. 

Census Bureau, Business Dynamics Statistics, 

available at http://www.ces.census.gov/index.php/ 

bds/bds_overview (which tracks information on 

businesses, based on the size and age of the 

business, and assigns a ‘‘birth’’ year to a business 

beginning in the year in which it reports positive 

employment of workers on the payroll); The 

Kauffman Foundation, Where Will the Jobs Come 

From?, November 2009, at 5 (identifying ‘‘start-ups’’ 

as those firms younger than one year); Anastasia Di 

Carlo & Roger Kelly, Private Equity Market Outlook 

27 (European Investment Fund, Working Paper 

2010/005) (defining start-ups as companies that are 

‘‘in the process of being set up or may have been 

in business for a short time, but have not sold their 

product commercially’’). 

64See, e.g., The Kauffman Foundation, An 

Overview of the Kauffman Firm Survey, Results 

from the 2004–2008 Data, May 2010, at 26 

(‘‘Overview of the Kauffman Firm Survey’’) 

(discussing the difficulties of compiling data on 

new businesses; start-up businesses were generally 

identified based on several factors: the payment of 

state unemployment taxes, the payment of Federal 

Insurance Contributions Act taxes, the existence of 

a legal entity, use of an employer identification 

number, and use of a schedule C to report business 

income on a personal tax return). 

65See, e.g., NVCA Yearbook 2010, supra note 41, 

at 61, 69, 111 (not defining ‘‘start-up’’ but classifying 

investments in ‘‘start-up/seed’’ companies and 

defining the ‘‘seed stage’’ of a company as ‘‘the state 

of a company when it has just been incorporated 

and its founders are developing their product or 

service,’’ whereas an ‘‘early stage’’ company is one 

that is beyond the ‘‘seed stage’’ but has not yet 

generated revenues). Cf. PricewaterhouseCoopers 

MoneyTree Report Definitions, https:// 

www.pwcmoneytree.com/MTPublic/ns/ 

nav.jsp?page=definitions (last visited Sept. 23, 

2010) (defining a ‘‘seed/start-up’’ company as one 

that has a concept or product in development but 

not yet operational and usually has been in 

existence for less than 18 months). 

66According to the Kauffman Survey, in 2004, 

36.0% of all start-up companies were sole 

proprietorships; by 2008, 34.4% of all surviving 

companies were sole proprietorships. Overview of 

the Kauffman Firm Survey, supra note 64, at 8. 

67See, e.g., Ying Lowrey, Startup Business 

Characteristics and Dynamics: A Data Analysis of 

the Kauffman Firm Survey, Aug. 2009, at 6 

(Working Paper) (based on a survey sample of 

businesses started in 2004, reporting that 59% of all 

start-up companies in 2004 had zero employees; a 

‘‘start-up’’ business was any business that met any 

one of the five following criteria for being a startup: the payment of state unemployment taxes, the 

payment of Federal Insurance Contributions Act 

taxes, the existence of a legal entity, use of an 

employer identification number, and use of a 

schedule C to report business income on a personal 

tax return). 

68According to the Kauffman Survey, which 

conducted a longitudinal study of ‘‘start-up’’ 

businesses that began in 2004, 46.5% of all such 

‘‘start-up’’ companies in 2004 had zero revenues; by 

2008, 30.2% of the surviving companies in the 

sample reported zero revenues. In comparison, in 

2004, 15.3% of start-up companies reported 

revenues of more than $100,000 and in 2008, 36.1% 

of the surviving companies in the survey reported 

revenues of more than $100,000. Overview of the 

Kauffman Firm Survey, supra note 64, at 9. 

69Among countries that are members of the 

Organisation for Economic Co-operation and 

Development, ‘‘small and medium-sized 

enterprises’’ (‘‘SMEs’’) are defined as non-subsidiary, 

independent firms employing fewer than the 

number of employees as is set by each country. The 

definition of SME may be used to determine 

funding or other programs sponsored by member 

countries. Although the European Union generally 

defines SMEs as businesses with fewer than 250 

employees, the United States sets the threshold at 

fewer than 500 employees. Moreover, ‘‘small’’ firms 

are generally defined as those with fewer than 50 

employees, while micro-enterprises have at most 

10, or in some cases five, workers. In 2005, the 

European Union adopted additional tests for small 

other types of private funds, venture 

capital funds do not trade in the public 

markets, but may sell portfolio company 

securities into the public markets once 

the portfolio company has matured.56

As of year-end 2009, U.S. venture 

capital funds managed approximately 

$179.4 billion in assets.57 In 

comparison, as of year-end 2009, the 

U.S. publicly traded equity market had 

a market value of approximately $13.7 

trillion,58 whereas global hedge funds 

had approximately $1.4 trillion in assets 

under management.59 As a 

consequence, the aggregate amount 

invested in venture capital funds is 

considerably smaller, and Congressional 

testimony asserted that these funds may 

be less connected with the public 

markets and may involve less potential 

for systemic risk.60 This appears to be a 

key consideration by Congress that led 

to the enactment of the venture capital 

exemption.61

We request comment on our proposed 

approach. We considered more narrow 

definitions, such as defining a 

qualifying portfolio company as a ‘‘startup company’’ or ‘‘small company.’’ 62

There appears to be little consensus, 

however, as to what a start-up company 

is. A company may be considered a 

‘‘start-up’’ business depending on when 

it was formed as a legal entity,63

whether it employs workers or paid 

employment taxes,64 or whether it has 

generated revenues.65 Defining a 

portfolio company based on any one of 

these factors may inadvertently exclude 

too many start-up portfolio companies. 

For example, solely relying on the age 

of the company (e.g., first year since 

incorporation) fails to recognize that 

many companies may be incorporated 

for some period of time prior to 

initiating business operations or remain 

unincorporated for significant periods of 

time.66 Likewise, payment of 

employment taxes assumes the hiring of 

employees, despite the fact that many 

new business ventures are sole 

proprietorships without employees.67

Such a test could also have the 

unintended effect of discouraging 

hiring. Similarly, a bright-line revenue 

test set too low could exclude young or 

new businesses that generate significant 

revenues more quickly than other 

companies.68 This could have the 

unintended consequence of venture 

capital funds that seek to fall within the 

definition investing in less promising, 

non-revenue generating, young 

companies. 

We also considered defining a 

qualifying portfolio company as a small 

company. As in the case of defining 

‘‘start-up,’’ there is no single definition 

for what constitutes a ‘‘small 

company.’’ 69 We are concerned that 


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Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 77195 

businesses, defining small business (i.e., 10–49 

employees) as those with no more than Ö10 million 

in annual revenue and no more than Ö10 million 

in assets as evidenced on their annual balance 

sheet. See, e.g., Organisation for Economic Cooperation and Development, Glossary of Statistical 

Terms, http://stats.oecd.org/glossary/ 

detail.asp?ID=3123. 

Under one regulatory framework in the United 

States, a business may be considered ‘‘small’’ 

depending on the specified number of employees or 

the net worth or net income of such business. 

Separate tests are specified for a business based on 

various factors, such as the size of the industry, its 

geographical concentration, and the number of 

market participants. See, e.g., Small Business 

Administration, SBA Size Standards Methodology 

(Apr. 2009) at 8, http://www.sba.gov/idc/groups/ 

public/documents/sba_homepage/ 

size_standards_methodology.pdf (noting that the 

Small Business Administration (‘‘SBA’’) decided to 

apply the net worth and net income measures to its 

Small Business Investment Company (‘‘SBIC’’) 

financing program because investment companies 

typically evaluate businesses using these measures 

when determining whether or not to invest). For 

example, under the SBIC program administered by 

the SBA, SBA loans may be made to SBICs that 

invest in companies that are ‘‘small’’ (usually 

defined as having a net worth of $18 million or less 

and an average after-tax net income for the prior 

two years of no more than $6 million, although 

there are specific tests depending on the industry 

of the company that may be based on net income, 

net worth or number of employees). The size 

requirement is codified at 13 CFR 121.301(c)(2). See 

SBA, Investment Program Summary, http:// 

www.sba.gov/financialassistance/borrowers/vc/ 

sbainvp/index.html. 70Under section 260.204.9 of the California Code 

of Regulations (the ‘‘California VC exemption’’), an 

adviser is exempt from the requirement to register 

if it provides investment advice only to ‘‘venture 

capital companies,’’ which are generally defined as 

entities that, on at least one annual occasion 

(commencing with the first annual period following 

the initial capitalization), have at least 50% of their 

assets (other than short-term investments pending 

long-term commitment or distribution to investors), 

valued at cost, in ‘‘venture capital investments.’’ A 

venture capital investment is defined as an 

acquisition of securities in an operating company as 

to which the adviser has or obtains management 

rights. See Cal. Code Regs. tit. 10, § 260.204.9(a), 

(b)(3), (b)(4) (2010). An ‘‘operating company’’ is 

defined to mean any entity ‘‘primarily engaged, 

directly or through a majority owned subsidiary or 

subsidiaries, in the production or sale (including 

any research or development) of a product or 

service other than the management or investment of 

capital but shall not include an individual or sole 

proprietorship.’’ Id. tit. 10, § 260.204.9(b)(7). 

‘‘Management rights’’ is defined as the ‘‘right, 

obtained contractually or through ownership of 

securities . . . to substantially participate in, to 

substantially influence the conduct of, or to provide 

(or offer to provide) significant guidance and 

counsel concerning, the management, operations or 

business objectives of the operating company in 

which the venture capital investment is made.’’ Id. 

tit. 10, § 260.204.9(b)(6). Management rights may be 

held by the adviser, the fund or an affiliated person 

of the adviser, and may be obtained either through 

one person or through two or more persons acting 

together. Id. 

The U.S. Department of Labor regulations (‘‘VCOC 

exemption’’) are similar to the California VC 

exemption. The regulations define ‘‘operating 

company’’ to mean an entity that is ‘‘primarily 

engaged, directly or through a majority owned 

subsidiary or subsidiaries, in the production or sale 

of a product or service other than the investment 

of capital. The term ‘operating company’ includes 

an entity that is not described in the preceding 

sentence, but that is a ‘venture capital operating 

company’ described in paragraph (d) or a ‘real 

estate operating company’ described in paragraph 

(e).’’ 29 CFR 2510.3–101(c)(1). The regulations 

define a venture capital operating company 

(‘‘VCOC’’) as any entity that, as of the date of the 

first investment (or other relevant time), has at least 

50% of its assets (other than short-term investments 

pending long-term commitment or distribution to 

investors), valued at cost, invested in venture 

capital investments. 29 CFR 2510.3–101(d). A 

venture capital investment is defined as ‘‘an 

investment in an operating company (other than a 

venture capital operating company) as to which the 

investor has or obtains management rights’’ that are 

‘‘contractual rights * * * to substantially 

participate in, or substantially influence the 

conduct of, the management of the operating 

company.’’ 29 CFR 2510.3–101(d)(3). 

71See Cal. Code Reg. tit. 10, § 260.204.9. 

72The California VC exemption does not limit 

permitted investments to companies that are startup or privately held companies, which were cited 

as characteristic of venture capital investing in 

testimony to Congress. See McGuire Testimony, 

supra note 41; Loy Testimony, supra note 40. 

73See Letter of Keith P. Bishop (July 28, 2009) 

(recommending elements of the California VC 

exemption). Cf. Letter of P. James (August 21, 2010) 

(expressing the view that the provision of 

management services does not distinguish venture 

capital from private equity). We received these 

letters in response to our request for public views 

on rulemaking and other initiatives under the 

Dodd-Frank Act. See generally supra note 24. 

74See, e.g., Loy Testimony, supra note 40, at 3 

(discussing the role of follow-on investments); 

NVCA Yearbook 2010, supra note 41, at 34 

(statistics comparing initial investments versus 

follow-on investments made by venture capital 

funds at Figure 3.15). 

75See proposed rule 203(l)–1(c)(4)(i). 

76See supra note 55. 

77See, e.g., rule 144 under the Securities Act (17 

CFR 230.144) (prohibiting the resale of certain 

restricted and control securities by ‘‘affiliates’’ 

unless certain conditions are met). 

imposing a standardized metric such as 

net income, the number of employees, 

or another single factor test could ignore 

the complexities of doing business in 

different industries or regions. As in the 

case of adopting a revenue-based test, 

there is the potential that even a low 

threshold for a size metric could 

inadvertently restrict venture capital 

funds from funding otherwise promising 

young small companies. 

Other tests also present concerns. A 

test adopted by the California 

Corporations Commission and the U.S. 

Department of Labor requires that a 

venture capital company hold at least 50 

percent of its assets in ‘‘operating 

companies,’’ which are defined as 

companies primarily engaged in the 

production or sale of a product or 

services other than the investment of 

capital.70 Under the California 

exemption, a venture capital fund could 

invest in older and more mature 

companies that qualify as ‘‘operating 

companies’’ as well as in securities 

issued by publicly traded companies 

provided that the venture capital fund 

obtained management rights in such 

publicly traded companies.71 Hence, 

although the California venture capital 

exemption is for advisers to so-called 

‘‘venture capital companies,’’ the rule 

provides a much broader exemption that 

would include many types of private 

equity and other types of private funds 

and thus does not appear consistent 

with our understanding of the intended 

scope of section 203(l).72 We request 

comment on any of these approaches or 

alternative ones that we have not 

discussed.73

We also request comment on our 

approach to ‘‘follow-on’’ investments.74

Under our proposed rule, a qualifying 

portfolio company is defined to include 

a company that is not publicly traded 

(or controlled by a publicly traded 

company) at the time of each fund 

investment,75 but would not exclude a 

portfolio company that ultimately 

becomes a successful venture capital 

investment (typically when the 

company is taken ‘‘public’’). Under this 

approach, an adviser could continue to 

rely on the exemption even if the 

venture capital fund’s portfolio 

ultimately consisted entirely of publicly 

traded securities, a result that could be 

viewed as inconsistent with section 

203(l) of the Advisers Act. We believe 

that our proposed approach would give 

advisers to venture capital funds 

sufficient flexibility to exercise their 

business judgment on the appropriate 

time to dispose of portfolio company 

investments—which may occur at a 

time when the company is privately 

held or publicly held.76 Moreover, 

under the federal securities laws, a 

person that is deemed to be an affiliate 

of a publicly traded company may be 

limited in its ability to dispose of 

publicly traded securities.77 Would our 

proposed approach to follow-on 

investments accommodate the way 

venture capital funds typically invest? 

Are there circumstances in which a 

venture capital fund would provide 

follow-on investments in a company 

that has become public? Should the rule 

specifically provide that a venture 

capital fund includes a fund that invests 

a limited percentage of its capital in 

publicly traded securities under certain 

circumstances (e.g., a follow-on 

investment in a company in which the 

fund’s previous investments were made 

when the company was private)? If so, 

what is the appropriate percentage 

threshold (e.g., 5, 10 or 20 percent)? 

We request comment on whether our 

definition should exclude any venture 

capital fund that holds any publicly 

traded securities or a specified 

percentage of publicly traded portfolio 

company securities. What percentage 


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77196 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

78Cf. note 94 (discussing limits applicable to 

BDCs). 

79Proposed rule 203(l)–1(a)(2). 

80See Loy Testimony, supra note 40, at 2, 4; 

Pinedo, supra note 55, Vol. 1 at 12–2; Levin, supra 

note 55, at 1–5 (noting that venture capital funds 

focus on ‘‘common stock or common equivalent 

securities, with any purchase of subordinated 

debentures and/or preferred stock generally 

designed merely to fill a hole in the financing or 

to provide [the venture capitalist] with some 

priority over management in liquidation or return 

of capital’’). See also Jesse M. Fried and Mira Ganor, 

Agency Costs of Venture Capitalist Control in 

Startups, 81 N.Y.U. Law Journal 967, 970 (2006) 

(venture capital funds investing in U.S. start-ups 

‘‘almost always receive convertible preferred 

stock’’); Fenn et al., supra note 55, at 32. 

81McGuire Testimony, supra note 41, at 4; Loy 

Testimony, supra note 40, at 2. 

82See infra section II.A.3 of this Release. 

83See, e.g., Darian M. Ibrahim, Debt as Venture 

Capital, 4 U. Ill. L. Rev. 1169, 1173, 1206 (2010) 

(‘‘VCs sometimes [provide] bridge loans to their 

portfolio companies * * * [A] bridge loan * * * is 

[essentially] about ‘funding to subsequent rounds of 

equity’ rather than relying on the underlying startup’s ability to repay the loan through cash flows.’’); 

Alan Olsen, Venture Capital Financing: Structure 

and Pricing, VirtualStreet (July 25, 2010), available 

at http://www20.csueastbay.edu/news/2010/07/ 

alan-olsen-venture-capital.html (‘‘Bridge financing 

is designed as temporary financing in cases where 

the company has obtained a commitment for 

financing at a future date, which funds will be used 

to retire the debt.’’); Thomas Flynn, Venture Capital: 

Current Trends and Lessons Learned, Ventures and 

Intellectual Property Letter (2003), available at 

http://www.shipmangoodwin.com/publications/ 

Detail.aspx?pub=194 (‘‘The bridge financing, 

intended to take the cash strapped company either 

to the next full round of venture investment or 

alternatively to a liquidity event or wind-up, has 

become a familiar fixture in the life cycle of a 

venture-backed company.’’). 

84Provided such financings were structured to 

satisfy the definition of equity security, we would 

view such transactions to satisfy the definition of 

qualifying portfolio company under proposed rule 

203(l)–1(c)(4)(ii). 

85See 15 U.S.C. 78c(a)(11) (defining ‘‘equity 

security’’ as ‘‘any stock or similar security; or any 

security future on any such security; or any security 

convertible, with or without consideration, into 

such a security, or carrying any warrant or right to 

subscribe to or purchase such a security; or any 

such warrant or right; or any other security which 

the Commission shall deem to be of similar nature 

and consider necessary or appropriate, by such 

rules and regulations as it may prescribe in the 

public interest or for the protection of investors, to 

treat as an equity security.’’); rule 3a11–1 under the 

Exchange Act (17 CFR 240.3a11–1) (defining 

‘‘equity security’’ to include ‘‘any stock or similar 

security, certificate of interest or participation in 

any profit sharing agreement, preorganization 

certificate or subscription, transferable share, voting 

trust certificate or certificate of deposit for an equity 

security, limited partnership interest, interest in a 

joint venture, or certificate of interest in a business 

trust; any security future on any such security; or 

any security convertible, with or without 

consideration into such a security, or carrying any 

warrant or right to subscribe to or purchase such 

a security; or any such warrant or right; or any put, 

call, straddle, or other option or privilege of buying 

such a security from or selling such a security to 

another without being bound to do so.’’). 

86See rule 3a11–1 under the Exchange Act (17 

CFR 240.3a11–1) (defining ‘‘equity security’’ to 

include any ‘‘limited partnership interest’’). 

87Our proposed use of the definition of equity 

security under the Exchange Act acknowledges that 

venture capital funds typically invest in common 

stock and other equity instruments that may be 

convertible into equity common stock. See supra 

note 80. Our proposed definition does not 

otherwise specify the types of equity instruments 

that a venture capital fund could hold in deference 

to the business judgment of venture capital 

investors. 

88Proposed rule 203(l)–1(a)(2)(ii). 

89 ‘‘[T]he capital supplied to a venture capital 

fund consists entirely of equity commitments 

provided as cash from investors in installments on 

an as-needed basis. * * * The ‘capital calls’ for 

investments generally happen in cycles over the full 

life of the fund on an ‘as needed’ basis as 

investments are identified by the general partners 

and then as further rounds of investment are made 

into the portfolio companies.’’ Loy Testimony, 

supra note 40, at 2; Paul A. Gompers & Josh Lerner, 

would be appropriate? What percentage 

would give venture capital funds 

sufficient flexibility to dispose of their 

publicly traded securities? Would 30 or 

40 percent of the value of a venture 

capital fund’s assets be appropriate? 78

Should the rule specify that publicly 

traded securities may only be held for 

a limited period of time, such as oneyear, or that a venture capital fund’s 

entire portfolio may not consist only of 

publicly traded securities except for a 

limited period of time, such as one-year 

or other period? 

b. Equity Securities, Cash and Cash 

Equivalents and Short-Term U.S. 

Treasuries. 

We propose to define venture capital 

fund for purposes of the exemption as 

a fund that invests in equity securities 

of qualifying portfolio companies, cash 

and cash equivalents and U.S. 

Treasuries with a remaining maturity of 

60 days or less.79 Under our proposed 

definition, a fund would not qualify as 

a venture capital fund for purposes of 

the exemption if it invested in debt 

instruments (unless they met the 

definition of ‘‘equity security’’) of a 

portfolio company or otherwise lent 

money to a portfolio company, strategies 

that are not the typical form of venture 

capital investing.80 Congress received 

testimony that, unlike other types of 

private funds, venture capital funds 

‘‘invest cash in return for an equity share 

of the company’s stock.’’ 81 As a 

consequence, venture capital funds 

avoid using financial leverage, and 

leverage appears to have raised systemic 

risk concerns for Congress.82 Should our 

definition of venture capital fund 

include funds that invest in debt, or 

certain types of debt, issued by 

qualifying portfolio companies, or make 

certain types of loans to qualifying 

portfolio companies? We understand 

that some venture capital funds may 

extend ‘‘bridge’’ financing to portfolio 

companies in anticipation of a future 

round of venture capital investment.83

Such financings may take the form of 

investment in instruments that are 

ultimately convertible into a portfolio 

company’s common or preferred stock 

at a subsequent investment stage and 

thus would meet the definition of 

‘‘equity security.’’ 84 Should our 

definition include any fund that extends 

bridge financing that does not meet the 

definition of ‘‘equity security’’ on a 

short-term limited basis to a qualifying 

portfolio company? Should our 

definition be limited to those funds that 

make bridge loans to a portfolio 

company that are convertible into equity 

funding only in the next round of 

venture capital investing? Under our 

proposed definition, debt investments 

or loans with respect to qualifying 

portfolio companies that did not meet 

the definition of ‘‘equity security’’ could 

not be made by a fund seeking to qualify 

as a venture capital fund. Should we 

modify the proposed rule so that such 

investments and loans could be made 

subject to a limit? If so, what would be 

an appropriate limit (e.g., 5 or 10 

percent) and how should the limit be 

determined (e.g., as a percentage of the 

fund’s capital commitments)? 

We propose to use the definition of 

equity security in section 3(a)(11) of the 

Securities Exchange Act of 1934 

(‘‘Exchange Act’’) and rule 3a11–1 

thereunder.85 This definition is broad, 

and includes common stock as well as 

preferred stock, warrants and other 

securities convertible into common 

stock in addition to limited partnership 

interests.86 This definition would 

include various securities in which 

venture capital funds typically invest 

and would provide venture capital 

funds with flexibility to determine 

which equity securities in the portfolio 

company capital structure are 

appropriate for the fund.87 We request 

comment on the use of this definition. 

Should we consider a more limited 

definition of equity security? Do venture 

capital funds typically invest in other 

types of equity securities that are not 

covered by the proposed definition? 

Under the proposed rule, we define a 

venture capital fund for purposes of the 

exemption as a fund that holds cash and 

cash equivalents or short-term U.S. 

Treasuries, in recognition of the manner 

in which venture capital funds 

operate.88 A venture capital fund may 

hold cash funded by its investors until 

the cash is allocated to an investment 

opportunity; subsequently, upon 

liquidation of the investment, the 

venture capital fund will receive cash as 

a return on its investment, which is then 

distributed to the fund’s 

investors.89 Thus, pending receipt of all 


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The Venture Capital Cycle, at 459 (MIT Press 2004) 

(‘‘Gompers & Lerner’’) (‘‘Venture capitalists can 

liquidate their position in the company by selling 

shares on the open market and then paying those 

proceeds to investors in cash.’’). 

90Proposed rule 203(l)–1(a)(2)(ii). 

91Rule 2a51–1(b)(7) under the Investment 

Company Act provides that cash and cash 

equivalents include foreign currencies ‘‘held for 

investment purposes’’ and ‘‘(i) [b]ank deposits, 

certificates of deposit, bankers acceptances and 

similar bank instruments held for investment 

purposes; and (ii) [t]he net cash surrender value of 

an insurance policy.’’ 17 CFR 270.2a51–1(b)(7). 

92See generally sections 2(a)(51) and 3(c)(7) of the 

Investment Company Act; 17 CFR 270.2a51(b) and 

(c). 

93We have treated debt securities with maturities 

of 60 days or less differently than debt securities 

with longer maturities under our rules. In 

particular, we have recognized that the potential for 

fluctuation in those shorter-term securities’ market 

value has decreased sufficiently that, under certain 

conditions, we allow certain open-end investment 

companies to value them using amortized cost 

value rather than market value. See Valuation of 

Debt Instruments by Money Market Funds and 

Certain Other Open-End Investment Companies, 

Investment Company Act Release No. 9786 (May 

31, 1977) [42 FR 28999 (June 7, 1977)]. We believe 

that the same consideration warrants treating U.S. 

Treasury securities with a remaining maturity of 60 

days or less as more akin to cash equivalents than 

Treasuries with longer maturities for purposes of 

the definition of venture capital fund. 

94See sections 2(a)(46) and 2(a)(48) of the 

Investment Company Act. Under section 55 of the 

Investment Company Act, a BDC is prohibited from 

acquiring any assets, except for permitted assets, 

unless, at the time the acquisition is made, 

permitted assets ‘‘represent at least 70 per centum 

of the value of [the BDC’s] total assets.’’ Permitted 

assets for this purpose generally mean securities of 

an ‘‘eligible portfolio company,’’ which is defined in 

section 2(a)(46) of the Investment Company Act. 

95See infra section II.A.8 of this Release. 

96Proposed rule 203(l)–1(c)(4)(ii) (setting forth 

this requirement as a condition for the portfolio 

company to qualify as a ‘‘qualifying portfolio 

company’’). 

97A leveraged buyout fund is a private equity 

fund that will ‘‘borrow significant amounts from 

banks to finance their deals—increasing the debt-toequity ratio of the acquired companies.’’ U.S. Govt. 

Accountability Office, Private Equity: Recent 

Growth in Leveraged Buyouts Exposed Risks that 

Warrant Continued Attention (2008) (‘‘GAO Private 

Equity Report’’), at 1. A leverage buyout fund in 

2005 typically financed a deal with 34% equity and 

66% debt. Id. at 13. See also Fenn et al., supra note 

55, at 23 (companies that have been taken private 

in an LBO transaction generally ‘‘spend less on 

research and development, relative to assets, and 

have a greater proportion of fixed assets; their debtto-assets ratios are high, above 60%, and are two to 

four times those of venture-backed firms.’’ 

Moreover, compared to venture capital backed 

companies, LBO-private equity backed companies 

that are taken public typically use proceeds from an 

IPO to reduce debt whereas new venture capital 

backed firms tend to use proceeds to fund growth.); 

Tresnowski Testimony, supra note 40, at 2 

(indicating that portfolio companies in which 

private equity funds invest typically have 60% debt 

and 40% equity). 

98See infra discussion in section II.A.1.d of this 

Release. 

99See S. Rep. No. 111–176, supra note 7, at 74 

(‘‘The Committee believes that venture capital 

funds, a subset of private investment funds 

specializing in long-term equity investment in small 

or start-up businesses, do not present the same risks 

as the large private funds whose advisers are 

required to register with the SEC under this title.’’); 

id. at 75 (concluding that private funds that use 

limited or no leverage at the fund level engage in 

Continued 

capital commitments from investors or 

pending distribution of such proceeds to 

investors, a venture capital fund could 

hold cash and cash equivalents and 

short-term U.S. Treasuries.90 We define 

‘‘cash and cash equivalents’’ by reference 

to rule 2a51–1(b)(7)(i) under the 

Investment Company Act.91 Rule 2a51– 

1, however, is used to determine 

whether an owner of an investment 

company excluded by reason of section 

3(c)(7) of the Investment Company Act 

meets the definition of a qualified 

purchaser by examining whether such 

owner holds sufficient ‘‘investments’’ 

(generally securities and other assets 

held for investment purposes).92 We do 

not propose to define a venture capital 

fund’s cash holdings by reference to 

whether the cash is held ‘‘for investment 

purposes’’ or to the net cash surrender 

value of an insurance policy. 

Furthermore, since rule 2a51–1 does not 

explicitly include short-term U.S. 

Treasuries, which we believe would be 

an appropriate form of cash equivalent 

for a venture capital fund to hold 

pending investment in a portfolio 

company or distribution to investors, 

our rule would include short-term U.S. 

Treasuries with a remaining maturity of 

60 days or less among the investments 

a venture capital fund could hold.93

Should we specify a shorter or longer 

period of remaining maturity for U.S. 

Treasuries? 

We request comment on whether the 

proposed rule’s provision for cash 

holdings is too broad or too narrow. 

Should the rule only specify that cash 

be held in anticipation of investments, 

or in connection with the payment of 

expenses or liquidations from 

underlying portfolio companies? Are 

there other types of cash instruments in 

which venture capital funds typically 

invest and/or that should be reflected in 

the proposed rule? 

We do not propose to define venture 

capital fund for purposes of the 

exemption as one that invests solely in 

U.S. companies. In contrast, the BDC 

provisions in the Investment Company 

Act generally limit the exemption to 

U.S. companies and require that 

permitted investments generally be 

made in U.S. companies.94 However, as 

we discuss below, there is no indication 

in the legislative record that Congress 

intended the venture capital exemption 

would be available only to U.S. advisers 

or to advisers that invest fund assets 

solely in U.S. companies.95 Should our 

proposed definition similarly define a 

venture capital fund as a fund formed 

under the laws of the United States 

and/or that invests exclusively or 

primarily in U.S. portfolio companies or 

a sub-set of such companies (e.g., U.S. 

companies operating in non-financial 

sectors)? Are venture capital funds that 

invest in non-U.S. portfolio companies 

more or less likely to have financial 

relationships that may pose systemic 

risk issues, a rationale that was 

presented and appeared significant to 

Congress in exempting advisers to 

venture capital funds? 

c. Portfolio Company Leverage 

Proposed rule 203(l)–1 would define 

a qualifying portfolio company for 

purposes of the exemption as one that 

does not borrow, issue debt obligations 

or otherwise incur leverage in 

connection with the venture capital 

fund’s investments.96 As a consequence, 

certain types of funds that use leverage 

or finance their investments in portfolio 

companies or the buyout of existing 

investors with borrowed money (e.g., 

leveraged buyout funds, which are a 

different subset of private equity funds) 

would not meet the proposed rule’s 

definition of a venture capital fund.97

As discussed in greater detail below, we 

believe that Congress did not intend the 

venture capital fund definition to apply 

to these other types of private equity 

funds.98 This definition of qualifying 

portfolio company would only exclude 

companies that borrow in connection 

with a venture capital fund’s 

investment, but would not exclude 

companies that borrow in the ordinary 

course of their business (e.g., to finance 

inventory or capital equipment, manage 

cash flows, and meet payroll). We 

would generally view any financing or 

loan (unless it met the definition of 

equity security) to a portfolio company 

that was provided by, or was a 

condition of a contractual obligation 

with, a fund or its adviser as part of the 

fund’s investments as being a type of 

financing that is ‘‘in connection with’’ 

the fund’s investment, although we 

recognize that other types of financings 

may also be ‘‘in connection with’’ a 

fund’s investment. Should we provide 

guidance on other types of financing 

transactions as being ‘‘in connection 

with’’ a fund’s investment in a 

qualifying portfolio company? If so, 

what types of financing transactions 

should such guidance address? We 

propose this element of the qualifying 

portfolio company definition because of 

the focus on leverage in the Dodd-Frank 

Act as a potential contributor to 

systemic risk as discussed by the Senate 

Committee report,99 and the testimony 


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activities that do not pose risks to the wider markets 

through credit or counterparty relationships). 

100See Loy Testimony, supra note 40, at 6 (noting 

that ‘‘many venture capital funds significantly limit 

borrowing’’). See also McGuire Testimony, supra 

note 41, at 7 (‘‘Not only are our partnerships run 

without debt but our portfolio companies are 

usually run without debt as well.’’). 

101See Loy Testimony, supra note 40, at 3. See 

also James Schell, Private Equity Funds: Business 

Structure and Operations (2010), at § 1.03[1] 

(‘‘Schell’’) (‘‘Venture Capital Funds provide 

investment capital to business enterprises early in 

their development cycle at a time when access to 

conventional financing sources is non-existent or 

extremely limited.’’). 

102Proposed rule 203(l)–1(a)(2)(i). 

103Proposed rule 203(l)–1(c)(4)(iii). 

104See Loy Testimony, supra note 40, at 2 

(‘‘Although venture capital funds may occasionally 

borrow on a short-term basis immediately preceding 

the time when the cash installments are due, they 

do not use debt to make investments in excess of 

the partner’s capital commitments or ‘lever up’ the 

fund in a manner that would expose the fund to 

losses in excess of the committed capital or that 

would result in losses to counter parties requiring 

a rescue infusion from the government.’’). See also 

infra notes 109–111; Mark Heesen & Jennifer C. 

Dowling, National Venture Capital Association, 

Venture Capital & Adviser Registration, materials 

submitted in connection with the Commission’s 

Government-Business Forum on Small Business 

Capital Formation (‘‘Heesen’’) (summarizing the 

differences between venture capital funds and 

buyout and hedge funds), available at http:// 

www.sec.gov/info/smallbus/ 

2010gbforumstatements.htm. 

105See, e.g., McGuire Testimony, supra note 41, 

at 1; NVCA Yearbook 2010, supra note 41; 

PricewaterhouseCoopers/National Venture Capital 

Association MoneyTree Report, Q4 2009/Full-year 

2009 Report (providing data on venture capital 

investments in portfolio companies); Schell, supra 

note 101, at § 1.03[1]; Gompers & Lerner, supra note 

89, at 178, 180 table 8.2 (displaying percentage of 

annual venture capital investments by stage of 

development and classifying ‘‘early stage’’ as seed, 

start-up, or early stage and ‘‘late stage’’ as expansion, 

second, third, or bridge financing). 

106See McGuire Testimony, supra note 41, at 1; 

Loy Testimony, supra note 40, at 3 (‘‘Once the 

venture fund is formed, our job is to find the most 

promising, innovative ideas, entrepreneurs, and 

companies that have the potential to grow 

exponentially with the application of our expertise 

and venture capital investment.’’). See also William 

A. Sahlman, The Structure and Governance of 

Venture-Capital Organizations, Journal of Financial 

Economics 27 (1990), at 473, 503 (‘‘Sahlman’’) 

(noting venture capitalists typically invest more 

than once during the life of a company, with the 

expectation that each capital investment will be 

sufficient to take the company to the next stage of 

development, at which point the company will 

require additional capital to make further progress). 

107See Sahlman, at 503; Loy Testimony, supra 

note 40, at 3 (‘‘[W]e continue to invest additional 

capital into those companies that are performing 

well; we cease follow-on investments into 

companies that do not reach their agreed upon 

milestones.’’). 

108 GAO Private Equity Report, supra note 97, at 

8 (‘‘A private equity-sponsored LBO generally is 

defined as an investment by a private equity fund 

in a public or private company (or division of a 

company) for majority or complete ownership.’’). 

109See Annalisa Barrett et al., Prepared by the 

Corporate Library Inc., under contract for the IRRC 

Institute, What is the Impact of Private Equity 

Buyout Fund Ownership on IPO Companies’ 

Corporate Governance?, at 7 (June 2009) (‘‘Barrett et 

al.’’) (‘‘In general, VC firms provide funding to 

companies in early stages of their development, and 

the money they provide is used as working capital 

for the firm. Buyout firms, in contrast, work with 

mature companies, and the funds they provide are 

used to compensate the firm’s existing owners.’’); 

Ieke van den Burg and Poul Nyrup Rasmussen, 

Hedge Funds and Private Equity: A Critical 

Analysis (2007), at 16–17 (‘‘van den Burg’’); 

Sahlman, supra note 106, at 517. See also Tax 

Legislation: CRS Report, Taxation of Hedge Fund 

and Private Equity Managers, Tax Law and Estate 

Planning Course Handbook Series, Practicing Law 

Institute (Nov. 2, 2007) at 2 (noting that in a 

leveraged buyout ‘‘private equity investors use the 

proceeds of debt issued by the target company to 

acquire all the outstanding shares of a public 

company, which then becomes private’’). 

110Unlike venture capital funds, which generally 

invest in portfolio companies for 10 years or more, 

private equity funds that use leveraged buyouts 

invest in their portfolio companies for shorter 

periods of time. See Loy Testimony, supra note 40, 

at 3 (citing venture capital fund investments 

periods in portfolio companies of five to 10 years 

or longer); van den Burg, at 19 (noting that LBO 

investors generally retain their investment in a 

listed company for 2 to 4 years or even less after 

the company goes public). See also Paul A. 

Gompers, The Rise and Fall of Venture Capital, 

Business And Economic History, vol. 23, no. 2, 

Winter 1994, at 17 (‘‘Gompers’’) (stating that ‘‘an 

LBO investment is significantly shorter than that of 

a comparable venture capital investment. Assets are 

sold off almost immediately to meet debt burden, 

and many companies go public again (in a reverse 

LBO) in a very short period of time’’). 

111See Barrett et al., supra note 109. See also 

Fenn et al., supra note 55, at 23 (when comparing 

venture capital backed companies that are taken 

public to LBO-private equity backed companies that 

are taken public, the common use of proceeds from 

an IPO are used by LBO-private equity backed 

companies to reduce debt whereas new firms use 

proceeds to fund growth). 

before Congress that stressed the lack of 

leverage in venture capital investing.100

Should we use a test other than whether 

the loan is ‘‘in connection with’’ the 

fund’s investments? For example, 

should the test be whether the portfolio 

company currently intends to borrow at 

the time of the fund’s investment? 

Should the test depend only on how the 

portfolio company uses the proceeds of 

borrowing, such as by excluding 

companies that use proceeds to buyout 

investors or return capital to a fund? 

Venture capital has been described as 

investing in companies that cannot 

borrow from the usual lending 

sources.101 Should we define a 

qualifying portfolio company as a 

company that does not incur certain 

specified types of borrowing or other 

forms of leverage? Would such a 

definition narrow the current range of 

portfolio companies in which venture 

capital funds typically invest? 

d. Capital Used for Operating and 

Business Purposes 

Under proposed rule 203(l)–1, a 

venture capital fund is defined as a fund 

that holds equity securities of qualifying 

portfolio companies, and at least 80 

percent of each company’s equity 

securities owned by the venture capital 

fund were acquired directly from each 

such qualifying portfolio company.102

This element reflects the distinction 

between venture capital funds that 

provide capital to portfolio companies 

for operating and business purposes (in 

exchange for an equity investment) and 

leveraged buyout funds, which acquire 

controlling equity interests in operating 

companies through the ‘‘buy out’’ of 

existing security holders. Hence, in 

addition to the definitional element that 

a venture capital fund is one that does 

not redeem or repurchase securities 

from other shareholders (i.e., a 

‘‘buyout’’), a related criterion in the rule 

specifies that a qualifying portfolio 

company is one that does not distribute 

company assets to other security holders 

in connection with the venture capital 

fund’s investment in the company 

(which could be an indirect buyout).103

One of the distinguishing features of 

venture capital funds is that, unlike 

many hedge funds and private equity 

funds, they invest capital directly in 

portfolio companies for the purpose of 

funding the expansion and development 

of the company’s business rather than 

buying out existing security holders, 

otherwise purchasing securities from 

other shareholders, or leveraging the 

capital investment with debt 

financing.104 Testimony received by 

Congress and our research suggest that 

venture capital funds provide capital to 

many types of businesses at different 

stages of development,105 generally with 

the goal of financing the expansion of 

the company 106 and helping it progress 

to the next stage of its development 

through successive tranches of 

investment (i.e., ‘‘follow-on’’ 

investments) if the company reaches 

agreed-upon milestones.107

In contrast, private equity funds that 

are identified as buyout funds typically 

provide capital to an operating company 

in exchange for majority or complete 

ownership of the company,108 generally 

achieved through the buyout of existing 

shareholders or other security holders 

and financed with debt incurred by the 

portfolio company,109 and compared to 

venture capital funds, hold the 

investment for shorter periods of 

time.110 As a result of the use of the 

capital provided and the incurrence of 

this debt, following the buyout fund 

investment, the operating company may 

carry debt several times its equity and 

may devote significant levels of its cash 

flow and corporate earnings to repaying 

the debt financing, rather than investing 

in capital improvement or business 

operations.111


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112See supra notes 39, 42, 43, 99 and 

accompanying text. 

113Proposed rule 203(l)–1(a)(2)(i). 

114Proposed rule 203(l)–1(c)(4)(iii). 

115For example, concurrently with the issuance 

of new securities to the venture capital fund, a 

portfolio company could redeem existing 

shareholders and use proceeds from the venture 

capital fund investment to pay such shareholders 

redemption proceeds. Similarly, existing 

shareholders may receive new securities that are 

subordinated to the securities issued to the venture 

capital fund in exchange for tendering their 

outstanding securities, partially funded with 

investments received from the venture capital fund. 

In each of these examples, the fund becomes a 

majority owner of the company by ‘‘buying out’’ the 

existing owners with investment capital initially 

provided by the fund. 

116See NVCA Yearbook 2010, supra note 41, at 

57 (defining ‘‘angel’’ as ‘‘a wealthy individual that 

invests in companies in relatively early stages of 

development’’). See also Fenn et al., supra note 55, 

at 2 (defining angel capital as ‘‘investments in small, 

closely held companies by wealthy individuals, 

many of whom have experience operating similar 

companies [and] * * * may have substantial 

ownership stakes and may be active in advising the 

company, but they generally are not as active as 

professional managers in monitoring the company 

and rarely exercise control.’’). 

117See Int. Rev. Code § 1202(e)(1)(A) (26 U.S.C. 

1202) (‘‘IRC 1202’’) (which permits partial exclusion 

from income tax gain on directly acquired equity 

securities of certain issuers that, among other 

things, devote at least 80% of their assets to the 

conduct of their business as specified in IRC 1202). 

Under our proposed rule, at least 80% of the 

portfolio company securities owned by a venture 

capital fund must be acquired directly from the 

portfolio company, which in turn cannot redeem or 

repurchase existing security holders in connection 

with such venture capital fund investment. Thus 

we presume that venture capital funding proceeds 

(or at least 80% of such proceeds) will be used for 

operating and business expansion purposes, which 

is similar to the requirements under IRC 1202. 

118Proposed rule 203(l)–1(c)(4)(iv). For this 

purpose, pooled investment vehicles include 

investment companies, investment companies 

relying on rule 3a–7 under the Investment Company 

Act and commodity pools. 

We believe that these differences (i.e., 

the use of buyouts and associated 

leverage) distinguish venture capital 

funds from buyout private equity funds 

for which Congress did not provide an 

exemption.112 Under our proposed rule, 

an exempt adviser relying on section 

203(1) of the Advisers Act would not be 

eligible for the exemption if it advised 

these types of private equity funds that 

in effect acquire a majority of the equity 

securities of portfolio companies 

directly from other security holders.113

Correspondingly, we also propose to 

define a qualifying portfolio company 

for purposes of the exemption as one 

that does not redeem or repurchase 

outstanding securities in connection 

with a venture capital fund’s 

investment.114 Because at least 80 

percent of each portfolio company’s 

equity securities in which the fund 

invests must be acquired directly from 

the portfolio company, a venture capital 

fund relying on the exemption could 

purchase the remainder of the securities 

directly from existing shareholders (i.e., 

a ‘‘buyout’’). Under our proposed 

definition, however, a company that 

achieves an indirect buyout of its 

security holders, such as through the 

complete recapitalization or 

restructuring of the portfolio company 

capital structure would not be a 

qualifying portfolio company.115 The 80 

percent test is not intended to preclude 

conversions of directly acquired 

securities into other equity securities. 

Similarly, we would not view a capital 

reorganization intended merely to 

simplify a qualifying portfolio 

company’s capital structure and 

outstanding securities without any 

change in the existing beneficial 

owners’ rights, priority, or economic 

terms as breaching the 80 percent 

condition. 

We propose to define a venture 

capital fund by reference to ownership 

of equity securities of a qualifying 

portfolio company, wherein at least 80 

percent of the securities owned were 

acquired directly from the company, in 

order to give venture capital funds 

relying on the exemption some 

flexibility to acquire securities from a 

portfolio company founder or ‘‘angel’’ 

investor who may seek liquidity from 

his or her initial investment.116 We 

adopted this 80 percent threshold 

because we understand that many 

venture capital funds currently are 

managed in a manner that seeks to rely 

on provisions of the tax code providing 

favorable tax treatment for directly 

acquired equity securities of issuers that 

satisfy certain conditions.117 Thus, 

using this threshold in our definition 

may not result in substantial changes to 

either investment strategies employed, 

or the compliance programs currently 

used, by venture capital advisers. Is our 

assumption that venture capital funds 

do not generally acquire portfolio 

company securities directly from 

existing shareholders correct? Is 80 

percent the appropriate threshold? 

Should the threshold be set lower? 

Should direct acquisitions of equity 

securities be increased to 90 percent or 

100 percent in order to more effectively 

prevent advisers to funds engaged in 

activities that are not characteristic of 

venture capital funds from relying on 

the exemption? 

In contrast to leveraged buyout fund 

financing, venture capital received by a 

portfolio company is devoted to 

developing the company’s business 

rather than repurchasing the securities 

of other shareholders or making 

payments to fund debt financing 

through the portfolio company. We 

request comment on this criterion. Does 

the definition’s focus on a portfolio 

company’s use of capital received from 

a venture capital fund impose any 

unnecessary burdens on the company’s 

operation or business? Rather than 

define a venture capital fund by 

reference to the manner in which it 

acquires equity securities (or the 

manner in which qualifying portfolio 

companies may indirectly facilitate a 

buyout), should the proposed rule 

instead define the manner in which 

proceeds from a venture capital 

investment may be used? For example, 

should the rule specify that proceeds of 

borrowings or other financings not be 

used to finance the acquisition of equity 

securities by a venture capital fund or 

otherwise distribute company assets to 

equity owners? Would defining 

qualifying portfolio company in this 

manner facilitate compliance or would 

this approach make it easier for a 

company to achieve a ‘‘buyout’’ and 

thereby circumvent the intended scope 

of the exemption, given the fungibility 

of cash and the privately negotiated 

nature of typical venture capital 

transactions? We do not intend that a 

venture capital fund would not meet the 

proposed definition if it acquired equity 

securities from a portfolio company in 

connection with a capital reorganization 

intended to simplify the company’s 

capital structure without changing the 

existing beneficial owners’ rights, 

priority, or economic terms. Are there 

other capital reorganizations that would 

be consistent with the intent of our 

proposed rule but that would prevent a 

venture capital fund from satisfying the 

proposed definition? 

e. Operating Companies 

Proposed rule 203(l)–1 would define 

the term qualifying portfolio company 

for the purposes of the exemption to 

exclude any private fund or other 

pooled investment vehicle.118 There is 

no indication that Congress intended 

the venture capital exemption to apply 

to funds of funds. Without this 

definition, a venture capital fund could 

circumvent the intended scope of the 

exemption by investing in other pooled 

investment vehicles that are not 

themselves subject to the definitional 

criteria under our proposed rule. For 

example, a venture capital fund could 

circumvent the intent of the proposed 

rule by incurring off-balance sheet 

leverage or indirectly investing in 

companies that may be publicly traded. 

Our proposed exclusion would be 

similar to the approach of other 

definitions of ‘‘venture capital’’ 

discussed above, which limit 


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119See California VC exemption, supra notes 70– 

72; see also VCOC exemption under 29 CFR 2510.3– 

101(d), supra note 70. 

120Proposed rule 203(l)–1(a)(3). Under section 

202(a)(12) of the Advisers Act, ‘‘control’’ is defined 

to mean ‘‘the power to exercise a controlling 

influence over the management or policies of a 

company, unless such power is solely the result of 

an official position with such company.’’ 

121See McGuire Testimony, supra note 41, at 1 

(‘‘[W]e build companies by actively partnering with 

each entrepreneur and management team to help 

propel their ideas into market leading businesses. 

We do this by providing a small amount of capital 

and a large amount of operating expertise and 

strategic counsel over a long period of time. While 

providing capital is the first order of business, it is 

the least time consuming of all our activities. We 

also recruit and attract employees at all levels [for 

the portfolio company]. We identify and structure 

strategic partnerships. We raise additional equity to 

help the [portfolio] company make it to the next 

milestone. And, we’re available 24/7 to support 

great teams, solve problems, identify opportunities 

and detect ‘land mines.’ * * * We provide access 

to [our] expertise and network at all stages of a 

[portfolio] company’s development and across all 

strategic areas of the business.’’). See also Levin, 

supra note 55, at 1–3 (noting that the ‘‘first feature 

distinguishing venture capital/private equity 

investing is the VC professional’s active 

involvement in identifying the investment, 

negotiating and structuring the transaction, and 

monitoring the portfolio company after the 

investment has been made. Often, the VC 

professional will serve as a board member and/or 

financial advisor to the portfolio company. Hence, 

venture capital/private equity investing is 

significantly different from passive selection and 

retention of stock and debt investments by a money 

manager.’’) (emphasis in original); Sahlman, supra 

note 106, at 508 (noting that venture capitalists 

typically play a role in the operation of the 

company, help to establish tactics and strategy, 

work with suppliers and customers, and often 

assume more direct control by changing 

management and sometimes taking over day-to-day 

operations themselves). See also Fenn et al., supra 

note 55, at 32–33 for a discussion of various control 

mechanisms available to venture capital and private 

equity funds, including preferred stock ownership, 

representation on the board and various contractual 

covenants. 

122See generally supra note 121. See also Alan T. 

Frankel, et al., Venture Capital: Financial and Tax 

Considerations, The CPA Journal (Aug. 2003) at 1 

(noting that the ‘‘VC will also monitor the portfolio 

company after the investment has been made. 

Oftentimes, the VC will serve as a board member 

or financial and strategic advisor to the portfolio 

company.’’). 

123The term ‘‘business development company’’ 

was first introduced into the Investment Company 

Act and the Advisers Act in 1980 as part of the 

Small Business Investment Incentive Act of 1980 

(‘‘Small Business Act’’), and was amended as part 

of the National Securities Markets Improvement Act 

of 1996, Public Law 104–290, 110 Stat. 3416 (1996) 

(‘‘NSMIA’’). Congress introduced an alternative 

regulatory framework applicable to BDCs, which 

was designed to remove ‘‘unnecessary 

disincentives’’ for BDCs to provide capital to small 

businesses, while also preserving protection for 

investors and preventing fraud and abuse. See 1980 

House Report, supra note 44, at 21–22. 

In the Small Business Act, Congress modeled the 

definition of a BDC under section 202(a)(22) of the 

Advisers Act on the capital formation activities of 

venture capital funds. Congress recognized that the 

principal activity of a BDC is to invest in and 

provide managerial assistance to small, growing and 

financially troubled companies. See 1980 House 

Report, supra note 44, at 21. See also infra note 129 

(definition of ‘‘making available significant 

managerial assistance’’ by a BDC under section 

2(a)(47) of the Investment Company Act). 

124See 1980 House Report, supra note 44, at 21. 

125See section 202(a)(22) of the Advisers Act; 

section 2(a)(48)(B) of the Investment Company Act. 

Generally, a BDC under the Advisers Act is any 

company that meets the definition of BDC under the 

Investment Company Act, except that certain 

requirements were modified for ‘‘private’’ BDCs 

under the Advisers Act. See also Prohibition of 

Fraud by Advisers to Certain Pooled Investment 

Vehicles; Accredited Investors in Certain Private 

Investment Vehicles, Investment Advisers Act 

Release No. 2576 (Dec. 27, 2006) [72 FR 400 (Jan. 

4, 2007)] (‘‘Accredited Natural Person Release’’), at 

n.69 (discussing the difference between the term 

BDC under the Investment Company Act and the 

Advisers Act). In 1996, as part of NSMIA, Congress 

sought to encourage greater investment in small 

businesses by giving BDCs more flexibility, and 

therefore expanded the class of eligible portfolio 

companies in which BDCs could invest without 

being required to provide ‘‘managerial assistance.’’ 

See S. Rep. No. 104–293, at 13 (1996). 

126We have looked to the BDC definition to 

define a venture capital fund before. In 2006, we 

proposed to impose a qualification standard for all 

investors of private investment funds, excluding 

venture capital funds, which we proposed to define 

by reference to section 202(a)(22) of the Advisers 

Act. See Accredited Natural Person Release, supra 

note 125 (proposing to define the term ‘‘accredited 

natural person’’ as any natural person who satisfies 

the requirements in Regulation D as an accredited 

investor and who also owns investments of at least 

$2.5 million). We sought additional comment on 

this proposal in a subsequent release but a rule has 

not been adopted. See Revisions of Limited Offering 

Exemptions in Regulation D, Securities Act Release 

No. 8828 (Aug. 3, 2007) [72 FR 45116 (Aug. 10, 

2007)]. 

127See generally Loy Testimony, supra note 40; 

McGuire Testimony, supra note 41. 

128See 1980 House Report, supra note 44, at 21– 

2. 

investments to operating companies and 

thus would exclude investments in 

other private funds or securitized asset 

vehicles.119 We request comment on 

this definitional element. Under the 

proposed definition, a venture capital 

fund would not invest in another 

private fund, a commodity pool or other 

‘‘investment companies.’’ Should the 

proposed definition specifically identify 

other types of pooled investment 

vehicles (e.g., real estate funds or 

structured investment vehicles) in 

which a fund seeking to satisfy the 

proposed definition could not invest? 

1. Management Involvement 

To qualify as a venture capital fund 

under our proposed definition, the fund 

or its investment adviser would: (i) 

Have an arrangement under which it 

offers to provide significant guidance 

and counsel concerning the 

management, operations or business 

objectives and policies of the portfolio 

company (and, if accepted, actually 

provides the guidance and counsel) or 

(ii) control the portfolio company.120

Because a key distinguishing 

characteristic of venture capital 

investing is the assistance beyond the 

mere provision of capital, we propose 

that advisers seeking to rely on the rule 

have a significant level of involvement 

in developing a fund’s portfolio 

companies.121 Managerial assistance 

generally takes the form of active 

involvement in the business, operations 

or management of the portfolio 

company, or less active forms of control 

of the portfolio company, such as 

through board representation or similar 

voting rights.122 We also acknowledge 

that the nature of managerial assistance 

may evolve over time as the needs of 

qualifying portfolio companies change, 

and hence the proposed rule does not 

specify that managerial assistance has a 

fixed character. 

We have modeled the proposed 

approach to managerial assistance in 

part on existing provisions under the 

Advisers Act and the Investment 

Company Act dealing with BDCs, which 

were added over the years to ease the 

regulatory burdens on venture capital 

and other private equity investments.123

In 1980, when Congress first introduced 

BDCs into the Advisers Act and 

Investment Company Act, it 

acknowledged that the purpose of the 

BDC provisions was to support ‘‘venture 

capital’’ activity in capital formation for 

small business, and described BDCs as 

principally investing in and providing 

managerial assistance to small, growing 

and financially troubled businesses.124

Because Congress modeled the 

definition of BDC under the Advisers 

and Investment Company Acts on the 

capital formation activities of venture 

capital funds, both definitions under 

such Acts incorporate the requirement 

to make available significant managerial 

assistance to portfolio companies.125

Congress did not use the existing BDC 

definitions when determining the scope 

of the venture capital exemption,126 and 

the primary policy considerations that 

led to the adoption of the BDC 

exemptions differed from those under 

the Dodd-Frank Act. However, we 

believe these provisions are instructive 

because they reflect many of the same 

characteristics of venture capital and 

private equity fund activity presented in 

testimony before Congress in connection 

with the Dodd-Frank Act.127 Although 

Congress viewed BDC activities as 

typical of ‘‘venture capital’’ investing,128

the BDC provisions are complex. Hence, 

we are proposing a modified version of 

the definition of ‘‘making available 

significant managerial assistance’’ in 

order to simplify the language and to 

reduce the potential for confusion that 

might arise in interpreting the meaning 

of the term. 


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129Section 2(a)(47) of the Investment Company 

Act states: 

‘‘‘Making available significant managerial 

assistance’ by a business development company 

means— 

(A) Any arrangement whereby a business 

development company, through its directors, 

officers, employees, or general partners, offers to 

provide, and, if accepted, does so provide, 

significant guidance and counsel concerning the 

management, operations, or business objectives and 

policies of a portfolio company; 

(B) the exercise by a business development 

company of a controlling influence over the 

management or policies of a portfolio company by 

the business development company acting 

individually or as part of a group acting together 

which controls such portfolio company; or 

(C) with respect to a small business investment 

company licensed by the Small Business 

Administration to operate under the Small Business 

Investment Act of 1958, the making of loans to a 

portfolio company. 

For purposes of subparagraph (A), the 

requirement that a business development company 

make available significant managerial assistance 

shall be deemed to be satisfied with respect to any 

particular portfolio company where the business 

development company purchases securities of such 

portfolio company in conjunction with one or more 

other persons acting together, and at least one of the 

persons in the group makes available significant 

managerial assistance to such portfolio company, 

except that such requirement will not be deemed 

to be satisfied if the business development 

company, in all cases, makes available significant 

managerial assistance solely in the manner 

described in this sentence.’’ 

In contrast to section 2(a)(47) of the Investment 

Company Act, our proposed definitional approach 

to managerial assistance does not specifically define 

managerial assistance by referring to a fund’s 

directors, officers, employees, or general partners or 

address how managerial assistance is determined 

for funds that invest as a group. 

130According to one study, funds focusing on 

later-stage companies and middle-market buyout 

investing tend to invest alongside other funds, 

whereas venture capital funds focusing on early 

stage companies tend to invest individually in 

portfolio companies. See Fenn et al., supra note 55, 

at 31. 

131See supra note 70 and accompanying text 

(discussing the California VC exemption and the 

VCOC exemption). 

132See Amendments to Form ADV, Investment 

Advisers Act Release No. 3060 (July 28, 2010) [75 

FR 49234 (Aug. 12, 2010)] (‘‘Form ADV Release’’). 

133Proposed rule 203(l)–1(a)(4). Similarly, our 

proposed rule would exclude from the definition of 

‘‘qualifying portfolio company’’ a company that 

borrowed in connection with the venture capital 

fund’s investments in the company. Proposed rule 

203(l)–1(c)(4)(ii). See supra section II.A.1 of this 

Release. 

134We note that because commercial paper 

issuers often refinance the repayment of maturing 

commercial paper with newly issued commercial 

Continued 

We request comment on the approach 

to managerial assistance in the 

definition of venture capital fund. As 

we have noted above, Congressional 

testimony asserted that a key 

characteristic of venture capital funds is 

the provision of managerial assistance. 

Is this true in the industry generally? 

We request comment on the description 

of managerial assistance in proposed 

rule 203(l)–1. Is this description easier 

to understand and apply than the 

definition in section 2(a)(47) of the 

Investment Company Act? 129 As under 

the definition of BDC in the Advisers 

and Investment Company Acts, the 

proposed definition specifies the fund 

or its adviser need only offer assistance. 

Should the rule specify that the fund or 

its adviser actually provide assistance? 

If so, what if a portfolio company that 

initially accepts the offer of assistance 

later refuses any actual or further 

assistance? We understand that when 

venture capital funds invest as a group, 

there may be an understanding among 

the funds and the portfolio company 

that while all fund advisers may be 

available to provide managerial 

assistance if necessary, one adviser is 

generally expected to provide most, if 

not all, of the assistance to the portfolio 

company. Is that understanding correct? 

Under proposed rule 203(l)–1, venture 

capital funds that invest as a group 

would only satisfy the definition if each 

venture capital fund (or its adviser) 

offered (and, if accepted, provided) 

managerial assistance or exercised 

control.130 Should the rule specify how 

managerial assistance or control is to be 

determined in the case of venture 

capital funds that invest as a group if 

only one fund (or its adviser) provides 

the assistance? Should the rule specify 

the extent to which each fund (or its 

adviser) must offer or provide 

managerial assistance or adopt the 

approach of other regulatory definitions 

of ‘‘venture capital’’ funds, which 

impose strict numerical investment or 

ownership tests for determining 

whether a venture capital fund exercises 

supervision or influence over the 

operation or business of the operating 

company? 131 Does the fact that the 

assistance need only be offered render 

the condition so readily met that the 

criterion should be removed from the 

rule? Should our rule provide guidance 

on what constitutes ‘‘control’’ under our 

proposed definition? For example, 

instructions to Form ADV provide a 

presumption of control if a person has 

the power to vote 25 percent or more of 

a corporation’s voting securities, or a 

person acts as manager of a limited 

liability company.132 Should the 

proposed rule rely on similar or 

different presumptions? 

Our proposed rule provides that when 

a fund controls the qualifying portfolio 

company, an offer to provide managerial 

assistance is not required. As in the case 

of ‘‘managerial assistance’’ as defined in 

the BDC provisions, the proposed rule 

presumes that when a fund acquires 

control, it is likely to be exercised. 

Should the rule specify that in all cases 

managerial assistance includes both the 

offer of assistance as well as the exercise 

of control? We request comment on 

whether venture capital funds (or their 

advisers) typically have the personnel to 

provide significant managerial 

assistance to all of their portfolio 

companies or only a subset. Would the 

requirement to offer and potentially 

provide managerial assistance to all of a 

fund’s portfolio companies result in 

potential demands on a fund or its 

adviser that could not be satisfied if all 

or a significant subset of a fund’s 

portfolio companies accepted the offer? 

Alternatively, does the proposed 

definition provide a venture capital 

fund (including those that invest as a 

group) with sufficient flexibility to 

determine the scope of any managerial 

assistance or control it may seek to offer 

(or provide) to a portfolio company? 

2. Limitation on Leverage 

Under proposed rule 203(l)–1, the 

definition of a venture capital fund for 

purposes of the exemption would be 

limited to a private fund that does not 

borrow, issue debt obligations, provide 

guarantees or otherwise incur leverage, 

in excess of 15 percent of the fund’s 

capital contributions and uncalled 

committed capital, and any such 

borrowing, indebtedness, guarantee or 

leverage is for a non-renewable term of 

no longer than 120 calendar days.133

Under the proposed definition, a fund 

could borrow and still be a venture 

capital fund provided it did not borrow 

or otherwise use leverage in excess of 

the specified threshold. 

By specifying that loans be nonrenewable, we would avoid the 

transformation of short-term debt into 

long-term debt without full repayment 

to the lender. Should the rule specify 

other borrowing or financing terms or 

conditions that would nevertheless 

avoid this type of transformation? Do 

venture capital funds use lines of credit 

repeatedly but pay the outstanding 

amounts in full before drawing down 

additional credit? Should loans of this 

nature be included in the definition? 

Under our proposed definition, it would 

be possible for a venture capital fund to 

issue commercial paper on a short-term 

basis to potential investors because the 

proposed definition does not specify 

which types of instruments a venture 

capital fund issues. Should the 

proposed rule specifically exclude 

commercial paper from debt issuances 

to avoid the potential that a venture 

capital fund could convert short-term 

debt into long-term debt by continuing 

to roll over its commercial paper 

issuances? 134 This criterion regarding 


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paper, they may face roll-over risk, i.e., the risk that 

investors may not be willing to refinance maturing 

commercial paper. These risks became particularly 

apparent for issuers of asset-backed commercial 

paper beginning in August 2007. At that time, 

structured investment vehicles (‘‘SIVs’’), which are 

off-balance sheet funding vehicles sponsored by 

financial institutions, issued commercial paper to 

finance the acquisition of long-term assets, 

including residential mortgages. As a result of 

problems in the residential home mortgage market, 

short-term investors began to avoid asset-backed 

commercial paper tied to residential mortgages, 

regardless of whether the securities had substantial 

exposure to sub-prime mortgages. Unable to roll 

over their commercial paper, SIVs suffered severe 

liquidity problems and significant losses. See 

Money Market Fund Reform, Investment Company 

Act Release No. 28807 (June 30, 2009) [74 FR 32688 

(July 8, 2009)] (‘‘Money Market Fund Reform 

Release’’) at nn.37–39 and preceding and 

accompanying text; Marcin Dacperczyk and Philipp 

Schnabl, When Safe Proved Risky: Commercial 

Paper During the Financial Crisis of 2007–2009 

(Nov. 2009). 

135See proposed rule 203(l)–1(c)(4)(ii); supra 

section II.A.1.c of this Release. Because private 

equity funds often engage in leveraged buy-out 

transactions in which the portfolio company, rather 

than the fund, incurs debt, our proposed definition 

would exclude leveraged buy-out funds. 

136See, e.g., section 115 of the Dodd-Frank Act 

(enumerating prudential standards for addressing 

systemic risks, including risk-based capital 

requirements, leverage limits, liquidity 

requirements, resolution plan and credit exposure 

report requirements, concentration limits, a 

contingent capital requirement, enhanced public 

disclosures, short-term debt limits, and overall risk 

management requirements). See also G20 Working 

Group 1, Enhancing Sound Regulation and 

Strengthening Transparency, at iii–iv (March 25, 

2009) (‘‘G20 Working Group Report’’), at iii (noting 

contribution to ‘‘market turmoil’’ when ‘‘the 

financial system developed new structures and 

created new instruments, some with embedded 

leverage.’’ Further, ‘‘[w]hile the build-up of leverage 

and the underpricing of credit risk were recognized 

in advance of the turmoil, their extent was underappreciated and there was no coordinated approach 

to assess the implications of these systemic risks 

***’’); International Monetary Fund, Lessons of 

the Global Crisis for Macroeconomic Policy, 

February 19, 2009, at 6 (noting how ‘‘[l]everage 

* * * increases lender exposure by magnifying the 

impact of a price adjustment on borrowers’ balance 

sheets and, thus on banks’ losses and capital.’’). See 

generally Department of Treasury, Financial 

Regulatory Reform, A New Foundation: Rebuilding 

Financial Supervision and Regulation, June 2009, 

available at http://www.financialstability.gov/docs/ 

regs/FinalReport_web.pdf. 

137See McGuire Testimony, supra note 41, at 7 

(‘‘Venture capital firms do not use long term 

leverage, rely on short term funding, or create third 

party or counterparty risk * * * [F]rom previous 

testimony submitted by the buy-out industry, the 

typical capital structure of the companies acquired 

by a buyout fund is approximately 60% debt and 

40% equity. In contrast, borrowing at the venture 

capital fund level, if done at all, typically is only 

used for short-term capital needs (pending 

drawdown of capital from its partners) and does not 

exceed 90 days. Not only are our partnerships run 

without debt but our portfolio companies are 

usually run without debt as well.’’); Loy Testimony, 

supra note 40, at 2 (‘‘Although venture capital funds 

may occasionally borrow on a short-term basis 

immediately preceding the time when the cash 

installments are due, they do not use debt to make 

investments in excess of the partner’s capital 

commitments or ‘lever up’ the fund in a manner 

that would expose the fund to losses in excess of 

the committed capital or that would result in losses 

to counter parties requiring a rescue infusion from 

the government.’’). 

138See S. Rep. No. 111–176, supra note 7, at 74– 

75. 

139 In proposing an exemption for advisers to 

private equity funds, which would have required 

the Commission to define the term private equity 

fund, the Senate Banking Committee noted the 

difficulties in distinguishing some private equity 

funds from hedge funds and expected the 

Commission to exclude from the exemption private 

equity funds that raise significant potential 

systemic risk concerns. S. Rep. No. 111–176, supra 

note 7, at 75. See also G20 Working Group Report, 

supra note 136, at 7 (noting that unregulated 

entities such as hedge funds may contribute to 

systemic risks through their trading activities). 

140See Loy Testimony, supra note 40, at 7 

(‘‘[V]enture capital firms do not generally rely on 

short-term funding. In fact, quite the opposite is 

true.’’); Schell, supra note 101, at § 1.03[6] (‘‘Venture 

Capital Funds rarely have the ability to borrow 

money, other than short-term loans to cover 

Partnership Expenses or to ‘bridge’ Capital 

Contributions.’’); Heesen, supra note 104, at 17. 

141See, e.g., Financial Crisis Inquiry Commission, 

Preliminary Staff Report, Shadow Banking and the 

Financial Crisis (May 4, 2010). 

142See McGuire Testimony, supra note 41, at 7. 

143Schell, supra note 101, at § 1.03[8] (‘‘The 

typical Venture Capital Fund calls for Capital 

Contributions from time to time as needed for 

investments.’’); id. at § 2.05[2] (stating that ‘‘[venture 

capital funds] begin operation with Capital 

Commitments but no meaningful assets. Over a 

specific period of time, the Capital Commitments 

are called by the General Partner and used to 

acquire Portfolio Investments.’’). 

144See Loy Testimony, supra note 40, at 5 

(‘‘[Limited partners] make their investment in a 

venture fund with the full knowledge that they 

generally cannot withdraw their money or change 

their commitment to provide funds. Essentially they 

agree to ‘‘lock-up’’ their money for the life of the 

fund.’’). See also Stephanie Breslow & Phyllis 

Schwartz, Private Equity Funds, Formation and 

Operation 2010 (‘‘Breslow & Schwartz’’), at § 2:5.6 

(discussing the various remedies that may be 

imposed in the event an investor fails to fund its 

contractual capital commitment, including, but not 

limited to, ‘‘the ability to draw additional capital 

from non-defaulting investors;’’ ‘‘the right to force a 

sale of the defaulting partner’s interests at a price 

determined by the general partner;’’ and ‘‘the right 

leverage at the venture capital fund 

level is in addition to the conditions 

relating to a qualifying portfolio 

company’s debt issuances in connection 

with the venture capital fund’s 

investment.135 Under this condition, a 

venture capital fund seeking to satisfy 

the definitional criteria could not avoid 

the borrowing element at the portfolio 

company level by incurring such 

leverage at the venture capital fund 

level. 

Congress cited the implementation of 

trading strategies that use financial 

leverage by certain private funds as 

creating a potential for systemic risk.136

In testimony before Congress, the 

venture capital industry identified the 

lack of financial leverage in venture 

capital funds as a basis for exempting 

advisers to venture capital funds 137 in 

contrast to other types of private funds 

such as hedge funds, which may engage 

in trading strategies that may contribute 

to systemic risk and affect the public 

securities markets.138 For this reason, 

our proposed rule is designed to address 

concerns that financial leverage may 

contribute to systemic risk by excluding 

funds that incur more than a limited 

amount of leverage from the definition 

of venture capital fund.139

We also understand that venture 

capital funds generally do not rely on 

short-term financing,140 which has been 

identified as another potential systemic 

risk factor.141 Should we increase or 

reduce the 15 percent threshold for 

short-term borrowing? If so, what is the 

appropriate threshold (e.g., 20, 10, or 5 

percent)? Or should we define a venture 

capital fund as a private fund that does 

not borrow at all or otherwise incur any 

financial leverage? Would even the 

limited ability to engage in short-term 

borrowing or other forms of leverage 

encourage venture capital funds to incur 

other investment risks different from 

those typically associated with venture 

capital investing today? To the extent 

that venture capital funds use shortterm leverage or borrowing, 90 days has 

been cited as typical.142 Would a 120- 

day period, as specified in our proposed 

rule, create other investment risks for 

venture capital funds? Our proposed 

rule refers specifically to borrowing but 

also is designed to give venture capital 

funds the flexibility to issue debt (which 

is also a form of borrowing) for shortterm purposes. Should the rule refer 

specifically to additional forms of 

borrowing not already identified? Do 

any or many venture capital funds 

borrow in excess of 120 days? Should 

the 15 percent limit not apply when a 

fund borrows in order to invest in a 

qualifying portfolio company and is 

repaid with capital called from the 

fund’s investors? Would the 120-day 

limit alone achieve a similar result? 

Our proposed rule specifies that the 

15 percent calculation must be 

determined based on the fund’s 

aggregate capital contributions and 

uncalled capital commitments. Unlike 

most registered investment companies 

or hedge funds, venture capital funds 

rely on investors funding their capital 

commitments from time to time in order 

to acquire portfolio companies.143 A 

capital commitment is a contractual 

obligation to acquire an interest in, or 

provide the total commitment amount 

over time to, a fund, when called by the 

fund. Accordingly, advisers to venture 

capital funds manage the fund in 

anticipation of all investors fully 

funding their commitments when due 

and typically have the right to penalize 

investors for failure to do so.144 Venture 


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to take any other action permitted at law or in 

equity’’). 

145See, e.g., Breslow & Schwartz, supra note 144, 

at § 2:5.7 (noting that a cap of 10% to 25% of 

remaining capital commitments is a common 

limitation on follow-on investments). See also 

Schell, supra note 101, at § 1.01 (noting that capital 

contributions made by the investors are used to 

‘‘make investments * * * in a manner consistent 

with the investment strategy or guidelines 

established for the Fund.’’); id. at § 1.03 

(‘‘Management fees in a Venture Capital Fund are 

usually an annual amount equal to a fixed 

percentage of total Capital Commitments.’’); see also 

Dow Jones, Private Equity Partnership Terms and 

Conditions, 2007 edition (‘‘Dow Jones Report’’) at 

15. 

146See, e.g., NVCA Yearbook 2010, supra note 41, 

at 16; John Jannarone, Private Equity’s Cash 

Problem, Wall St. J., June 23, 2010, http:// 

online.wsj.com/article/SB10001424052748704853

404575323073059041024.html#printMode. 

147See Loy Testimony, supra note 40, at 6 

(‘‘[M]any venture capital funds significantly limit 

borrowing such that all outstanding capital 

borrowed by the fund, together with guarantees of 

portfolio company indebtedness, does not exceed 

the lesser of (i) 10–15% of total limited partner 

commitments to the fund and (ii) undrawn limited 

partner commitments.’’). 

148Proposed rule 203(l)–1(a)(5) (limiting venture 

capital funds to funds that ‘‘[o]nly issue[] securities 

the terms of which do not provide a holder with 

any right, except in extraordinary circumstances, to 

withdraw, redeem or require the repurchase of such 

securities but may entitle holders to receive 

distributions made to all holders pro rata’’). 

149See Schell, supra note 101, at § 1.03[7] 

(venture capital fund ‘‘redemptions and 

withdrawals are rarely allowed, except in the case 

of legal compulsion’’); Breslow & Schwartz, supra 

note 144, at § 2:14.2 (‘‘the right to withdraw from 

the fund is typically provided only as a last resort’’). 

150Loy Testimony, supra note 40, at 2–3 (‘‘As 

portfolio company investments are sold in the later 

years of the [venture capital] fund—when the 

company has grown so that it can access the public 

markets through an initial public offering (an IPO) 

or when it is an attractive target to be bought—the 

liquidity from these ‘exits’ is distributed back to the 

limited partners. The timing of these distributions 

is subject to the discretion of the general partner, 

and limited partners may not otherwise withdraw 

capital during the life of the venture [capital] 

fund.’’). Id. at 5 (Investors ‘‘make their investment 

in a venture [capital] fund with the full knowledge 

that they generally cannot withdraw their money or 

change their commitment to provide funds. 

Essentially they agree to ‘lock-up’ their money for 

the life of the fund, generally 10 or more years as 

I stated earlier.’’). See also Dow Jones Report, supra 

note 145, at 60 (noting that an investor in a private 

equity or venture capital fund typically does not 

have the right to transfer its interest). 

151See Hedge Fund Adviser Registration Release, 

supra note 17, at n.240 and accompanying text 

(‘‘Many partnership agreements provide the investor 

the opportunity to redeem part or all of its 

investment, for example, in the event continuing to 

hold the investment became impractical or illegal, 

in the event of an owner’s death or total disability, 

in the event key personnel at the fund adviser die, 

become incapacitated, or cease to be involved in the 

management of the fund for an extended period of 

time, in the event of a merger or reorganization of 

the fund, or in order to avoid a materially adverse 

tax or regulatory outcome. Similarly, some 

investment pools may offer redemption rights that 

can be exercised only in order to keep the pool’s 

assets from being considered ‘plan assets’ under 

ERISA [Employee Retirement Income Security Act 

of 1974].’’). See, e.g., Breslow & Schwartz, supra 

note 144, at § 2:14.1 (‘‘Private equity funds generally 

provide for mandatory withdrawal of a limited 

partner [i.e., investor] only in the case where the 

continued participation by a limited partner in a 

fund would give rise to a regulatory or legal 

violation by the investor or the fund (or the general 

partner [i.e., adviser] and its affiliates). Even then, 

it is often possible to address the regulatory issue 

by excusing the investor from particular 

investments while leaving them otherwise in the 

fund.’’). 

152See, e.g., Breslow & Schwartz, supra note 144, 

at § 2:14.2 (‘‘The most common reason for allowing 

withdrawals from private equity funds arises in the 

case of an ERISA violation where there is a 

substantial likelihood that the assets of the fund 

would be treated as ‘plan assets’ of any ERISA 

partner for purposes of Title I of ERISA or section 

4975 of the Code.’’). See also Schell, supra note 101, 

at § 9.04[3] (‘‘Exclusion provisions allow the 

General Partner to exclude a Limited Partner from 

participation in any or all investments if a violation 

of law or another material adverse effect would 

otherwise occur.’’); id. at Appendix D–31 (attaching 

model limited partnership agreement providing 

‘‘The General Partner at any time may cancel the 

obligations of all Partners to make Capital 

Contributions for Portfolio Instruments if * * * 

changes in applicable law * * * make such 

cancellation necessary or advisable. * * * ’’). 

capital funds are subject to investment 

restrictions, and calculate fees payable 

to an adviser, as a percentage of the total 

capital commitments of investors, 

regardless of whether or not the capital 

commitment is ultimately funded by an 

investor.145 Venture capital fund 

advisers typically report and market 

themselves to investors on the basis of 

aggregate capital commitment amounts 

raised for prior or existing funds.146

These factors would lead to the 

conclusion that, in contrast to other 

types of private funds, such as hedge 

funds, which trade on a more frequent 

basis, a venture capital fund would view 

the fund’s total capital commitments as 

the primary metric for managing the 

fund’s assets and for determining 

compliance with investment guidelines. 

Hence, we believe that calculating the 

leverage threshold to include uncalled 

capital commitments is appropriate, 

given that capital commitments are 

already used by venture capital funds 

themselves to measure investment 

guideline compliance. 

The proposed 15 percent threshold 

would be determined based on the 

venture capital fund’s aggregate capital 

commitments. In practice, this means 

that a venture capital fund relying on 

the exemption could leverage an 

investment transaction up to 100 

percent when acquiring equity 

securities of a particular portfolio 

company as long as the investment 

amount does not exceed 15 percent of 

the fund’s total capital commitments, 

albeit on a short-term basis that did not 

exceed 120 days. Should the 15 percent 

calculation be determined with respect 

to the total investment amount for each 

portfolio company? Would this standard 

be easier to apply? 

Our proposed rule defines a venture 

capital fund by reference to a maximum 

of 15 percent of borrowings based on 

our understanding that venture capital 

funds typically would not incur 

borrowings in excess of 10 to 15 percent 

of the fund’s total capital contributions 

and uncalled capital commitments.147

We believe that imposing a maximum at 

the upper range of borrowings typically 

used by venture capitals may 

accommodate existing practices of the 

vast majority of industry participants. 

3. No Redemption Rights 

Proposed rule 203(l)-1 would define a 

venture capital fund as a fund that 

issues securities that do not provide 

investors redemption rights except in 

‘‘extraordinary circumstances’’ but that 

do entitle investors generally to receive 

pro rata distributions.148 Unlike hedge 

funds, venture capital funds do not 

typically permit investors to redeem 

their interests during the life of the 

fund,149 but rather distribute assets 

generally as investments mature.150

Although venture capital funds 

typically return capital and profits to 

investors only through pro rata 

distributions, such funds may also 

provide extraordinary rights for an 

investor to withdraw from the fund 

under foreseeable but unexpected 

circumstances or rights to be excluded 

from particular investments due to 

regulatory or other legal 

requirements.151 These events may be 

‘‘foreseeable’’ because they are 

circumstances that are known to occur 

(e.g., changes in law, corporate events 

such as mergers) but are unexpected in 

their timing or scope. Thus, withdrawal 

or exclusion rights might be triggered by 

a change in the tax law after an investor 

invests in the fund, or the enactment of 

laws that may prohibit an investor’s 

participation in the fund’s investment in 

particular countries or industries.152

The trigger events for these rights are 

typically beyond the control of the 

adviser and fund investor (e.g., tax and 

regulatory changes). 

For these purposes, for example, a 

fund that permits quarterly or other 

periodic withdrawals would be 

considered to have granted investors 

redemption rights in the ordinary course 

even if those rights may be subject to an 

initial lock-up or suspension or 

restrictions on redemption. Is the phrase 

‘‘extraordinary circumstances’’ 

sufficiently clear to distinguish the 

investor liquidity terms of venture 

capital funds, as they operate today, 

from hedge funds? Congressional 


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153See supra notes 149–150 and accompanying 

text. 

154For example, a private fund’s governing 

documents may provide that investors do not have 

any right to redeem without the consent of the 

general partner. In practice, if the general partner 

typically permits investors to redeem or transfer 

their otherwise non-redeemable, non-transferable 

interests on a periodic basis, then the fund would 

not be considered to have issued securities that ‘‘do 

not provide a holder with any right, except in 

extraordinary circumstances, to withdraw.’’ 

155Proposed rule 203(l)–1(a)(1). 

156We also note that a fund that represents to 

investors that it is one type of fund while pursuing 

a different type of fund strategy may raise concerns 

under rule 206(4)–8 of the Advisers Act. 

157See Gompers, supra note 110, at 6–7. 

158See section 202(a)(29) of the Advisers Act. 

159Proposed rule 203(l)–1(a)(6). 

160Legislative history does not indicate that 

Congress addressed this matter, nor does testimony 

before Congress suggest that this was contemplated. 

See, e.g., McGuire Testimony, supra note 41, at 3 

(noting that venture capital funds are not directly 

accessible by individual investors); Loy Testimony, 

supra note 40, at 2 (‘‘Generally * * * capital for the 

venture fund is provided by qualified institutional 

investors such as pension funds, universities and 

endowments, private foundations, and to a lesser 

extent, high net worth individuals.’’). See generally 

supra note 158 (definition of ‘‘private fund’’). 

161See S. Rep. No. 111–176, supra note 7, at 74 

(describing venture capital funds as a subset of 

‘‘private investment funds’’). 

162See, e.g., Heesen, supra note 104 (generally 

describing characteristics that distinguish venture 

capital funds from hedge funds and buyout funds). 

163See Loy Testimony, supra note 40, at 2 

(‘‘[g]enerally, 95 to 99 percent of capital for the 

venture fund is provided by * * * investors * * * 

and we supply the rest of the capital for the fund 

from our own personal assets’’); McGuire 

Testimony, supra note 41, at 3. Industry data 

confirm that such investments are typical in the 

venture capital industry. See, e.g., Dow Jones 

Report, supra note 145, at 23–24 (showing that, in 

a survey of 110 North American general partners, 

at least 83% contributed at least 1% of venture 

capital fund capital). We note that certain investors 

perceive an investment in the fund as aligning the 

interest of investors and advisers. See Institutional 

Limited Partners Association Private Equity 

Principles, September 9, 2009, at 3 (recommending 

that the ‘‘general partner should have a substantial 

equity interest in the fund to maintain a strong 

alignment of interest with the limited partners, and 

a high percentage of the amount should be in cash 

as opposed to being contributed through the waiver 

of the management fee.’’); Mercer Investment 

Consulting, Inc., Key Terms and Conditions for 

Private Equity Investing, 1996 at 13 (‘‘Many limited 

partners view the 1% standard as an inadequate 

sharing of risk * * * .’’). 

164See McGuire Testimony, supra note 41, at 3 

(‘‘Venture capital funds are not sold directly to retail 

investors like mutual funds.’’); Loy Testimony, 

supra note 40, at 2 (‘‘Generally, 95 to 99 percent of 

capital for the venture fund is provided by qualified 

institutional investors such as pension funds, 

universities and endowments, private foundations, 

and to a lesser extent, high net worth individuals.’’). 

165See Loy Testimony, supra note 40, at 2; 

McGuire Testimony, supra note 41, at 3. 

166See Loy Testimony, supra note 40, at 4; 

McGuire Testimony, supra note 41, at 5. 

testimony cited an investor’s inability to 

withdraw from a venture capital fund as 

a key characteristic of venture capital 

funds and a factor for reducing their 

potential for systemic risk.153 Although 

a fund prohibiting redemptions would 

be a venture capital fund for purposes 

of the exemption, the rule does not 

specify a minimum period of time for an 

investor to remain in the fund. Should 

the rule define when withdrawals by 

investors would be ‘‘extraordinary?’’ 

Should the rule specify minimum 

investment periods for investors? Could 

venture capital funds provide investors 

with ‘‘extraordinary’’ rights to redeem 

that could effectively result in 

redemption rights in the ordinary 

course? 154 Should we address this 

potential for circumvention of the 

definition by establishing a maximum 

amount that may be redeemed during 

any period of time (e.g., 10 percent of 

an investor’s total capital 

commitments)? Would such a limit 

constrain investors in a way so as to 

prevent them from complying with 

other legal or regulatory requirements? 

4. Represents Itself as a Venture Capital 

Fund 

Proposed rule 203(l)–1 would limit 

the definition of venture capital fund for 

the purposes of the exemption to a 

private fund that represents itself as 

being a venture capital fund to its 

investors and potential investors.155 A 

private fund could satisfy this 

definitional element by, for example, 

describing its investment strategy as 

venture capital investing or as a fund 

that is managed in compliance with the 

elements of our proposed rule. Without 

this element, a fund that did not engage 

in typical venture capital activities 

could be treated as a venture capital 

fund simply because it met the other 

elements specified in our proposed rule 

(because for example it only invests in 

short term Treasuries, controls portfolio 

companies, does not borrow, does not 

offer investors redemption rights, and is 

not a registered investment 

company).156 We believe that only 

funds that do not significantly differ 

from the common understanding of 

what a venture capital fund is,157 and 

that are actually offered to investors as 

venture capital funds, should qualify for 

the exemption. Thus, an adviser to a 

venture capital fund that is otherwise 

relying on the exemption could not 

identify the fund as a hedge fund or 

multi-strategy fund (i.e., venture capital 

is one of several strategies used to 

manage the fund) or include the fund in 

a hedge fund database or hedge fund 

index. 

We request comment on a venture 

capital fund’s representations regarding 

itself as a criterion under the proposed 

definition. Is our criterion inconsistent 

with current practice? Does the 

proposed criterion regarding venture 

capital fund representations adequately 

address our concern that advisers 

should not be eligible for the exemption 

if they advise funds that otherwise meet 

the definitional criteria in the rule but 

engage in activities that do not 

constitute venture capital investing? 

5. Is a Private Fund 

We propose to define a venture 

capital fund for the purposes of the 

exemption as a private fund, which is 

defined in the Advisers Act,158 and 

exclude from the proposed definition 

funds that are registered investment 

companies (e.g., mutual funds) or have 

elected to be regulated as BDCs.159

There is no indication that Congress 

intended this exemption to apply to 

advisers to these publicly available 

funds,160 referring to venture capital 

funds as a ‘‘subset of private investment 

funds.’’ 161 We request comment on this 

requirement and whether it 

appropriately reflects the expectation of 

Congress. 

6. Other Factors 

We request comment on whether the 

proposed rule should include other 

elements that were described in 

testimony as characteristic of venture 

capital funds or that distinguish venture 

capital funds from other types of private 

equity or private funds.162 For example, 

testimony presented to Congress 

indicated that venture capital funds 

typically have capital contributions 

from their advisers, generally up to five 

percent of the fund’s total capital 

commitments.163 Congress also received 

testimony that venture capital funds are 

generally not open to retail investors,164

have long investment periods, generally 

of at least ten years,165 and contribute to 

the U.S. economy by creating jobs, 

fostering competition and facilitating 

innovation.166

Are any of these characteristics 

appropriate to include as elements in 

the definition? If so, which elements 

should be included and what would be 

appropriate thresholds for application? 

Do venture capital advisers typically 

invest in the funds they manage? 

Should we modify the proposed rule to 

include as a condition that advisers 

relying on the exemption under section 

203(l) would invest in the venture 

capital fund at a specified minimum 

threshold? If so, what is an appropriate 

investment threshold—less than one 

percent, one percent, three percent, five 

percent, or somewhere in between? 

Should the proposed rule be modified to 

specify that venture capital funds have 

a minimum term, for example, of 10 


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Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 77205 

167Rule 205–3 generally defines a qualified client 

as any person who has at least $750,000 under 

management with an adviser immediately after 

entering into the contract or who has a net worth 

of more than $1,500,000 at the time the contract is 

entered into. 

168See section 203(l) of the Advisers Act; H. Rep. 

No. 111–517, supra note 7, at 867; S. Rep. No. 111– 

176, supra note 7, at 74–75. 

169See Loy Testimony, supra note 40, at 4–5; 

McGuire Testimony, supra note 41, at 5–6. 

170See supra note 5 and accompanying text. 

171See rule 203(b)(3)–1(b)(5). 

172See rule 203(b)(3)–1(a)(2). See also ABA 

Subcommittee on Private Investment Companies, 

SEC Staff No-Action Letter (Aug. 10, 2006) (‘‘ABA 

Letter’’). In the ABA Letter, Commission staff 

expressed the view that the substantive provisions 

of the Advisers Act do not apply to offshore 

advisers with respect to such advisers’ dealings 

with offshore funds and other offshore clients to the 

extent described in prior staff no-action letters and 

the Hedge Fund Adviser Registration Release, supra 

note 17. The staff took the position, however, that 

an offshore adviser registered with the Commission 

under the Advisers Act must comply with the 

Advisers Act and the Commission’s rules 

thereunder with respect to any U.S. clients (and any 

prospective U.S. clients) it may have. 

173See proposed rule 203(m)–1(e)(8); proposed 

rule 202(a)(30)–1(c)(2)(i). 

174See proposed rule 203(l)–1(a). 

175An issuer that is organized under the laws of 

the United States or of a state is a private fund if 

it is excluded from the definition of an investment 

company for most purposes under the Investment 

Company Act pursuant to sections 3(c)(1) or 3(c)(7). 

Section 7(d) of the Investment Company Act 

prohibits a non-U.S. fund from using U.S. 

jurisdictional means to make a public offering, 

absent an order permitting registration. A non-U.S. 

fund may conduct a private U.S. offering without 

violating section 7(d) only if the fund complies with 

either section 3(c)(1) or 3(c)(7) with respect to its 

U.S. investors (or some other available exemption 

or exclusion). Consistent with this view, a non-U.S. 

fund is a private fund if it makes use of U.S. 

jurisdictional means to, directly or indirectly, offer 

or sell any security of which it is the issuer and 

relies on either section 3(c)(1) or 3(c)(7). See Hedge 

Fund Adviser Registration Release, supra note 17, 

at n.226; Offer and Sale of Securities to Canadian 

Tax-Deferred Retirement Savings Accounts, 

Securities Act Release No. 7656 (Mar. 19, 1999) [64 

FR 14648 (Mar. 26, 1999)], at nn.10, 20, 23; 

Statement of the Commission Regarding Use of 

Internet Web Sites to Offer Securities, Solicit 

Securities Transactions or Advertise Investment 

Services Offshore, Securities Act Release No. 7516 

(Mar. 23, 1998) [63 FR 14806 (Mar. 27, 1998)], at 

n.41. See also Dechert LLP, SEC Staff No-Action 

Letter (Aug. 24, 2009) at n.8; Goodwin, Procter & 

Hoar LLP, SEC Staff No-Action Letter (Feb. 28, 

1997) (‘‘Goodwin Procter Letter’’); Touche Remnant 

& Co., SEC Staff No-Action Letter (Aug. 27, 1984). 

176Proposed rule 203(l)–1(b). 

177See also Electronic Filing and Revision of 

Form D, Securities Act Release No. 8891(Feb. 6, 

2008) [73 FR 10592 (Feb. 27, 2008)], at section VIII, 

Form D, General Instructions—When to File (noting 

that a Form D is required to be filed within 15 days 

of the first sale of securities which would include 

‘‘the date on which the first investor is irrevocably 

contractually committed to invest’’), n.159 (‘‘a 

mandatory capital commitment call would not 

constitute a new offering, but would be made under 

the original offering’’). 

years? Should the proposed rule be 

modified to specify that a venture 

capital fund is one that does not have 

retail investors? If so, how should ‘‘retail 

investor’’ be defined? Should ‘‘retail 

investor’’ exclude persons who are not 

‘‘qualified clients’’ for purposes of the 

Advisers Act?167

7. Application to Non-U.S. Advisers 

Neither the statutory text of section 

203(l) nor the legislative reports gives an 

indication of whether Congress 

intended the exemption to be available 

to advisers that operate principally 

outside of the United States but that 

invest in U.S. companies or solicit U.S. 

investors.168 Testimony before Congress 

presented by members of the U.S. 

venture capital industry discussed the 

industry’s role primarily in the U.S. 

economy including its lack of 

interconnection with the U.S. financial 

markets and ‘‘interdependence’’ with the 

world financial system.169 Nevertheless, 

we expect that venture capital funds 

with advisers operating principally 

outside of the United States may seek to 

access the U.S. capital markets by 

investing in U.S. companies or soliciting 

U.S. investors; investors in the United 

States may also have an interest in 

venture capital opportunities outside of 

the United States. We request comment 

on whether the proposed rule should 

specify that an adviser with its principal 

office and place of business outside of 

the United States (a ‘‘non-U.S. adviser’’) 

is eligible to rely on the exemption even 

if it advises funds that do not meet our 

proposed definition of venture capital 

fund. 

A non-U.S. adviser currently may rely 

on the private adviser exemption, if it 

meets the conditions of current section 

203(b)(3) of the Advisers Act, including 

advising no more than 14 clients.170 We 

have permitted such an adviser to count 

only clients that are residents of the 

United States,171 and for this purpose 

permitted the adviser to treat a private 

fund incorporated outside of the United 

States as a non-resident of the United 

States, even if some or all of the 

investors in the private fund are 

residents of the United States.172 A nonU.S. adviser may rely on the venture 

capital exemption if all of its clients, 

whether U.S. or non-U.S., are venture 

capital funds. In effecting the new 

venture capital exemption, should we 

specifically provide that a non-U.S. 

adviser may avail itself of the exemption 

even if it advises clients other than 

venture capital funds, provided such 

clients are non-United States persons, 

under the definition we propose for 

purposes of the other exemptions 

discussed below? 173 If we take this 

approach, should the non-U.S. adviser 

be able to rely on the venture capital 

exemption if it advises these other 

clients from within the United States? 

If a non-U.S. adviser must advise 

solely venture capital funds (even those 

advisers that principally operate outside 

of the United States) our proposed 

definition may have the result of 

subjecting non-U.S. advisers to United 

States regulatory oversight because they 

advise funds offered only outside the 

United States. Under our proposed rule, 

only a private fund as defined under 

section 202(a)(29) may be a venture 

capital fund.174 A non-U.S. fund that 

uses U.S. jurisdictional means in the 

offering of the securities it issues and 

relies on sections 3(c)(1) or 3(c)(7) 

would be a private fund.175 A non-U.S. 

fund that does not make such a U.S. 

offering would not be a private fund and 

therefore could not qualify as a venture 

capital fund, even if operated as a 

venture capital fund in a manner that 

would otherwise meet the criteria under 

our proposed definition. If we adopt the 

approach we are proposing today, 

should we allow an adviser to treat such 

a non-U.S. fund as a private fund and, 

to the extent that the fund meets all of 

the other conditions of our proposed 

definition, as a venture capital fund for 

purposes of the exemption? If so, under 

what conditions? For example, should a 

non-U.S. fund be a private fund under 

the proposed rule if the non-U.S. fund 

would be deemed a private fund upon 

conducting a private offering in the 

United States in reliance on sections 

3(c)(1) or 3(c)(7)? 

8. Grandfathering Provision 

We propose to include in the 

definition of ‘‘venture capital fund’’ any 

private fund that: (i) Represented to 

investors and potential investors at the 

time the fund offered its securities that 

it is a venture capital fund; (ii) has sold 

securities to one or more investors prior 

to December 31, 2010; and (iii) does not 

sell any securities to, including 

accepting any additional capital 

commitments from, any person after 

July 21, 2011 (the ‘‘grandfathering 

provision’’).176 The grandfathering 

provision thus would include any fund 

that has accepted capital commitments 

by the specified dates even if none of 

the commitments has been called.177 As 

a result, any investment adviser that 

solely advises private funds that meet 

the definitions in either proposed rule 

203(l)–1(a) or (b) would be exempt from 

registration. 

We believe that most funds previously 

sold as venture capital funds likely 

would satisfy all or most of the 

conditions in the proposed rule. 


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77206 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

178See proposed rule 203(l)–1(a)(5); supra 

discussion in section II.A.4 of this Release. 

179See proposed rule 203(l)–1(a)(4); supra 

discussion in section II.A.3 of this Release. 

180See proposed rule 203(l)–1(a)(1); supra 

discussion in section II.A.1.b of this Release. 

181See proposed rule 203(l)–1(a)(3); supra 

discussion in section II.A.2 of this Release. 

182See supra discussion in sections II.A.1.e and 

II.A.6 of this Release. 

183See Breslow & Schwartz, supra note 144, at 

§ 2:4.1 (private equity fundraising may take six to 

12 months following the initial closing, depending 

upon whether the adviser has an existing investor 

base or a successful performance record). 

184Section 408 of the Dodd-Frank Act, which is 

codified in section 203(m) of the Advisers Act. See 

supra note 22. 

185See proposed rule 203(m)–1(a) and (b). A 

‘‘private fund’’ includes a private fund that invests 

in other private funds. 

186Proposed rule 203(m)–1(b)(1). 

187Rule 203(b)(3)–1(b)(5) (‘‘If you have your 

principal office and place of business outside the 

United States, you are not required to count clients 

that are not United States residents, but if your 

principal office and place of business is in the 

United States, you must count all clients.’’). See 

infra note 207. 

Nevertheless, we recognize that 

investment advisers currently seeking to 

sponsor new funds before the adoption 

of the final version of proposed rule 

203(l)–1 will continue to face 

uncertainty regarding the precise terms 

of the definition and hence uncertainty 

regarding their eligibility for the new 

exemption. Thus, our proposed rule 

presumes that a fund that has 

commenced its offering (i.e., has 

initially sold securities by December 

2010) and that also concludes its 

offering by the effective date of Title IV 

of the Dodd-Frank Act (i.e., July 21, 

2011) is unlikely to have been 

structured to circumvent the intended 

scope of the exemption. Moreover, 

requiring existing venture capital funds 

to modify their investment conditions or 

characteristics, liquidate portfolio 

company holdings or alter the rights of 

investors in the funds in order to satisfy 

the proposed definition of a venture 

capital fund would likely be impossible 

in many cases and yield unintended 

consequences for the funds and their 

investors. 

Thus, we propose that an investment 

adviser may treat any existing private 

fund as a venture capital fund for 

purposes of section 203(l) of the 

Advisers Act if the fund meets the 

elements of the grandfathering 

provision. The current private adviser 

exemption does not require an adviser 

to identify or characterize itself as any 

type of adviser (or impose limits on 

advising any type of funds). 

Accordingly, we believe that advisers 

have not had an incentive to mischaracterize existing venture capital 

funds that have already been marketed 

to investors. As we note above, a fund 

that ‘‘represents’’ itself to investors as a 

venture capital fund is typically one 

that discloses it pursues a venture 

capital investing strategy and identifies 

itself as such. We do not expect funds 

identifying themselves as ‘‘private 

equity’’ or ‘‘hedge’’ would be able to rely 

on this exemption. 

We request comment on this 

grandfathering provision. Should we 

include other conditions in addition to 

the fund representing itself as a venture 

capital fund? For example, should a 

fund seeking to be grandfathered also 

provide that its investors do not have 

any redemption rights except in 

extraordinary circumstances,178 not 

incur leverage except on a short-term 

basis,179 limit the securities that it 

acquires from portfolio companies to 

equity securities,180 or provide 

significant managerial assistance to the 

portfolio companies in which the fund 

invests? 181 Should the grandfathering 

provision be modified to exclude other 

types of funds, such as funds of venture 

capital funds or publicly available 

venture capital funds? 182 We 

understand that venture capital funds 

may be in the planning and initial 

offering stage for a considerable period 

of time.183 Should funds that have their 

first sale of securities within a period of 

time such as 180 days after the final rule 

is adopted be able to rely on the 

proposed grandfathering provision? 

Does our grandfathering provision 

unnecessarily encourage the formation 

of new funds before December 31, 2010, 

and therefore should the grandfathering 

provision only apply to funds in 

existence on the date of this proposal or 

some other time before December 31, 

2010? Would the dates specified in the 

grandfathering provision significantly 

shorten the fundraising periods for 

venture capital funds? Should we 

specify a date later than December 31, 

2010 or earlier than July 21, 2011? Do 

venture capital fund advisers need more 

time or flexibility to determine 

eligibility for the grandfathering 

provision? Alternatively, would exempt 

advisers consider registering with the 

Commission in order to retain flexibility 

to raise capital for new venture capital 

funds without regard to the 

grandfathering provision? 

B. Exemption for Investment Advisers 

Solely to Private Funds With Less Than 

$150 Million in Assets Under 

Management 

Section 203(m) of the Advisers Act 

directs the Commission to exempt from 

registration any investment adviser 

solely to private funds that has less than 

$150 million in assets under 

management in the United States.184 We 

are proposing a new rule 203(m)–1 that 

would provide the exemption and 

address several interpretive questions 

raised by section 203(m). We will refer 

to this exemption as the ‘‘private fund 

adviser exemption.’’ 

1. Advises Solely Private Funds 

Proposed rule 203(m)–1 would, like 

section 203(m) of the Advisers Act, limit 

an adviser relying on the exemption to 

advising ‘‘private funds’’ as that term is 

defined in that Act.185 An adviser that 

acquires a different type of client would 

have to register under the Advisers Act 

unless another exemption is available. 

An adviser could advise an unlimited 

number of private funds, provided the 

aggregate value of the adviser’s private 

fund assets is less than $150 million. 

In the case of an adviser with a 

principal office and place of business 

outside of the United States (a ‘‘non-U.S. 

adviser’’), we propose to provide the 

exemption as long as all of the adviser’s 

clients that are United States persons 

are qualifying private funds.186 As a 

consequence, a non-U.S. adviser could 

enter the U.S. market and take 

advantage of the exemption without 

regard to the type or number of its nonU.S. clients. Under this approach, a 

non-U.S. adviser would not lose the 

private fund adviser exemption as a 

result of its business activities outside 

the United States. Recognizing that nonU.S. activities of non-U.S. advisers are 

less likely to implicate U.S. regulatory 

interests and in consideration of general 

principles of international comity, our 

rules have taken a similar approach by 

permitting a non-U.S. adviser to count 

only clients that are U.S. persons when 

determining whether it has 14 or fewer 

clients, and is thus eligible for the 

private adviser exemption.187

We request comment on our proposed 

application of the statute to non-U.S. 

advisers. Should we, alternatively, 

interpret section 203(m) as denying the 

private fund adviser exemption to a 

non-U.S. adviser that has other types of 

clients outside of the United States? 

This interpretation would have the 

effect of treating non-U.S. and U.S. 

advisers equally with respect to the 

types of clients they may have, but 

could also have the result of requiring 

many non-U.S. advisers to register 

because of the scope and nature of their 

non-U.S. advisory business, an outcome 

which the ‘‘assets under management in 

the United States’’ limitation in section 

203(m) suggests was not a consideration 

relevant to the scope of the exemption. 


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Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 77207 

188See supra note 174–175 and accompanying 

paragraph. 

189Proposed rule 203(m)–1(c). 

190See proposed rules 203(m)–1(a)(2); 203(m)– 

1(b)(2); 203(m)–1(e)(1) (defining ‘‘assets under 

management’’ to mean ‘‘regulatory assets under 

management’’ in proposed item 5.F of Form ADV, 

Part 1A); 203(m)–1(e)(4) (defining ‘‘private fund 

assets’’ to mean the assets under management 

attributable to a qualifying private fund). This 

uniform method of calculation would be used to 

determine whether an adviser qualifies to register 

with the Commission rather than the states, as well 

as to determine eligibility for the private fund 

adviser exemption and the foreign private adviser 

exemption discussed in this Release. Under the 

proposed Form ADV instructions, advisers would 

include in their ‘‘regulatory assets under 

management’’ any proprietary assets, assets 

managed without receiving compensation, and 

assets of non-U.S. clients, all of which an adviser 

may currently exclude, as well as, in the case of 

private funds, uncalled capital commitments. 

Moreover, the adviser could not deduct liabilities, 

such as accrued fees and expenses or the amount 

of any borrowing. See Implementing Release, supra 

note 25, at section II.A.3 (discussing the rationale 

underlying the proposed new instructions for 

calculating assets under management under Form 

ADV). 

191See proposed Form ADV: Instructions for Part 

1A, instr. 5.b(2). 

192See proposed Form ADV: Instructions for Part 

1A, instr. 5.b(1). 

193See supra notes 143–145. 

194 Id. 

195See proposed rule 203(m)–1(c); supra note 

190; proposed Form ADV: Instructions for Part 1A, 

instr. 5.b(4). As discussed in the Implementing 

Release, we are proposing to require advisers to 

value private fund assets using fair value when 

calculating their assets under management for 

several purposes under the Advisers Act. See 

Implementing Release, supra note 25, at section 

II.A.3. A fund’s governing documents may provide 

for a specific process for calculating fair value (e.g., 

that the general partner, rather than the board of 

directors, determines the fair value of the fund’s 

assets). An adviser would be able to rely on such 

a process also for purposes of calculating its assets 

under management. 

196See, e.g., Comment Letter of National Venture 

Capital Association (July 28, 2009), at 2 (the ‘‘vast 

majority of venture capital funds provide their LPs 

[i.e., investors] quarterly and audited annual 

financial reports. These reports are prepared under 

generally accepted accounting principles, or GAAP, 

and audited under the standards established for all 

investment companies, including the largest mutual 

fund complexes.’’); Comment Letter of Managed 

Funds Association (July 28, 2009), at 3 (a 

‘‘substantial proportion of hedge fund managers, 

whether or not they are registered with the 

Commission, provide independently audited 

financial statements of the [hedge] fund to 

investors.’’). These comment letters were submitted 

in connection with the Commission’s proposed 

amendments to the custody rule, Custody of Funds 

or Securities of Clients by Investment Advisers, 

Investment Advisers Act Release No. 2876 (May 20, 

2009) [74 FR 25354 (May 27, 2009)], and are 

available on the Commission’s Internet Web site at 

http://www.sec.gov/comments/s7–09–09/ 

s70909.shtml. 

197Those assets include, for example, ‘‘distressed 

debt’’ (such as securities of companies or 

government entities that are either already in 

default, under bankruptcy protection, or in distress 

and heading toward such a condition) or certain 

types of emerging market securities that are not 

readily marketable. See Gerald T. Lins et al., Hedge 

Funds and Other Private Funds: Reg and Comp 

§ 5:22 (2009) (‘‘At any given time, some portion of 

a hedge fund’s portfolio holdings may be illiquid 

and/or difficult to value. This is particularly the 

case for certain types of hedge funds, such as those 

focusing on distressed securities, activist investing, 

etc.’’). 

Under such an approach, moreover, the 

exemption would be unavailable to a 

non-U.S. adviser unless all of the nonU.S. funds it manages are offered to 

investors in the United States (and 

therefore meet the definition of ‘‘private 

fund’’).188 If we adopt this alternative 

approach, should the exemption apply 

to a non-U.S. adviser even if not all of 

the non-U.S. funds it manages are 

offered in the United States? 

2. Private Fund Assets 

Under proposed rule 203(m)–1, an 

adviser would have to aggregate the 

value of all assets of private funds it 

manages in the United States to 

determine if the adviser remains below 

the $150 million threshold.189 Proposed 

rule 203(m)–1 would require advisers to 

calculate the value of private fund assets 

by reference to Form ADV, under which 

we propose to provide a uniform 

method of calculating assets under 

management for regulatory purposes 

under the Advisers Act.190 In the case 

of a sub-adviser, it would have to count 

only that portion of the private fund 

assets for which it has responsibility.191

In addition to assets appearing on a 

private fund’s balance sheet, advisers 

would include any uncalled capital 

commitments, which are contractual 

obligations 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.192 Advisers to private funds that 

use capital commitments seek 

investments early in the life of the fund 

in anticipation of all investors fully 

paying in these capital commitments 

during the life of the fund, and fees 

payable to the adviser are calculated as 

a percentage of total capital 

commitments.193 Many of these types of 

private funds are managed following 

investment guidelines and restrictions 

that are determined as a percentage of 

overall capital commitments, rather 

than as a percentage of current net asset 

value.194 We request comment on 

whether the method for calculating the 

relevant assets under management 

should deviate from the method in the 

proposed amendments to Form ADV 

instructions by, for example, excluding 

proprietary assets, assets managed 

without compensation, or uncalled 

capital commitments. 

Under proposed rule 203(m)–1, each 

adviser would have to determine the 

amount of its private fund assets 

quarterly, based on the fair value of the 

assets at the end of the quarter.195 We 

propose that advisers use the fair value 

of private fund assets in order to ensure 

that, for purposes of this exemption, 

advisers value private fund assets on a 

meaningful and consistent basis. Use of 

the cost basis (i.e., the value at which 

the assets were originally acquired), for 

example, could under certain 

circumstances understate significantly 

the value of appreciated assets, and thus 

result in advisers availing themselves of 

the exemption. Use of the fair valuation 

method by all advisers, moreover, 

would result in more consistent asset 

calculations and reporting across the 

industry and, therefore, in a more 

coherent application of the Advisers 

Act’s regulatory requirements and of our 

staff’s risk assessment program. 

We understand that many, but not all, 

private funds value assets based on their 

fair value in accordance with U.S. 

generally accepted accounting 

principles (‘‘GAAP’’) or other 

international accounting standards.196

Some private funds do not use fair value 

methodologies, which may be more 

difficult to apply when the fund holds 

illiquid or other types of assets that are 

not traded on organized markets.197

Would the proposed approach result in 

advisers valuing their private fund 

assets in a generally uniform manner 

and in comparability of the valuations? 

We are not proposing to require advisers 

to determine fair value in accordance 

with GAAP. Should we adopt such a 

requirement? If not, should we specify 

that advisers may only determine the 

fair value of private fund assets in 

accordance with a body of accounting 

principles used in preparing financial 

statements? We understand that GAAP 

does not require some funds to fair 

value certain investments. Should we 

provide for an exception from the 

proposed fair valuation requirement 

with respect to any of those 

investments? 

Should we adopt a different approach 

altogether and allow advisers to use a 

method other than fair value? Are there 

other methods that would not 

understate the value of fund assets? 

Should the rule permit advisers to rely 

exclusively on the method set forth in 

a fund’s governing documents, or the 

method used to report the value of 

assets to investors or to calculate fees (or 

other compensation) for investment 

advisory services? What method should 

apply if a fund uses different methods 

for different purposes? Should we 

modify the proposed rule to require that 

the valuation be derived from audited 

financial statements or subject to review 


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77208 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

198The proposed frequency of the calculation is 

consistent with section 2(a)(41)(A) of the 

Investment Company Act, which specifies the 

valuation of the assets of an issuer for purposes of 

determining whether it meets the definition of 

investment company under section 3 of that Act. 

199See proposed rules 204–1(a) and 204–4(a) and 

proposed General Instruction 3 to Form ADV. See 

Implementing Release, supra note 25, at section 

II.B.3. See also Form ADV Release, supra note 132, 

at 15 (‘‘Advisers must update the amount of their 

assets under management annually (as part of their 

annual updating amendment) and make interim 

amendments only for material changes in assets 

under management when they are filing an ‘other 

than annual amendment’ for a separate reason.’’). 

200Proposed rule 203(m)–1(a). The proposed rule 

also would define the United States to have the 

same meaning as in rule 902(l) of Regulation S 

under the Securities Act, which is ‘‘the United 

States of America, its territories and possessions, 

any State of the United States, and the District of 

Columbia.’’ Proposed rule 203(m)–1(e)(7). 

201Proposed rule 203(m)–1(b). Any assets 

managed from a U.S. place of business for clients 

other than private funds would make the exemption 

unavailable. We understand that others have 

supported a jurisdictional approach to regulation, 

which focuses on the primary market in which an 

adviser conducts its business. See, e.g., G20 

Working Group Report, supra note 136, at 16; 

Testimony of W. Todd Groome, Chairman, The 

Alternative Investment Management Association, 

before the House Subcommittee on Capital Markets, 

Insurance and Government Sponsored Enterprises, 

May 7, 2009, at 3. These commenters propose an 

approach that looks to the location where the 

primary business is conducted, which is similar to 

our territorial approach. 

202See rule 203A–3(c); rule 222–1. Both rules 

define ‘‘principal place of business’’ of an 

investment adviser as the executive office of the 

investment adviser from which the officers, 

partners or managers of the investment adviser 

direct, control and coordinate the activities of the 

investment adviser. 

203See proposed rule 203(m)–1(e)(3) (defining 

‘‘principal office and place of business’’ as the 

adviser’s executive office from which the officers, 

partners, or managers of the adviser direct, control, 

and coordinate the adviser’s activities); proposed 

rule 203(m)–1(e)(2) (defining ‘‘place of business,’’ by 

reference to proposed rule 222–1(a), as (i) an office 

where the investment adviser regularly provides 

investment advisory services, solicits, meets with, 

or otherwise communicates with clients, and (ii) 

any other location that it holds out to the general 

public as a place where those activities take place). 

204Under our proposed rule, assets under 

management for purposes of the exemption are 

those assets for which the adviser provides 

‘‘continuous and regular supervisory or 

management services.’’ See proposed rule 203(m)– 

1(e)(1); proposed Form ADV: Instructions for Part 

1A, instr. 5.b(3). For a non-U.S. adviser, the assets 

for which the adviser provides such services from 

a place of business in the United States would 

count towards the $150 million asset threshold 

under the exemption. See proposed rule 203(m)– 

1(b)(2). See also supra note 203 for the definition 

of ‘‘place of business’’ under proposed rule 203(m)– 

1(e)(2). 

205See section II.C of this Release. 

206Rule 203(b)(3)–1(b)(5) (adviser with principal 

office and place of business outside of the United 

States not required to count clients that are not 

United States residents, but adviser with principal 

office and place of business is in the United States 

must count all clients). Our staff has taken the 

position that under the existing private adviser 

exemption, a non-U.S. adviser need not count its 

non-U.S. clients, including an offshore fund, even 

if there are U.S. investors in the fund. See ABA 

Letter, supra note 172, at 2 and discussion infra 

section II.C.1 of this Release. 

207See, e.g., Regulation S (adopting a territorial 

approach to offers and sales of securities); rule 15a– 

6 under the Exchange Act (17 CFR 240.15a–6) 

(providing an exemption from U.S. registration for 

non-U.S. broker-dealers who limit their activities 

and satisfy certain conditions). 

by auditors or another independent 

third party? 

As discussed above, we are proposing 

that funds value assets no less 

frequently than quarterly, although such 

values are not subject to quarterly 

reporting to us.198 As a consequence, 

short-term market value fluctuations 

would not affect the availability of the 

exemption between the ends of calendar 

quarters. We request comment on our 

proposed quarterly calculation. Should 

compliance with the $150 million 

threshold be determined more or less 

frequently than quarterly? For purposes 

of reporting on proposed amendments 

on Form ADV, registered investment 

advisers (and exempt reporting advisers) 

would be required to report their 

regulatory assets under management 

annually.199 Should the availability of 

the exemption under proposed rule 

203(m)–1 be conditioned on annual 

valuation rather than quarterly 

valuation? 

3. Assets Managed in the United States 

Under proposed rule 203(m)–1, all of 

the private fund assets of an adviser 

with a principal office and place of 

business in the United States would be 

considered to be ‘‘assets under 

management in the United States,’’ even 

if the adviser has offices outside of the 

United States.200 A non-U.S. adviser, 

however, would need only count private 

fund assets it manages from a place of 

business in the United States toward the 

$150 million asset limit under the 

exemption.201

Rule 203(m)–1 would deem all of the 

assets managed by an adviser to be 

managed ‘‘in the United States’’ if the 

adviser’s ‘‘principal office and place of 

business’’ is in the United States. We 

would look to an adviser’s principal 

office and place of business as the 

location where the adviser controls, or 

has ultimate responsibility for, the 

management of private fund assets, and 

therefore as the place where all the 

advisers’ assets are managed, although 

day-to-day management of certain assets 

may also take place at another location. 

This approach is similar to the way we 

have identified the location of the 

adviser for regulatory purposes under 

our current rules,202 which define an 

adviser’s principal office and place of 

business as the location where it 

‘‘directs, controls and coordinates’’ its 

global advisory activities, regardless of 

the location where some of the advisory 

activities might occur.203 For most 

advisers, this approach would avoid 

difficult attribution determinations that 

would be required if assets are managed 

by teams located in multiple 

jurisdictions, or if portfolio managers 

located in one jurisdiction rely heavily 

on research or other advisory services 

performed by employees located in 

another jurisdiction. 

We considered but decided not to 

propose an approach that would 

presume that a non-U.S. adviser to 

private funds offered in the United 

States would have no assets managed 

from a location in the United States if 

its principal office and place of business 

is not ‘‘in the United States.’’204 Such an 

interpretation of the statute would treat 

U.S. advisers the same as non-U.S. 

advisers, but would seem to ignore the 

fact that day-to-day management of 

some assets of the private fund does in 

fact take place ‘‘in the United States,’’ 

even though that management is 

ultimately controlled from outside of 

the United States. Moreover, it would 

permit an adviser engaging in 

substantial advisory activities in the 

United States to escape our regulatory 

oversight merely because the adviser’s 

principal office and place of business is 

outside the United States. This 

consequence seems at odds not only 

with section 203(m), but also with the 

‘‘foreign private adviser’’ exemption 

discussed below in which Congress 

specifically set forth circumstances 

under which a non-U.S. adviser may be 

exempt provided it does not have any 

place of business in the United States, 

among other conditions.205

We request comment on our proposed 

approach, which is similar to the way 

we have administered the current 

private adviser exemption in section 

203(b)(3) of the Advisers Act with 

respect to non-U.S. advisers. Under that 

exemption (as discussed above), an 

adviser with a principal office and place 

of business outside of the United States 

need only count clients that are 

residents of the United States towards 

the 14 client limit.206 As with other 

Commission rules that adopt a territorial 

approach, the private adviser exemption 

is available to a non-U.S. adviser 

(regardless of its non-U.S. advisory 

activities) in recognition of the fact that 

non-U.S. activities of non-U.S. advisers 

are less likely to implicate U.S. 

regulatory interests and in consideration 

of general principles of international 

comity.207 This approach to the 

exemption is designed to encourage the 

participation of non-U.S. advisers in the 


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Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 77209 

208See generally Division of Investment 

Management, SEC, Protecting Investors: A Half 

Century of Investment Company Regulation, May 

1992, at 223–227 (recognizing that non-U.S. 

advisers that registered with the Commission were 

arguably subject to all of the substantive provisions 

of the Advisers Act with respect to their U.S. and 

non-U.S. clients, which could result in inconsistent 

regulatory requirements or practices imposed by the 

regulations of their local jurisdiction and the U.S. 

securities laws; in response, advisers could form 

separate and independent subsidiaries but this 

could result in U.S. clients having access to a 

limited number of advisory personnel and reduced 

access by the U.S. subsidiary to information or 

research by non-U.S. affiliates). 

209See, e.g., James D. Rosener, Legal 

Considerations for Establishing Operations in the 

United States, Pepper Hamilton LLP, June 25, 2002, 

http://www.pepperlaw.com/ 

publications_article.aspx?ArticleKey=186 (creating 

separate subsidiaries offers benefits, including the 

ability to offset profits from one subsidiary against 

losses in another); see also Edward F. Greene, et al., 

U.S. Regulation of the International Securities and 

Derivatives Markets, § 11.02[2]. 

210See infra note 270. 

211Proposed rule 203(m)–1(b)(1). 

212Proposed rule 203(m)–1(e)(8). 

213 17 CFR 230.902(k)(1)(i). 

214See, e.g., 17 CFR 230.902(k)(1) and (2). 

215 17 CFR 230.902(k)(1)(ii) and (iv). 

216 17 CFR 230.902(k)(1)(vii). 

217For instance, our staff has generally taken the 

interpretive position that an investor that is not a 

U.S. person under Regulation S is not a U.S. person 

when determining whether a non-U.S. private fund 

meets the counting or qualification requirements 

that apply to U.S. beneficial owners or owners of 

a private fund under sections 3(c)(1) or 3(c)(7) of the 

Investment Company Act. We understand that 

many U.S. and non-U.S. advisers currently follow 

our staff’s guidance and rely on this definition 

when determining whether a pooled investment 

vehicle qualifies as a private fund. See Goodwin 

Procter Letter, supra note 175; ABA Letter, supra 

note 172. Advisers apply the Regulation S 

definition of ‘‘U.S. person’’ also for other purposes. 

See infra note 259. 

218 In connection with adopting rule 203(b)(3)–2 

under the Advisers Act, we previously noted that 

commenters had suggested that we incorporate the 

definition of U.S. person from Regulation S. 

Pending our reconsideration of the use of the 

Regulation S definition, we indicated at the time 

that we would not object if advisers identified U.S. 

persons by looking: ‘‘(i) In the case of individuals 

to their residence, (ii) in the case of corporations 

and other business entities to their principal office 

and place of business, (iii) in the case of personal 

trusts and estates to the rules set out in Regulation 

S, and (iv) in the case of discretionary or nondiscretionary accounts managed by another 

investment adviser to the location of the person for 

whose benefit the account is held.’’ See Hedge Fund 

Adviser Registration Release, supra note 17, at 

n.201. We reconsidered the use of Regulation S and 

concluded it is appropriate as modified in our 

proposed rule. 

219Proposed rule 203(m)–1(e)(8). 

220Under Regulation S, a discretionary account 

maintained by a non-U.S. fiduciary (such as an 

investment adviser) is not a ‘‘U.S. person’’ even if 

the account is owned by a U.S. person. See rule 

902(k)(1)(vii); rule 902(k)(2)(i). 

U.S. market by applying the U.S. 

securities laws in a manner that does 

not impose U.S. regulatory and 

operational requirements on an 

adviser’s non-U.S. advisory business.208

Should we adopt a different approach 

that more broadly applies the 

availability of the private fund adviser 

exemption to U.S. advisers? We could 

treat U.S. and non-U.S. advisers alike, in 

which case a U.S. adviser could exclude 

assets it manages through non-U.S. 

offices. Under the proposed rule, would 

some or most advisers with non-U.S. 

branch offices re-organize those offices 

as subsidiaries in order to avoid 

attributing assets managed to the nonU.S. office? We understand that U.S. 

advisers that manage private fund assets 

in a non-U.S. country typically do so 

through one or more separate 

subsidiaries organized in such non-U.S. 

jurisdictions.209 If so, the proposed rule 

may have a limited effect on multinational advisory firms, which for tax or 

business reasons keep their non-U.S. 

advisory activities separate from their 

U.S. advisory activities. Is this 

understanding correct? Such U.S. 

advisers would not generally have to 

count the assets managed by the nonU.S. affiliates under the proposed 

rule.210 Should our rule determine 

‘‘private fund assets’’ on an aggregated 

basis if, for example, U.S. and non-U.S. 

affiliates share advisory duties for a 

private fund, or if one affiliate provides 

subadvisory services to another affiliate? 

Alternatively, should we interpret 

‘‘assets under management in the United 

States’’ by reference to the source of the 

assets (i.e., U.S. private fund investors)? 

Under this approach, a non-U.S. adviser 

would count the assets of private funds 

attributable to U.S. investors towards 

the $150 million threshold, regardless of 

the location where it manages the 

private funds. We note that this 

approach could have the result that 

fewer non-U.S. advisers would be 

eligible for the exemption if there are 

significant assets of U.S. investors in 

those funds that the advisers manage 

from a non-U.S. location. This approach 

could also mean that a U.S. adviser 

managing assets from, for example, an 

office in New York City, could manage 

substantially in excess of $150 million 

in assets of one or more private funds 

as long as the investors in those funds 

were not U.S persons. 

Do commenters view either of these 

alternatives, separately or in 

combination with our proposed 

approach, as more closely reflecting the 

intent of Congress in using the term 

‘‘assets under management in the United 

States’’ and our regulatory interests? 

Would either alternative approach be 

easier for advisers to comply with than 

the one we are proposing to adopt? 

Would it be easier for investors to 

understand the rationale for why an 

adviser is eligible for the exemption 

under the proposed approach or either 

of the alternative approaches? 

4. United States Person 

Under proposed rule 203(m)–1(b), a 

non-U.S. adviser could not rely on the 

exemption if it advised any client that 

is a United States person other than a 

private fund.211 We propose to define a 

‘‘United States person’’ generally by 

incorporating the definition of a ‘‘U.S. 

person’’ in our Regulation S.212

Regulation S looks generally to the 

residence of an individual to determine 

whether the individual is a United 

States person,213 and also addresses the 

circumstances under which a legal 

person, such as a trust, partnership or a 

corporation, is a United States 

person.214 Regulation S generally treats 

legal partnerships and corporations as 

Unites States persons if they are 

organized or incorporated in the United 

States, and trusts by reference to the 

residence of the trustee.215 It treats 

discretionary accounts generally as 

United States persons if the fiduciary is 

a resident of the United States.216

We are proposing to incorporate 

Regulation S because it would provide 

a well-developed body of law that 

would, in our view, appropriately 

address many of the questions that will 

arise under rule 203(m)–1. Moreover, 

managers to private funds and their 

counsel must today be familiar with the 

definition of ‘‘U.S. person’’ under 

Regulation S in order to comply with 

other provisions of the federal securities 

laws.217 We ask comment on the 

proposed use of the Regulation S 

definition of U.S. person. Should we use 

a different definition of United States 

person? We have previously suggested 

that advisers may rely on an alternative 

to Regulation S for certain types of 

clients.218 Would that approach be less 

prone to abuse or circumvention or 

provide greater clarity? 

Proposed rule 203(m)–1 contains a 

special rule for discretionary accounts 

maintained outside of the United States 

for the benefit of United States 

persons.219 Under the proposed rule, an 

adviser must treat a discretionary or 

other fiduciary account as a United 

States person if the account is held for 

the benefit of a United States person by 

a non-U.S. fiduciary who is a related 

person of the adviser. An adviser could 

not rely on the exemption if it 

established discretionary accounts for 

the benefit of U.S. clients with an 

offshore affiliate that would then 

delegate the actual management of the 

account back to the adviser.220 We 

request comment on this special rule. 

Does our proposed rule adequately 


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77210 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

221Proposed rule 203(m)–1(d). In effect, an 

adviser would register by the end of the calendar 

quarter following the quarter-end date at which 

private fund assets equaled or exceeded $150 

million. If, however, on the succeeding calendar 

quarter end date, private fund assets have declined 

below $150 million, then registration would not be 

required. 

222See rule 206(4)–7. 

223See proposed rule 203(m)–1(d); see also, e.g., 

proposed rule 204–4 under the Advisers Act 

(discussed in the Implementing Release, supra note 

25, at section II.B). 

224Section 402 of the Dodd-Frank Act (providing 

a definition of ‘‘foreign private adviser,’’ to be 

codified at section 202(a)(30) of the Advisers Act). 

See supra note 23 and accompanying text. 

225Subparagraph (B) of section 202(a)(30) refers 

to the number of ‘‘clients and investors in the 

United States in private funds,’’ while subparagraph 

(C) refers to assets of ‘‘clients in the United States 

and investors in the United States in private funds’’ 

(emphasis added). We interpret these provisions 

consistently so that only clients in the United States 

and investors in the United States should be 

counted for purposes of subparagraph (B). 

226 In addition, the exemption is not available to 

an adviser that ‘‘acts as (I) an investment adviser to 

any investment company registered under the 

[Investment Company Act]; or (II) a company that 

has elected to be a business development company 

pursuant to section 54 of [that Act] and has not 

withdrawn its election.’’ Section 202(a)(30)(D)(ii). 

We interpret subparagraph (II) to prevent an adviser 

that advises a business development company from 

relying on the exemption. 

227Section 202(a)(30)(C). 

228Rule 203(b)(3)–1, as currently in effect, 

provides a safe harbor for determining who may be 

deemed a single client for purposes of the private 

adviser exemption. We would not, however, carry 

over from rule 203(b)(3)-1 a provision that 

distinguishes between advisers whose principal 

places of business are inside or outside of the 

United States. Under the definition of ‘‘foreign 

private adviser,’’ an adviser may not have any place 

of business in the United States. See section 402 of 

the Dodd-Frank Act (defining ‘‘foreign private 

adviser’’); rule 203(b)(3)–1(b)(5). We would also not 

include rule 203(b)(3)–1(b)(7), which specifies that 

a client who is an owner of a private fund is a 

resident where the client resides at the time of the 

client’s investment in the fund. The provision was 

vacated by Goldstein. See supra note 18. As 

discussed below, we are proposing to include 

another, similar, provision in rule 202(a)(30)–1, 

which would apply to both clients and investors for 

purposes of the foreign private adviser exemption. 

See infra note 257 and accompanying text. 

229Proposed rule 202(a)(30)–1(c). 

230See supra note 9. 

231Proposed rule 202(a)(30)–1(a)(1). If a client 

relationship involving multiple persons does not 

fall within the rule, the question of whether the 

relationship may appropriately be treated as a 

single ‘‘client’’ must be determined on the basis of 

the facts and circumstances involved. 

address the concern that an adviser 

could avoid the limitation of the 

exemption through non-U.S. 

discretionary accounts? 

5. Transition Rule 

We propose to include in proposed 

rule 203(m)–1 a provision giving an 

adviser one calendar quarter (three 

months) to register with the 

Commission after becoming ineligible to 

rely on the exemption due to an 

increase in the value of its private fund 

assets.221 Because qualification for the 

exemption depends on remaining below 

the $150 million threshold on a 

quarterly basis, an adviser could exceed 

the limit based on market fluctuations 

without any new investments from 

existing or new investors. This three 

month period would enable the adviser 

to take steps to register and otherwise 

come into compliance with the 

requirements of the Advisers Act 

applicable to registered investment 

advisers, including the adoption and 

implementation of compliance policies 

and procedures.222 It would be available 

only to an adviser that has complied 

with all applicable Commission 

reporting requirements.223 We are not 

required to provide the safe harbor, and 

we do not believe it would be 

appropriate for an adviser to rely on it 

if the adviser has failed to comply with 

its reporting requirements. We request 

comment on this transition period. Is 

the calendar quarter period sufficient? 

Should the transition period be longer, 

such as two calendar quarters, or 

shorter, such as 30 days? If the adviser 

determines to expand its advisory 

business to manage assets other than 

private funds (e.g., separate accounts), 

should the transition period also be 

available? Should a transition period be 

available at all? 

C. Foreign Private Advisers 

Section 403 of the Dodd-Frank Act 

replaces the current private adviser 

exemption from registration under the 

Advisers Act with a new exemption for 

a ‘‘foreign private adviser,’’ as defined in 

new section 202(a)(30).224 The new 

exemption is codified as amended 

section 203(b)(3). 

Under section 202(a)(30), a foreign 

private adviser is any investment 

adviser that: (i) Has no place of business 

in the United States; (ii) has, in total, 

fewer than 15 clients in the United 

States and investors in the United States 

in private funds advised by the 

investment adviser; (iii) has aggregate 

assets under management attributable to 

clients in the United States and 

investors in the United States in private 

funds advised by the investment adviser 

of less than $25 million; 225 and (iv) 

does not hold itself out generally to the 

public in the United States as an 

investment adviser.226 Section 

202(a)(30) provides the Commission 

with authority to increase the $25 

million threshold ‘‘in accordance with 

the purposes of this title.’’ 227

We are proposing a new rule, 

202(a)(30)–1, which would define 

certain terms in section 202(a)(30) for 

use by advisers seeking to avail 

themselves of the foreign private adviser 

exemption. Because eligibility for the 

new foreign private adviser exemption, 

like the current private adviser 

exemption, is determined, in part, by 

the number of clients an adviser has, we 

propose to include in rule 202(a)(30)–1 

the safe harbor rules and many of the 

client counting rules that appear in rule 

203(b)(3)–1, as currently in effect.228 In 

addition, we propose to define other 

terms used in the definition of ‘‘foreign 

private adviser’’ in section 202(a)(30), 

including: (i) ‘‘investor;’’ (ii) ’’in the 

United States;’’ (iii) ‘‘place of business;’’ 

and (iv) ‘‘assets under management.’’ 229

1. Clients 

For purposes of the definition of 

‘‘foreign private adviser,’’ proposed rule 

202(a)(30)–1 would include the safe 

harbor for counting clients currently in 

rule 203(b)(3)–1, as modified to account 

for its use in the foreign private adviser 

context and to eliminate a provision 

allowing advisers not to count those 

clients from which they receive no 

compensation. We note, however, that 

the foreign private adviser exemption 

provides a much more limited 

exemption in this regard than our 

current rule 203(b)(3)–1 because section 

202(a)(30) requires an adviser to also 

count the number of ‘‘investors’’ of an 

issuer that is a ‘‘private fund’’ (a term 

that is defined in section 202(a)(29)) 

managed by the adviser.230

Specifically, proposed rule 

202(a)(30)–1, like current rule 203(b)(3)– 

1, would allow an adviser to treat as a 

single client a natural person and: (i) 

That person’s minor children (whether 

or not they share the natural person’s 

principal residence); (ii) any relative, 

spouse, or relative of the spouse of the 

natural person who has the same 

principal residence; (iii) all accounts of 

which the natural person and/or the 

person’s minor child or relative, spouse, 

or relative of the spouse who has the 

same principal residence are the only 

primary beneficiaries; and (iv) all trusts 

of which the natural person and/or the 

person’s minor child or relative, spouse, 

or relative of the spouse who has the 

same principal residence are the only 

primary beneficiaries.231 Proposed rule 

202(a)(30)–1 would also retain other 

provisions of rule 203(b)(3)–1 that 

permit an adviser to treat as a single 

‘‘client’’ (i) a corporation, general 

partnership, limited partnership, 

limited liability company, trust, or other 

legal organization to which the adviser 

provides investment advice based on 

the organization’s investment objectives, 

and (ii) two or more legal organizations 


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232Proposed rule 202(a)(30)–1(a)(2). In addition, 

proposed rule 202(a)(30)–1(b)(1) through (3) would 

retain the following related ‘‘special rules’’: (1) An 

adviser must count a shareholder, partner, limited 

partner, member, or beneficiary (each, an ‘‘owner’’) 

of a corporation, general partnership, limited 

partnership, limited liability company, trust, or 

other legal organization, as a client if the adviser 

provides investment advisory services to the owner 

separate and apart from the legal organization; (2) 

an adviser is not required to count an owner as a 

client solely because the adviser, on behalf of the 

legal organization, offers, promotes, or sells 

interests in the legal organization to the owner, or 

reports periodically to the owners as a group solely 

with respect to the performance of or plans for the 

legal organization’s assets or similar matters; and (3) 

any general partner, managing member or other 

person acting as an investment adviser to a limited 

partnership or limited liability company must treat 

the partnership or limited liability company as a 

client. 

233See rule 203(b)(3)–1(b)(4). 

234 In the Implementing Release, we are proposing 

to adopt a uniform method for calculating assets 

under management for purposes of registration 

pursuant to which an adviser would count assets 

that are managed without compensation. In this 

Release, we propose to apply the proposed method 

of calculation to the foreign private adviser 

exemption and the private fund adviser exemption. 

See infra section II.C.5 of this Release; 

Implementing Release, supra note 25, at section 

II.A.3. 

235As discussed in the Implementing Release, our 

proposed changes to the method of calculating 

assets under management would remove the option 

of excluding certain assets from an adviser’s 

calculation in order to avoid registration with the 

Commission and regulatory requirements associated 

with registration. See Implementing Release, supra 

note 25, nn.44–50 and accompanying and following 

text. Allowing an adviser not to count as clients 

persons in the United States that do not compensate 

the adviser would similarly allow certain advisers 

to avoid registration through reliance on the foreign 

private adviser exemption despite the fact that the 

adviser provides advisory services to such persons. 

236See proposed rule 202(a)(30)–1(b)(4). 

237See proposed rule 202(a)(30)–1(b)(4); 

202(a)(30)–1(c)(1). See also infra section II.C.2 of 

this Release (discussing the definition of investor). 

238See proposed rule 202(a)(30)–1(c)(1); supra 

notes 8–13 and accompanying text. Under the 

proposed rule, knowledgeable employees with 

respect to the private fund (and certain persons 

related to them) and beneficial owners of short-term 

paper issued by the private fund would also count 

as investors. See infra note 246 and accompanying 

text. 

239See proposed rule 202(a)(30)–1(c)(1), at note to 

paragraph (c)(1). 

240See supra notes 11 and 13. 

that have identical shareholders, 

partners, limited partners, members, or 

beneficiaries.232

We would not include the ‘‘special 

rule’’ providing advisers with the option 

of not counting as a client any person 

for whom the adviser provides 

investment advisory services without 

compensation.233 As noted above, we 

propose to require advisers to include 

the assets of such clients in their 

‘‘regulatory assets under 

management,’’ 234 and we propose the 

same approach with respect to counting 

clients.235

Finally, we propose to add a 

provision that would avoid doublecounting private funds and their 

investors by advisers.236 This provision 

would specify that an adviser need not 

count a private fund as a client if the 

adviser counted any investor, as defined 

in the rule, in that private fund as an 

investor in that private fund for 

purposes of determining the availability 

of the exemption.237

We are proposing to include the 

current rule 203(b)(3)–1 safe harbor for 

counting clients in proposed rule 

202(a)(30)–1 because we believe that 

application of this provision (as we 

propose to modify it) will operate to 

effect the purposes of the foreign private 

adviser exemption. Congress replaced 

the private adviser exemption with the 

foreign private adviser exemption, both 

of which require advisers to count 

clients. As Congress was aware of rule 

203(b)(3)–1’s counting guidelines when 

it incorporated a limitation on the 

number of ‘‘clients’’ in the definition of 

‘‘foreign private adviser,’’ we believe it 

would be consistent with Congress’s 

amendment to preserve generally the 

method for counting clients, together 

with the requirement to count clients. 

We request comment generally on our 

approach to counting ‘‘clients’’ in 

proposed rule 202(a)(30)–1 and on each 

of the specific proposed provisions. Is it 

appropriate to derive the definition of 

‘‘client’’ in proposed rule 202(a)(30)–1 

from rule 203(b)(3)–1’s definition? Are 

there alternative approaches we should 

consider instead? Is including the 

‘‘special rules’’ in proposed rule 202(a) 

(30)–1 appropriate? Are there any that 

are not appropriate in this context and 

should not be included in the proposed 

rule? In particular, should we have 

maintained the special rule allowing an 

adviser not to count as a client any 

person for whom the adviser provides 

investment advisory services without 

compensation, even though such person 

may be treated as a client for other 

purposes (e.g., reporting on Form ADV)? 

Should we modify the proposed rule 

that allows an adviser not to count a 

private fund as a client if it counts any 

investor in that private fund by also 

providing that an adviser may avoid 

counting as a client any person it counts 

as an investor? Finally, are there any 

further modifications to the definition 

that we should make? 

2. Private Fund Investor 

Section 202(a)(30) provides that a 

‘‘foreign private adviser’’ eligible for the 

new registration exemption cannot have 

more than 14 clients ‘‘or investors in the 

United States in private funds’’ advised 

by the adviser. We propose to define 

‘‘investor’’ in a private fund in rule 

202(a)(30)–1 as any person who would 

be included in determining the number 

of beneficial owners of the outstanding 

securities of a private fund under 

section 3(c)(1) of the Investment 

Company Act, or whether the 

outstanding securities of a private fund 

are owned exclusively by qualified 

purchasers under section 3(c)(7) of that 

Act.238 In order to avoid doublecounting, an adviser would be able to 

treat as a single investor any person who 

is an investor in two or more private 

funds advised by the investment 

adviser.239

The term ‘‘investor’’ is not currently 

defined under the Advisers Act or the 

rules under the Advisers Act. Defining 

the term as proposed would ensure 

consistent application of the statutory 

provision and prevent, for example, 

non-U.S. advisers from circumventing 

the limitations in section 203(b)(3) by 

using nominee accounts that would 

aggregate investors into a single nominal 

investor for purposes of the counting 

requirement of section 202(a)(30). Under 

section 203(b)(3), an adviser relying on 

the foreign private adviser exemption 

may only have advisory relationships 

with private funds with a limited 

number of U.S. investors. Advisers 

should not be able to avoid this 

limitation by setting up intermediate 

accounts through which investors may 

access a private fund and not be 

counted for purposes of the exemption. 

Defining investors by reference to 

sections 3(c)(1) and 3(c)(7) of the 

Investment Company Act may best 

achieve these purposes. Funds and their 

advisers must determine who is a 

beneficial owner for purposes of section 

3(c)(1) or whether an owner is a 

qualified purchaser for purposes of 

section 3(c)(7).240 Typically, a 

prospective investor in a private fund 

must complete a subscription agreement 

that includes representations or 

confirmations that it is qualified to 

invest in the fund and whether it is a 

U.S. person. This information is 

designed to allow the adviser (on behalf 

of the fund) to make the above 

determination. Therefore, an adviser 

seeking to rely on the foreign private 

adviser exemption will have ready 

access to this information. 

More important, defining the term 

‘‘investor’’ by reference to sections 

3(c)(1) and 3(c)(7) appears to 

appropriately limit the ability of a nonU.S. adviser to avoid application of the 

registration provisions of the Advisers 

Act. For example, under the proposed 

rule, holders of both equity and debt 

securities would be counted as 


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77212 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

241Sections 3(c)(1) and 3(c)(7) of the Investment 

Company Act refer to beneficial owners and 

owners, respectively, of ‘‘securities’’ (which is 

broadly defined in section 2(a)(36) of that Act to 

include debt and equity). 

242Proposed rule 202(a)(30)–1(c)(1). See generally 

sections 3(c)(1) and 3(c)(7) of the Investment 

Company Act. 

243See section 208(d) of the Advisers Act. 

244A ‘‘master-feeder fund’’ is an arrangement in 

which one or more funds with identical investment 

objectives (‘‘feeder funds’’) invest all of their assets 

in a single fund (‘‘master fund’’) with the same 

investment objective and strategies. We have taken 

the same approach within our rules that expressly 

require a private fund to ‘‘look-through’’ any 

investor that is formed for the specific purpose of 

investing in a private fund. See rule 2a51–3(a) 

under the Investment Company Act (17 CFR 

270.2a51–3(a)) (a company is not a qualified 

purchaser if it is ‘‘formed for the specific purpose 

of acquiring the securities’’ of an investment 

company that is relying on section 3(c)(7) of the 

Investment Company Act, unless each of the 

company’s beneficial owners is also a qualified 

purchaser). See also Privately Offered Investment 

Companies, Investment Company Act Release No. 

22597 (Apr. 3, 1997) [62 FR 17512 (Apr. 9, 1997)] 

(‘‘NSMIA Release’’) (explaining that rule 2a51–3(a) 

would limit the possibility that ‘‘a company will be 

able to do indirectly what it is prohibited from 

doing directly [by organizing] * * * a ‘qualified 

purchaser’ entity for the purpose of making an 

investment in a particular Section 3(c)(7) Fund 

available to investors that themselves did not meet 

the definition of ‘qualified purchaser.’ ’’). 

245As noted above, we have recognized that in 

certain circumstances it is appropriate to ‘‘look 

through’’ an investor (i.e., attribute ownership of a 

private fund to another person who is the ultimate 

owner). See, e.g., NSMIA Release, supra note 244 

(‘‘The Commission understands that there are other 

forms of holding investments that may raise 

interpretative issues concerning whether a 

Prospective Qualified Purchaser ‘owns’ an 

investment. For instance, when an entity that holds 

investments is the ‘alter ego’ of a Prospective 

Qualified Purchaser (as in the case of an entity that 

is wholly owned by a Prospective Qualified 

Purchaser who makes all the decisions with respect 

to such investments), it would be appropriate to 

attribute the investments held by such entity to the 

Prospective Qualified Purchaser.’’). 

246See proposed rule 202(a)(30)–1(c)(1)(A) 

(referencing rule 3c–5 under the Investment 

Company Act (17 CFR 270.3c–5(b)), which excludes 

from the determinations under sections 3(c)(1) and 

3(c)(7) of that Act any securities beneficially owned 

by knowledgeable employees of a private fund; a 

company owned exclusively by knowledgeable 

employees; and any person who acquires securities 

originally acquired by a knowledgeable employee 

through certain transfers of interests, such as a gift 

or a bequest). 

247See proposed rule 202(a)(30)–1(c)(1)(B) 

(referencing the definition of ‘‘short-term paper’’ 

contained in section 2(a)(38) of the Investment 

Company Act, which defines ‘‘short-term paper’’ to 

mean ‘‘any note, draft, bill of exchange, or banker’s 

acceptance payable on demand or having a maturity 

at the time of issuance of not exceeding nine 

months, exclusive of days of grace, or any renewal 

thereof payable on demand or having a maturity 

likewise limited; and such other classes of 

securities, of a commercial rather than an 

investment character, as the Commission may 

designate by rules and regulations.’’) 

248See proposed rule 202(a)(30)–1(c)(1). 

249See section 3(c)(1) of the Investment Company 

Act; rule 3c–5(b) under the Investment Company 

Act. 

250See supra note 190. As discussed above, our 

proposed changes to the method of calculating 

assets under management would preclude some 

advisers from excluding certain assets from their 

calculation in order to avoid registration with the 

Commission and regulatory requirements associated 

with registration. Allowing an adviser not to count 

as investors persons that do not compensate the 

adviser, such as knowledgeable employees, would 

similarly allow certain advisers to avoid registration 

by relying on the foreign private adviser exemption. 

251 Various types of investment vehicles make 

significant use of short-term paper for financing 

purposes so holders of this type of security are, in 

practice, exposed to the investment results of the 

security’s issuer. See Money Market Fund Reform 

Release, supra note 134, at nn. 37–39 and preceding 

and accompanying text (discussing how money 

market funds were exposed to substantial losses 

during 2007 as a result of exposure to debt 

securities issued by structured investment 

vehicles). 

investors.241 Advisers, moreover, would 

have to ‘‘look though’’ nominee and 

similar arrangements to the underlying 

holders of private fund-issued securities 

to determine whether they have fewer 

than 15 clients and private fund 

investors in the United States.242

Under the proposed rule, an adviser 

would determine the number of 

investors in a private fund based on 

facts and circumstances and in light of 

the applicable prohibition not to do 

indirectly, or through or by any other 

person, what is unlawful to do 

directly.243 In the following 

circumstances, for example, an adviser 

relying on the exemption would have to 

count as an investor a person who is not 

the nominal owner of a private fund’s 

securities. First, the adviser to a master 

fund in a master-feeder arrangement 

would have to treat as investors the 

holders of the securities of any feeder 

fund formed or operated for the purpose 

of investing in the master fund rather 

than the feeder funds, which act as 

conduits.244 Second, an adviser would 

need to count as an investor any holder 

of an instrument, such as a total return 

swap, that effectively transfers the risk 

of investing in the private fund from the 

record owner of the private fund’s 

securities. The record owner of private 

fund securities could enter into a total 

return swap transaction to transfer to a 

third party any profits or losses that the 

record owner could incur as a result of 

its investment in the private fund. Thus, 

even though the record owner would 

remain the nominal owner of private 

fund securities, the associated risks of 

an investment in the securities would 

have been transferred to the third party 

who has made the determination to 

invest in the private fund indirectly 

through the record owner. In such a 

case, the third party would be counted 

as a beneficial owner under section 

3(c)(1), or be required to be a qualified 

purchaser under section 3(c)(7).245

Accordingly, the third party would be 

counted as an investor in the private 

fund for purposes of the foreign private 

adviser exemption. 

We are also proposing to treat as 

investors beneficial owners (i) who are 

‘‘knowledgeable employees’’ with 

respect to the private fund, and certain 

other persons related to such employees 

(we refer to these, collectively, as 

‘‘knowledgeable employees’’); 246 and (ii) 

of ‘‘short-term paper’’ 247 issued by the 

private fund,248 even though these 

persons are not counted as beneficial 

owners for purposes of section 3(c)(1), 

and knowledgeable employees are not 

required to be qualified purchasers 

under section 3(c)(7).249 We are 

proposing to count knowledgeable 

employees as investors under the same 

approach we take with our proposal that 

advisers count in their calculation of 

assets under management assets they 

manage without being compensated, 

which often include assets of 

knowledgeable employees.250 Under our 

proposed rule, holders of short-term 

paper, like other debt holders, would 

also be counted as investors because a 

private fund’s losses directly affect these 

holders’ interest in the fund just as they 

affect the interest of other debt holders 

in the fund.251

We request comment on our 

definition of ‘‘investor.’’ Does the term 

require further definition? Does our 

definition of ‘‘investor’’ appropriately 

reflect Congress’s intent in providing an 

exemption for foreign private advisers? 

Under our proposal, advisers would not 

be able to consolidate investors for 

counting purposes in the same manner 

they would be able to consolidate 

clients under certain circumstances. 

Should we consider extending to 

investors the ‘‘special rules’’ for counting 

clients under proposed rule 202(a)(30)– 

1? Would this lead to either undercounting or over-counting of investors? 

Is it appropriate to count as a single 

investor a person that invests in two or 

more private funds advised by the 

adviser? Is it appropriate to treat as 

investors beneficial owners who are 

‘‘knowledgeable employees’’ with 

respect to the private fund, and of shortterm paper issued by the fund? 

3. In the United States 

Section 202(a)(30)’s definition of 

‘‘foreign private adviser’’ employs the 

term ‘‘in the United States’’ in several 

contexts including: (i) Limiting the 

number of—and assets under 

management attributable to—an 

adviser’s ‘‘clients’’ ‘‘in the United States’’ 

and ‘‘investors’’ ‘‘in the United States’’ in 

private funds advised by the adviser; (ii) 

exempting only those advisers without 


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252See section 402 of the Dodd-Frank Act. 

253Proposed rule 202(a)(30)–1(c)(2). As discussed 

above, we are also proposing to reference 

Regulation S’s definition of a ‘‘U.S. person’’ for 

purposes of the definition of ‘‘United States person’’ 

in rule 203(m)–1. See sections II.B.3 and II.B.4 of 

this Release (discussing proposed rules 203(m)– 

1(e)(7) through (8)). 

254See 17 CFR 230.902(l). 

255See 17 CFR 230.902(k). 

256See 17 CFR 230.902(l). 

257Proposed rule 202(a)(30)–1, at note to 

paragraph (c)(2)(i) (‘‘A person that is in the United 

States may be treated as not being in the United 

States if such person was not in the United States 

at the time of becoming a client or, in the case of 

an investor in a private fund, at the time the 

investor acquires the securities issued by the 

fund.’’). 

258See supra notes 214–216 and accompanying 

text. See also Letter of Paul, Hastings, Janofsky & 

Walker LLP (Oct. 29, 2010) (‘‘Paul Hastings Letter’’) 

(addressing the foreign private adviser exemption in 

response to our request for public views, and 

recommending that we rely on a modified 

Regulation S definition of ‘‘U.S. person’’ for 

purposes of defining ‘‘in the United States’’ with 

respect to clients and investors). See generally 

supra note 24. 

259Many non-U.S. advisers identify whether a 

client is a ‘‘U.S. person’’ under Regulation S in order 

to determine whether such client may invest in 

certain private funds and certain private placement 

offerings exempt from registration under the 

Securities Act. With respect to ‘‘investors,’’ our staff 

has generally taken the interpretive position that an 

investor that does not meet that definition is not a 

U.S. person when determining whether a non-U.S. 

private fund meets the section 3(c)(1) and 3(c)(7) 

counting or qualification requirements. See supra 

note 217. Many non-U.S. advisers, moreover, 

currently determine whether a private fund investor 

is a ‘‘U.S. person’’ under Regulation S for purposes 

of the safe harbor for offshore offers and sales. 

260See supra discussion in section II.B.4 of this 

Release regarding the definition of United States 

persons and the treatment of discretionary 

accounts. 

261See supra notes 219–220 and accompanying 

paragraph. 

262See supra note 217 and accompanying and 

following text. 

263Rule 222–1(a) (defining ‘‘place of business’’ of 

an investment adviser as: ‘‘(1) An office at which 

the investment adviser regularly provides 

investment advisory services, solicits, meets with, 

or otherwise communicates with clients; and (2) 

Any other location that is held out to the general 

public as a location at which the investment adviser 

provides investment advisory services, solicits, 

meets with, or otherwise communicates with 

clients.’’). 

264Proposed rule 202(a)(30)–1(c)(3). 

265Under section 222(d) of the Advisers Act, a 

state may not require an adviser to register if the 

adviser does not have a ‘‘place of business’’ within, 

and has fewer than six clients resident in, the state. 

a place of business ‘‘in the United 

States’’; and (iii) exempting only those 

advisers that do not hold themselves out 

to the public ‘‘in the United States’’ as 

an investment adviser.252 We are 

proposing to define ‘‘in the United 

States’’ to provide clarification of the 

term for all of the above purposes as 

well as provide specific instruction as to 

the relevant time for making the related 

determination. 

Proposed rule 202(a)(30)–1 defines ‘‘in 

the United States’’ generally by 

incorporating the definition of a ‘‘U.S. 

person’’ and ‘‘United States’’ under 

Regulation S.253 In particular, we would 

define ‘‘in the United States’’ in 

proposed rule 202(a)(30)–1(c)(2) to 

mean: (i) With respect to any place of 

business located in the ‘‘United States,’’ 

as that term is defined in Regulation 

S; 254 (ii) with respect to any client or 

private fund investor in the United 

States, any person that is a ‘‘U.S. person’’ 

as defined in Regulation S,255 except 

that any discretionary account or similar 

account that is held for the benefit of a 

person ‘‘in the United States’’ by a nonU.S. dealer or other professional 

fiduciary is deemed ‘‘in the United 

States’’ if the dealer or professional 

fiduciary is a related person of the 

investment adviser relying on the 

exemption; and (iii) with respect to the 

public in the ‘‘United States,’’ as that 

term is defined in Regulation S.256 In 

addition, we are proposing to add a note 

to paragraph (c)(2)(i) specifying that for 

purposes of that definition, a person 

that is ‘‘in the United States’’ may be 

treated as not being ‘‘in the United 

States’’ if such person was not ‘‘in the 

United States’’ at the time of becoming 

a client or, in the case of an investor in 

a private fund, at the time the investor 

acquires the securities issued by the 

fund.257 We believe that without this 

note this rule might be burdensome 

because an adviser would have to 

monitor the location of clients and 

investors on an ongoing basis, and 

might have to choose between 

registering with us or terminating the 

relationship with any client that moved 

to the United States, or redeeming the 

interest in the private fund of any 

investor that moved to the United 

States. 

We believe that the use of Regulation 

S is appropriate for purposes of the 

foreign private adviser exemption 

because Regulation S provides more 

specific rules when applied to various 

types of legal structures.258 Advisers, 

moreover, already apply the Regulation 

S definition of U.S. person with respect 

to both clients and investors for other 

purposes and therefore are familiar with 

the definition.259 The proposed 

references to Regulation S with respect 

to a place of business ‘‘in the United 

States’’ and the public in the ‘‘United 

States’’ would also allow us to maintain 

consistency across our rules. 

Similar to our approach in proposed 

rule 203(m)–1(e)(8),260 we treat as 

persons ‘‘in the United States’’ for 

purposes of the foreign private adviser, 

certain persons that would not be 

considered ‘‘U.S. persons’’ under 

Regulation S. We are proposing to treat 

as a U.S. person discretionary accounts 

owned by a U.S. person and managed by 

a non-U.S. affiliate of the adviser in 

order to discourage non-U.S. advisers 

from creating such discretionary 

accounts with the goal of circumventing 

the exemption’s limitation with respect 

to persons in the United States.261

We request comment on the definition 

of ‘‘in the United States’’ in proposed 

rule 202(a)(30)–1(c)(2). Is our definition 

appropriate as it relates to a ‘‘place of 

business?’’ Is it appropriate as it relates 

to ‘‘clients’’ and ‘‘investors in a private 

fund?’’ Is it appropriate as it relates to 

the ‘‘public?’’ Is it necessary to define ‘‘in 

the United States’’ for purposes of the 

definition of ‘‘foreign private adviser’’ in 

new section 202(a)(30)? Is our 

understanding of non-U.S. advisers’ 

application of the Regulation S 

definition correct? Since private funds 

already rely on the Regulation S 

definition of U.S. person to determine 

which investors must qualify to invest 

in the fund, would adopting a different 

definition increase regulatory burdens 

associated with determining eligibility 

for the proposed exemption? 262 Are 

there alternatives that would better 

reflect the intent of Congress in creating 

a new category of ‘‘foreign private 

advisers’’ and providing them with an 

exemption from registration? Is our 

proposed note regarding the relevant 

time for determining whether a person 

is ‘‘in the United States’’ appropriate? If 

not, how should we modify it? 

4. Place of Business 

Proposed rule 203(a)(30)–1, by 

reference to proposed rule 222–1,263

defines ‘‘place of business’’ to mean any 

office where the investment adviser 

regularly provides advisory services, 

solicits, meets with, or otherwise 

communicates with clients, and any 

location held out to the public as a place 

where the adviser conducts any such 

activities.264 We believe this definition 

appropriately identifies a location 

where an adviser is doing business for 

purposes of section 202(a)(30) of the 

Advisers Act and thus provides a basis 

for an adviser to determine whether it 

can rely on the exemption in section 

203(b)(3) of the Advisers Act for foreign 

private advisers. Because both the 

Commission and the state securities 

authorities use this definition to identify 

an unregistered foreign adviser’s place 

of business for purposes of determining 

regulatory jurisdiction,265 it appears to 

be logical as well as efficient to use the 

rule 222–1(a) definition of ‘‘place of 


srobinson on DSKHWCL6B1PROD with PROPOSALS2
77214 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

266See proposed rule 202(a)(30)–1(c)(4); 

instructions to Item 5.F of Form ADV, Part 1A. As 

discussed above, we are proposing to take the same 

approach under proposed rule 203(m)–1. See supra 

section II.B.2 of this Release. 

267See supra note 190 and accompanying text. 

268 Id. See also Letter of Shearman and Sterling 

LLP (Nov. 3, 2010) (‘‘Shearman & Sterling Letter’’) 

(in response to our request for public views, arguing 

that ‘‘[w]hile each [exemption related asset 

threshold established by the Dodd-Frank Act] 

serves a different purpose, it appears to us that any 

steps that might be taken in the way of 

harmonization will facilitate both compliance with 

the requirements by the industry and their 

administration by the Commission and its Staff,’’ 

and suggesting that as an example, we raise the 

assets under management threshold under the 

foreign private adviser exemption to $150 million 

in line with the assets threshold under the private 

fund adviser exemption). See generally supra note 

24. 

269See, e.g., Pay to Play Release, supra note 10, 

at n.391–94 and accompanying and following text; 

Hedge Fund Adviser Registration Release, supra 

note 17, at n.243. 

270 Generally, a separately formed advisory entity 

that operates independently of an affiliate may be 

eligible for an exemption if it meets all of the 

criteria set forth in the relevant rule. However, the 

existence of separate legal entities may not by itself 

be sufficient to avoid integration of the affiliated 

entities. The determination of whether the advisory 

businesses of two separately formed affiliates may 

be required to be integrated is based on the facts 

and circumstances. Our staff has taken this position 

in Richard Ellis, Inc., SEC Staff No-Action Letter 

(Sept. 17, 1981) (discussing the staff’s views of 

factors relevant to the determination of whether a 

separately formed advisory entity operates 

independently of an affiliate). 

271We have received a number of letters 

requesting interpretative guidance on whether and 

to what extent certain prior staff positions would 

apply to the new exemptions provided by the DoddFrank Act. See, e.g., Letter of Katten Muchin 

Rosenman LLP (Sept. 14, 2010); Letter of TA Jones 

(Sept. 25, 2010); Letter of Ropes & Gray LLP (Nov. 

1, 2010) in response to our solicitation for public 

views. See generally supra note 24. We 

acknowledge that such determinations will depend 

on the particular facts and circumstances of nonU.S. advisers. Advisers should consider whether 

they may avail themselves of either the foreign 

private adviser exemption or the private fund 

adviser exemption as proposed in this Release, and 

are encouraged to submit comment letters 

addressing with particularity and specificity 

interpretative issues that may not be addressed in 

our proposed rules. 

272 44 U.S.C. 3501. 

business’’ for purposes of the foreign 

private adviser exemption. 

We request comment on our 

definition of ‘‘place of business’’ as it 

relates to the definition of ‘‘foreign 

private adviser.’’ Is this definition of 

‘‘place of business’’ appropriate in this 

context? Do commenters recommend 

any alternative definitions? 

5. Assets Under Management 

For purposes of rule 202(a)(30)–1 we 

propose to define ‘‘assets under 

management’’ by reference to the 

calculation of ‘‘regulatory assets under 

management’’ for Item 5 of Form 

ADV.266 As discussed above, in Item 5 

of Form ADV we are proposing to 

implement a uniform method of 

calculating assets under management 

that can be used for several purposes 

under the Advisers Act, including the 

foreign private adviser exemption.267

Because the foreign private adviser 

exemption is also based on assets under 

management, we believe that all 

advisers should use the same method 

for calculating assets under management 

to determine if they are required to 

register or may be eligible for the 

exemption. We believe that uniformity 

in the method for calculating assets 

under management would result in 

more consistent asset calculations and 

reporting across the industry and, 

therefore, in a more coherent 

application of the Advisers Act’s 

regulatory requirements and of our 

staff’s risk assessment program.268

We request comment on our 

definition of ‘‘assets under management’’ 

as it relates to the definition of ‘‘foreign 

private adviser.’’ Is this definition of 

‘‘assets under management’’ appropriate 

in this context? Are there any special 

considerations relevant to foreign 

private advisers? Do commenters 

recommend any alternative definitions? 

Should assets under management be 

calculated at a particular point of time? 

Should we, as proposed, require foreign 

private advisers to calculate assets 

under management consistent with the 

proposed ‘‘regulatory assets under 

management’’ calculation for Form 

ADV? Or should we require a different 

calculation? For example, should 

foreign private advisers be permitted to 

exclude proprietary assets or assets they 

manage without compensation? 

D. Subadvisory Relationships and 

Advisory Affiliates 

We generally interpret advisers as 

including subadvisers,269 and therefore 

believe it is appropriate to permit 

subadvisers to rely on each of the new 

exemptions, provided that subadvisers 

satisfy all terms and conditions of the 

applicable proposed rules. We are aware 

that in many subadvisory relationships 

a subadviser has contractual privity 

with a private fund’s primary adviser 

rather than the private fund itself. 

Although both the private fund and the 

fund’s primary adviser may be viewed 

as clients of the subadviser, we would 

consider a subadviser eligible to rely on 

section 203(m) if the subadviser’s 

services to the primary adviser relate 

solely to private funds and the other 

conditions of the exemptions are met. 

Similarly, a subadviser may be eligible 

to rely on section 203(l) if the 

subadviser’s services to the primary 

adviser relate solely to venture capital 

funds and the other conditions of the 

rule are met. 

We anticipate that an adviser with 

advisory affiliates will encounter 

interpretative issues as to whether it 

may rely on any of the exemptions 

discussed in this Release without taking 

into account the activities of its 

affiliates. The adviser, for example, 

might have advisory affiliates that are 

registered or that provide advisory 

services that are inconsistent with an 

exemption on which the adviser may 

seek to rely.270 We request comment on 

whether any proposed rule should 

provide that an adviser must take into 

account the activities of its advisory 

affiliates when determining eligibility 

for an exemption. For example, should 

the rule specify that the exemption is 

not available to an affiliate of a 

registered investment adviser? 271

III. Request for Comment 

The Commission requests comment 

on the proposed rules in this Release. 

We also request suggestions for 

additional changes to existing rules, and 

comments on other matters that might 

have an effect on the proposals 

contained in this Release. Commenters 

are requested to provide empirical data 

to support their views. 

IV. Paperwork Reduction Act Analysis 

The proposed rules do not contain a 

‘‘collection of information’’ requirement 

within the meaning of the Paperwork 

Reduction Act of 1995.272 Accordingly, 

the Paperwork Reduction Act is not 

applicable. 

V. Cost-Benefit Analysis 

The Commission is sensitive to the 

costs and benefits imposed by its rules. 

We have identified certain costs and 

benefits of the proposed rules, and we 

request comment on all aspects of this 

cost-benefit analysis, including 

identification and assessment of any 

costs and benefits not discussed in this 

analysis. We seek comment and data on 

the value of the benefits identified. We 

also welcome comments on the 

accuracy of the cost estimates in this 

analysis, and request that commenters 

provide data that may be relevant to 

these cost estimates. In addition, we 

seek estimates and views regarding 

these benefits and costs for advisers 

solely to venture capital funds, private 

fund advisers with less than $150 

million in aggregate assets under 

management and foreign private 

advisers as well as any other costs or 

benefits that may result from the 

adoption of the proposed rules. Where 

possible, we request commenters 


srobinson on DSKHWCL6B1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 77215 

273See supra notes 38–43 and accompanying and 

following text. 

274Proposed rule 203(l)–1(a). 

275Proposed rule 203(l)–1(c)(4). 

276Proposed rule 203(l)–1(b). 

277See supra note 99. See also S. Rep. No. 111– 

176, supra note 7, at 73–74 (stating that advisers of 

venture capital funds are not required to register 

with the SEC because they do not present the same 

risks as advisers to other private funds that are 

required to register, and specifying that the 

Commission shall require advisers of private funds 

to report systemic risk data including, among other 

things, information on the ‘‘use of leverage, 

counterparty credit risk exposure, trading and 

investment positions’’). See also supra notes 136– 

137 and accompanying text. 

278See supra note 100. 

279See, e.g., supra note 83 and accompanying 

text. 

280Proposed rule 203(l)–1(b). 

provide empirical data to support any 

positions advanced. 

As discussed above, we are proposing 

rules 203(l)–1, 203(m)–1 and 202(a)(30)– 

1 to implement certain provisions of the 

Dodd-Frank Act. As a result of the 

Dodd-Frank Act’s repeal of the private 

adviser exemption, some advisers that 

previously were eligible to rely on that 

exemption will be required to register 

under the Advisers Act unless these 

advisers are eligible for a new 

exemption. Thus, the benefits and costs 

associated with registration are 

attributable to the Dodd-Frank Act. The 

Commission has discretion, however, to 

adopt rules to define the terms used in 

the Advisers Act, and we undertake 

below to discuss the benefits and costs 

of the defined terms that we are 

proposing. 

A. Definition of Venture Capital Fund 

Our proposed rule is designed to: (i) 

implement the directive from Congress 

to define the term venture capital fund 

in a manner that reflects Congress’ 

understanding of what venture capital 

funds are, and as distinguished from 

other private equity funds and hedge 

funds; and (ii) facilitate the transition to 

the new exemption. Our proposal would 

define the term venture capital fund 

consistently with what we believe 

Congress understood venture capital 

funds to be, and in light of other 

provisions of the federal securities laws 

that seek to achieve similar 

objectives.273

Using these characteristics as our 

model, we propose to define a venture 

capital fund as a private fund that: (i) 

Invests in equity securities of private 

companies in order to provide operating 

and business expansion capital (i.e., 

‘‘qualifying portfolio companies’’) and at 

least 80 percent of each company’s 

equity securities owned by the fund 

were acquired directly from the 

qualifying portfolio company; (ii) 

directly, or through its investment 

advisers, offers or provides significant 

managerial assistance to, or controls, the 

qualifying portfolio company; (iii) does 

not borrow or otherwise incur leverage 

(other than limited short-term 

borrowing); (iv) does not offer its 

investors redemption or other similar 

liquidity rights except in extraordinary 

circumstances; (v) represents itself as a 

venture capital fund to investors; and 

(vi) is not registered under the 

Investment Company Act and has not 

elected to be treated as a BDC.274

We propose to define a ‘‘qualifying 

portfolio company’’ as any company 

that: (i) Is not publicly traded; (ii) does 

not incur leverage in connection with 

the investment by the private fund; (iii) 

uses the capital provided by the fund for 

operating or business expansion 

purposes rather than to buy out other 

investors; and (iv) is not itself a fund 

(i.e., is an operating company).275

We also propose to grandfather 

existing funds by including in the 

definition of ‘‘venture capital fund’’ any 

private fund that: (i) Represented to 

investors and potential investors at the 

time the fund offered its securities that 

it is a venture capital fund; (ii) prior to 

December 31, 2010, has sold securities 

to one or more investors that are not 

related persons of any investment 

adviser of the venture capital fund; and 

(iii) does not sell any securities to, 

including accepting any additional 

capital commitments from, any person 

after July 21, 2011 (the ‘‘grandfathering 

provision’’).276 An adviser seeking to 

rely on the exemption under section 

203(l) of the Advisers Act would be 

eligible for the venture capital 

exemption only if it exclusively advised 

venture capital funds that met all of the 

elements of the proposed definition or 

grandfathering provision. 

1. Benefits 

Based on the testimony presented to 

Congress and our research, we believe 

that venture capital funds today would 

meet most, if not all, of the elements of 

our proposed definition of venture 

capital fund. Our proposed definition 

includes one specific element, however, 

that may not be characteristic of some 

existing venture capital funds. The 

proposed rule defines a venture capital 

fund as one that does not issue debt or 

provide guarantees except on a shortterm basis (and correspondingly defines 

a qualifying portfolio company as one 

that does not borrow or otherwise incur 

leverage in connection with the venture 

capital fund investment). We propose 

this element of the qualifying portfolio 

company definition because of the focus 

on leverage in the Dodd-Frank Act as a 

potential contributor to systemic risk as 

discussed by the Senate Committee 

report,277 and the testimony before 

Congress that stressed the lack of 

leverage in venture capital investing.278

Our research suggests that on occasion, 

however, some venture capital funds 

may provide financing on a short-term 

basis to portfolio companies as a 

‘‘bridge’’ between funding rounds.279 It 

is possible that certain types of bridge 

financing currently used by venture 

capital funds may not satisfy the 

definition of equity security under our 

proposed rule. 

Although the limitation on acquiring 

debt securities from portfolio companies 

may not be characteristic of some 

existing venture capital funds, the 

failure of existing venture capital funds 

to meet the proposed definition would 

not preclude advisers to those funds 

from relying on the exemption in 

section 203(l) of the Advisers Act under 

our proposed rule. An adviser of 

existing venture capital funds could 

avail itself of the exemption under the 

proposed grandfathering provision 

provided that each fund (i) Has 

represented to investors that it is a 

venture capital fund, (ii) has initially 

sold interests by December 31, 2010, 

and (iii) does not sell any additional 

interests after July 21, 2011.280 We 

expect that all advisers to existing 

venture capital funds that currently rely 

on the private adviser exemption would 

be exempt from registration in reliance 

on the proposed grandfathering 

provision. As a result of this provision, 

we expect that advisers to existing 

venture capital funds that do not meet 

our proposed definition would benefit 

because those advisers could continue 

to manage existing funds without 

having to (i) Weigh the relative costs 

and benefits of registration and 

modification of fund operations to 

conform existing funds with our 

proposed definition and (ii) incur the 

costs associated with registration with 

the Commission or modification of 

existing funds. Advisers to venture 

capital funds that are in formation that 

would be able to launch by December 

31, 2010 and meet the July 21, 2011 

deadline for sales of all securities also 

would benefit from the grandfathering 

provision because they would not have 

to incur these costs. 

Going forward, we recognize that 

some advisers to existing venture capital 

funds that seek to rely on the exemption 

in section 203(l) of the Advisers Act 

might have to structure new funds 


srobinson on DSKHWCL6B1PROD with PROPOSALS2
77216 Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 

281See infra text following note 294; notes 299– 

303 and accompanying text for a discussion of 

potential costs for advisers that would have to 

choose between registering or restructuring venture 

capital funds formed in the future. 

282See supra note 99. 283See supra note 100. 284See S. Rep. No. 111–176, supra note 7, at 39 

(explaining the requirement that private funds 

disclose information regarding their investment 

positions and strategies, including information on 

fund size, use of leverage, counterparty credit risk 

exposure, trading and investment positions and any 

other information that the Commission in 

consultation with the Financial Stability Oversight 

Council determines is necessary and appropriate to 

protect investors or assess systemic risk). 

285See supra notes 85–87 and accompanying text. 

286See supra section II.A.1.d of this Release. 

287See supra notes 123–128 and accompanying 

text. 

288See supra note 128 and accompanying and 

following text. For example, unlike the BDC 

provision, the proposed definition does not 

specifically define managerial assistance by 

referring to a fund’s directors, officers, employees 

or general partners. In addition, like the BDC 

provision, the proposed definition would require 

the venture capital fund to control the qualifying 

portfolio company (if it does not offer or provide 

significant managerial assistance), but without 

reference to exercising a controlling influence 

because the ability to exercise a controlling 

influence is inherent in the control relationship. 

See section 202(a)(12) of the Advisers Act (defining 

control to mean the power to exercise a controlling 

influence over the management or policies of a 

company unless such power is solely the result of 

an official position with such company). See supra 

note 129 for the definition of ‘‘making available 

significant managerial assistance’’ by a BDC. 

289See supra discussion in section II.A.1.a of this 

Release. 

differently to meet the proposed 

limitation on qualified portfolio 

company leverage. To the extent that 

advisers choose not to change how they 

structure or manage new funds they 

launch, those advisers would have to 

register with the Commission,281 which 

offers many benefits to the investing 

public and facilitates our mandate to 

protect investors. Registered investment 

advisers are subject to periodic 

examinations by our staff and are also 

subject to our rules including rules on 

recordkeeping, custody of client funds 

and compliance programs. We believe 

that in general Congress considered 

registration to be beneficial to investors 

because of, among other things, the 

added protections offered by 

registration. Accordingly, Congress 

limited the section 203(l) exemption to 

advisers to venture capital funds. As 

noted above, we proposed certain 

elements in the portfolio company 

definition because of the focus on 

leverage in the Dodd-Frank Act as a 

potential contributor to systemic risk as 

discussed by the Senate Committee 

report,282 and the testimony before 

Congress that stressed the lack of 

leverage in venture capital investing.283

We expect that distinguishing between 

venture capital funds and other private 

funds that pursue investment strategies 

involving financial leverage that 

Congress highlighted for concern would 

benefit financial regulators mandated by 

the Dodd-Frank Act (such as the 

Financial Stability Oversight Council) 

with monitoring and assessing potential 

systemic risks. Because advisers that 

manage funds with these characteristics 

would be required to register, we expect 

that financial regulators could more 

easily obtain information and data 

regarding these financial market 

participants, which should benefit those 

regulators to the extent it helps to 

reduce the overall cost of systemic risk 

monitoring and assessment.284

In addition to the benefits discussed 

above, we expect that investment 

advisers that seek to rely on the 

exemption would benefit from the 

flexibility in the proposed definition of 

venture capital fund than a more rigid 

or narrow definition, which should 

allow them more easily to structure and 

operate funds that meet the definition. 

This flexibility should facilitate 

compliance with the proposed rule and 

transition to the new exemption. For 

example, we propose to define equity 

securities broadly to cover many types 

of equity securities in which venture 

capital funds typically invest, rather 

than limit the definition solely to 

common stock.285 To meet the proposed 

definition, at least 80 percent (not 100 

percent) of the equity securities of a 

portfolio company in which a venture 

capital fund invests must be acquired 

directly from the issuing portfolio 

company (including securities that have 

been converted into equity securities), 

but there is no limit as to how the 

remaining 20 percent could be 

acquired.286 Furthermore, under the 

proposed definition, the venture capital 

fund may offer or provide managerial 

assistance to or alternatively control the 

qualified portfolio company directly, or 

may do so through its advisers. As noted 

above, we have modeled this element of 

the definition in part on existing 

provisions under the Advisers Act and 

Investment Company Act dealing with 

BDCs.287 Our proposed definition also is 

designed to be a simplified version of 

the definition of ‘‘making available 

significant managerial assistance’’ under 

the BDC provisions, which we expect 

would reduce confusion and facilitate 

understanding of the proposed rule.288

This approach would preserve 

flexibility for venture capital funds that 

invest as a group to determine which 

members of the group are best qualified, 

or best able, to control the portfolio 

company or alternatively to offer 

(and/or provide) managerial assistance 

to the portfolio company. 

Our proposed definition of qualifying 

portfolio company is similarly broad 

because the definition does not restrict 

qualifying companies to ‘‘small or startup’’ companies. As we have noted 

above, we believe that such definitions 

would be too restrictive and provide 

venture capital fund advisers with too 

little flexibility and limited options with 

respect to potential portfolio company 

investments.289 In addition, we propose 

to define a ‘‘qualifying portfolio 

company’’ as a company that does not 

borrow from, or issue debt in 

connection with the investment from, 

venture capital funds. Thus, a qualifying 

portfolio company could borrow for 

working capital or other operating needs 

from other lenders, such as banks, 

without jeopardizing the venture capital 

fund adviser’s eligibility for the 

exemption. These proposed broad 

definitions and criteria should benefit 

advisers that intend to rely on the 

exemption because they give the adviser 

flexibility to structure transactions and 

investments in underlying portfolio 

companies in a manner that meets their 

business objectives without unduly 

creating systemic or other risks of the 

kind that Congress suggested should 

require registration of the fund’s 

adviser. For commenters recommending 

more narrow elements for our 

definition, we request comment on the 

costs to advisers of having to change 

their business practices to comply with 

such narrower elements. 

We believe that the grandfathering 

provision would promote efficiency 

because it will allow advisers to existing 

venture capital funds to continue to rely 

on the exemption without having to 

restructure funds that may not meet the 

proposed definition. It also would allow 

advisers to funds that are currently in 

formation and can meet the 

requirements of the grandfathering 

provision to rely on the exemption 

without the potential costs of having to 

renegotiate with potential investors and 

restructure those funds within the 

limited period before the rule must be 

adopted. Advisers that seek to form new 

funds should have sufficient time and 

notice to structure those funds to meet 

the proposed definition should they 

seek to rely on the exemption in section 

203(l) of the Advisers Act. 

Finally, we believe that our proposed 

definition would include an additional 

benefit for investors and regulators. 

Section 203(l) of the Advisers Act 

provides an exemption specifically for 


srobinson on DSKHWCL6B1PROD with PROPOSALS2
Federal Register / Vol. 75, No. 237 / Friday, December 10, 2010 / Proposed Rules 77217 

290See Implementing Release, supra note 25, at 

n.130 and accompanying text. 

291See NVCA Yearbook 2010, supra note 41, at 

figure 1.04 (providing number of ‘‘active’’ venture 

capital advisers who have raised a venture capital 

partnership within the past eight years). 

292We estimate that these advisers (and any other 

adviser that seeks to remain unregistered in reliance 

on the exemption under section 203(l) of the 

Advisers Act) would incur, on average, $2,041 per 

year to complete and update related reports on 

Form ADV, including Schedule D information 

relating to private funds. See Implementing Release, 

supra note 25, at section IV.B.2. This estimate 

includes internal costs to the adviser of $1,764 to 

prepare and submit an initial report on Form ADV 

and $277 to prepare and submit annual 

amendments to the report. These estimates are 

based on the following calculations: $1,764 = 

($3,528,000 aggregate costs ÷ 2,000 advisers); $277 

= ($554,400 aggregate costs ÷ 2,000 advisers). Id., at 

nn.337, 339 and accompanying text. We estimate 

that one exempt reporting adviser would file Form 

ADV–H per year at a cost of $204 per filing. Id., at 

n.344 and accompanying text. We further estimate 

that three exempt reporting advisers would file 

Form ADV–NR per year at a cost of $57 per filing. 

Id., at nn.347, 349 and accompanying text. We 

anticipate that filing fees for exempt reporting 

advisers would be the same as those for registered 

investment advisers. See infra note 300. These 

reporting costs are attributable to the Dodd-Frank 

Act, which directs the Commission to require 

advisers to venture capital funds to provide such 

annual and other reports as we determine necessary 

or in the public interest or for the protection of 

investors. See section 203(l) of the Advisers Act. 

293We expect that a venture capital adviser 

would need no more than 2 hours of legal advice 

to learn the differences between its current business 

practices and the conditions for reliance on the 

proposed grandfathering provision. We estimate 

that this advice would cost $400 per hour per firm 

based on our understanding of the rates typically 

charged by outside consulting or law firms. 

294See BRESLOW & SCHWARTZ, supra note 144, at 

2–22 (‘‘Once the first closing [of a private equity 

fund] has occurred, subsequent closings are 

typically held over a defined period of time [the 

marketing period] of approximately six to twelve 

months.’’). See also Dow Jones Report, supra note 

145, at 22. 

295This is the average annual increase in the 

number of venture capital advisers between 1980 

and 2009. See NVCA Yearbook 2010, supra note 41, 

at figure 1.04. 

296We expect that a venture capital adviser 

would need between 7 and 12 hours of consulting 

or legal advice to learn the differences between its 

current business practices and the proposed 

definition, depending on the experience of the firm 

and its familiarity with the elements of the 

proposed rule. We estimate that this advice would 

cost $400 per hour per firm based on our 

understanding of the rates typically charged by 

outside consulting or law firms. 

297This estimate is based on the following 

calculations: $2,800 x 24 = $67,200; 24 x $4,800 = 

$115,200. 

298For estimates of the costs of registration for 

those advisers that would choose to register, see 

infra notes 299–304. 

advisers that ‘‘solely’’ advise venture 

capital funds. Currently none of our 

rules requires that an adviser exempt 

from registration specify the basis for 

the exemption. We are proposing, 

however, to require exempt reporting 

advisers to identify the exemption(s) on 

which they are relying.290 Requiring 

that venture capital funds represent 

themselves as such to investors should 

allow the Commission and the investing 

public (particularly potential investors 

in venture capital funds) to determine, 

and confirm, an adviser’s rationale for 

remaining unregistered with the 

Commission. This element is designed 

to deter advisers to private funds other 

than venture capital funds from 

claiming to rely on an exemption from 

registration for which they are not 

eligible. 

We request comment on the potential 

benefits we have identified above. Are 

there benefits of the proposed definition 

that we have not identified? 

2. Costs 

Costs for advisers to existing venture 

capital funds. As discussed above, we 

do not expect that the proposed rule 

would result in any significant costs for 

unregistered advisers to venture capital 

funds currently in existence and 

operating. We estimate that currently 

there are 800 advisers to venture capital 

funds.291 We expect that all these 

advisers, which we assume currently are 

not registered in reliance on the private 

adviser exemption, would continue to 

be exempt after the repeal of that 

exemption on July 21, 2011 in reliance 

on the proposed grandfathering 

provision.292 We anticipate that such 

advisers to grandfathered funds would 

incur minimal costs, at most, to confirm 

that existing venture capital funds 

managed by the adviser meet the 

conditions of the grandfathering 

provision. We estimate that these costs 

would be no more than $800 to hire 

outside counsel to assist in this 

determination.293

We recognize, however, that advisers 

to funds that are currently in the process 

of being formed and negotiated with 

investors may incur costs to determine 

whether they qualify for the 

grandfathering provision. For example, 

these advisers may need to assess the 

impact on the fund of selling interests 

to initial third party investors by 

December 31, 2010 and selling interests 

to all investors no later than July 21, 

2011. We do not expect that the cost of 

evaluating the grandfathering provision 

would be significant, however, because 

we believe that most funds in formation 

represent themselves as being venture 

capital funds or funds that pursue a 

venture capital investing strategy to 

their potential investors and the typical 

fundraising period for a venture capital 

fund is approximately 12 months.294

Thus, we do not anticipate that venture 

capital fund advisers would have to 

alter typical business practice to 

structure or raise capital for venture 

capital funds being formed. 

Nevertheless, we recognize that after the 

final rule goes into effect, exempt 

advisers of such funds in formation may 

forgo the opportunity to accept 

investments from investors that may 

seek to invest after July 21, 2011 in 

order to comply with the grandfathering 

provision. 

We request comment on the potential 

costs of this aspect of our proposed rule. 

Are there advisers to existing venture 

capital funds or venture capital funds in 

formation that would not be covered by 

the grandfathering provision? We 

request commenters to quantify the 

number of these advisers and provide us 

with specific examples of why such 

advisers would not be able to rely on the 

grandfathering provision. 

Costs for new advisers and advisers to 

new venture capital funds. We expect 

that existing advisers that seek to form 

new venture capital funds and 

investment advisory firms that seek to 

enter the venture capital industry would 

incur one-time ‘‘learning costs’’ to 

determine how to structure new funds 

they may manage to meet the elements 

of our proposed definition. We estimate 

that on average, there are 24 new 

advisers to venture capital funds each 

year.295 We expect that the one-time 

learning costs would be no more than 

between $2,800 and $4,800 on average 

for an adviser if it hires an outside 

consulting or law firm to assist in 

determining how the elements of our 

proposed definition may affect intended 

business practices.296 Thus, we estimate 

the aggregate cost to existing advisers of 

determining how the proposed 

definition would affect funds they plan 

to launch would be from $67,200 to 

$115,200.297 We request comment on 

whether these estimates accurately 

reflect the fees an adviser would be 

likely to pay to consulting and law firms 

it hires. As they launch new funds and 

negotiate with potential investors, these 

advisers would have to determine 

whether it is more cost effective to 

register or to structure the venture 

capital funds they manage to meet the 

proposed definition. Such 

considerations of legal or other 

requirements, however, comprise a 

typical business and operating expense 

of conducting new business. New 

advisers that enter into the business of 

managing venture capital funds also 

would incur such ordinary costs of 

doing business in a regulated 

industry.298

We believe that existing advisers to 

venture capital funds meet most, if not 

all, of the elements of the proposed 


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299This estimate is based upon the following 

calculations: $11,526 = ($7,699,860 aggregate costs 

to complete Form ADV ÷ 750 advisers) + 

($1,197,000 aggregate costs to complete private fund 

reporting requirements ÷ 950 advisers). See 

Implementing Release, supra note 25, at nn.355– 

361. This also assumes that an adviser’s registration 

process would be conducted by a senior compliance 

examiner and a compliance manager at an 

estimated cost of $210 and $294 per hour, 

respectively. See Implementing Release, supra note 

25, at nn.354 and accompanying text. 

300The initial filing fee and annual filing fee for 

advisers with $25 million to $100 million of assets 

under management is $150 and for advisers with 

$100 million or more of assets under management 

is $200. See Electronic Filing for Investment 

Advisers on IARD: IARD Filing Fees, available at 

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

iardfee.shtml. 

301Part 1 of Form ADV requires advisers to 

answer basic identifying information about their 

business, their affiliates and their owners, 

information that is readily available to advisers, and 

thus should not result in significant costs to 

complete. Registered advisers must also complete 

Part 2 of Form ADV and file it electronically with 

us. Part 2 requires disclosure of certain conflicts of 

interest and could be prepared based on 

information already contained in materials 

provided to investors, which could reduce the costs 

of compliance even further. 

302See Implementing Release, supra note 25, at 

n.363, 421 (noting the cost estimate for compliance 

consulting services related to initial preparation of 

the amended Form ADV ranges from $3,000 for 

smaller advisers to $5,000 for medium-sized 

advisers). 

303We expect that most advisers that might 

choose to register have already built compliance 

infrastructures as a matter of good business 

practice. Nevertheless, we expect advisers will 

incur costs for outside legal counsel to evaluate 

their compliance procedures initially and on an 

ongoing basis. We estimate that the costs to advisers 

to establish the required compliance infrastructure 

will be, on average, $20,000 in professional fees and 

$25,000 in internal costs including staff time. These 

estimates were prepared in consultation with 

attorneys who, as part of their private practice, have 

counseled private fund advisers establishing their 

registrations with the Commission. We have 

included a range because we believe there are a 

number of unregistered private funds whose 

compliance operations are already substantially in 

compliance with the Advisers Act and that would 

therefore experience only minimal incremental 

ongoing costs as a result of registration. In 

connection with previous estimates we have made 

regarding compliance costs for registered advisers, 

we received comments from small advisers 

estimating that their annual compliance costs 

would be $25,000 and could be as high as $50,000. 

See, e.g., Comment Letter of Joseph L. Vidich (Aug. 

7, 2004). Cf. Comment Letter of Venkat Swarna 

(Sept. 14, 2004) (estimating costs of $20,000 to 

$25,000). These comment letters were submitted in 

connection with Hedge Fund Adviser Registration 

Release, supra note 17, and are available on the 

Commission’s Internet Web site at http:// 

www.sec.gov/rules/proposed/s73004.shtml. 

definition because it is modeled on 

current business practices of venture 

capital funds. We thus do not anticipate 

that many venture capital fund advisers 

would have to change significantly the 

structure of new funds they launch. 

Under our proposed definition, an 

adviser would not be able to rely on the 

exemption if a venture capital fund 

invested in securities that were not 

equity securities issued by qualifying 

portfolio companies. Although we 

believe this practice is not common in 

the industry, this element of our 

proposed rule may result in some 

venture capital funds incurring costs to 

structure and acquire equity 

investments that possess terms and 

protections typically found in debt 

instruments. To the extent that venture 

capital funds might not be able to 

structure equity investments in this 

way, and portfolio companies would 

have to forgo debt issuance, the 

proposal could have an adverse effect 

on capital formation. 

We also recognize that some existing 

venture capital funds may have 

characteristics that differ from the 

elements of the proposed definition 

other than the limitation on investments 

in debt securities issued by portfolio 

companies. To the extent that 

investment advisers seek to form new 

venture capital funds with these 

characteristics, those advisers would 

have to choose whether to structure new 

venture capital funds to conform to the 

proposed definition, forgo forming new 

funds, or register with the Commission. 

In any case, each investment adviser 

would assess the costs associated with 

registering with the Commission relative 

to the costs of remaining unregistered 

(and hence structuring funds to meet 

our proposed definition in order to be 

eligible for the exemption). We expect 

that this assessment would take into 

account many factors, including the 

size, scope and nature of its business 

and investor base. Such factors will vary 

from adviser to adviser, but each adviser 

would determine whether registration, 

relative to other choices, is the most 

cost-effective or strategic business 

option for itself. 

To the extent that advisers choose to 

structure new venture capital funds to 

conform to the proposed definition, or 

choose not to form new funds in order 

to avoid registration, these choices 

could result in fewer investment choices 

for investors, less competition and less 

capital formation. To the extent that 

advisers choose to register in order to 

structure new venture capital funds 

without regard to the proposed 

definitional elements or in order to 

expand their business (e.g., pursue 

additional investment strategies beyond 

venture capital investing or expand the 

potential investor base to include 

investors that are required to invest with 

registered advisers), these choices may 

result in greater investment choices for 

investors, greater competition and 

greater capital formation. 

Investment advisers to new venture 

capital funds that would not meet the 

proposed definition would have to 

register and incur the costs associated 

with registration (assuming the adviser 

could not rely on the private fund 

adviser exemption). We estimate that 

the internal cost to register with the 

Commission would be $11,526 on 

average for a private fund adviser,299

excluding the initial filing fees and 

annual filing fees to the Investment 

Adviser Registration Depository 

(‘‘IARD’’) system operator.300 These 

registration costs include the costs 

attributable to completing and 

periodically amending Form ADV, 

preparing brochure supplements, and 

delivering codes of ethics to clients.301

In addition to the internal costs 

described above, we estimate that for an 

adviser choosing to use outside legal 

services to complete its brochure, such 

costs would be $3,000 to $5,000.302

New registrants would also face costs 

to bring their business operations into 

compliance with the Advisers Act and 

the rules thereunder. These costs would 

vary depending on the size, scope and 

nature of the adviser’s business, but in 

any case would be an ordinary business 

and operating expense of entering into 

any business that is regulated. We 

estimate that the one-time costs to new 

registrants to establish a compliance 

infrastructure would range from $10,000 

to $45,000, while ongoing annual costs 

of compliance and examination would 

range from $10,000 to $50,000.303

We do not believe that the proposed 

definition of venture capital fund is 

likely to affect whether advisers to 

venture capital funds would choose to 

launch new funds or whether persons 

would choose to enter into the business 

of advising venture capital funds 

because, as noted above, we believe the 

proposed definition reflects the way 

most venture capital funds currently 

operate. For this reason, we expect that 

the proposed definition is not likely to 

significantly affect the way in which 

investment advisers to these funds do 

business and thus compete. For the 

same reason, we do not believe that our 

proposed rule is likely to have a 

significant effect on overall capital 

formation. 

We request comment on the costs we 

have discussed above. Are there costs of 

the proposed definition that we have 

not identified? How many advisers to 

venture capital funds are likely to 

choose to register or structure new 

venture capital funds differently from 

their existing funds in order to meet the 

proposed definition? How costly would 

it be for advisers to structure new 

venture capital funds to conform to the 

proposed definition in order to qualify 


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304Commission staff estimates that the one-time 

costs of registration for a venture capital fund 

adviser with $150 million in assets under 

management in the United States (i.e., an adviser 

that would not qualify for the exemption under 

section 203(m) of the Advisers Act), would be 

approximately 0.01% of assets, and annual costs of 

compliance and examination would range from 

0.007% to 0.03% of assets under management. 

These figures are based on the following 

calculations: ($11,526 (registration costs) + $3,000 

(lower estimate of external costs to prepare 

brochure)) ÷ $150,000,000 = 0.000097; ($11,526 

(registration costs) + $5,000 (higher estimate of 

external costs to prepare brochure)) ÷ $150,000,000 

= 0.0001); $10,000 (lower estimate of ongoing costs) 

÷ $150,000,000 = 0.000067; $50,000 (higher 

estimate of ongoing costs) ÷ $150,000,000 = 

0.000333). 

305See supra sections II.B.2–3 of this Release. 

306See supra note 190 and accompanying text; 

Implementing Release, supra note 25, at nn.58–59 

and accompanying text. Thus, under proposed rule 

203(m)–1, to determine its assets under 

management for purposes of the proposed private 

fund adviser exemption, an adviser would calculate 

its ‘‘regulatory assets under management’’ 

attributable to private funds according to the 

instructions to Form ADV. Proposed rule 203(m)– 

1(a)(2), (b)(2) (conditioning the exemption on an 

adviser managing private fund assets of less than 

$150 million); proposed rule 203(m)–1(e)(1) 

(defining ‘‘assets under management’’ for purposes 

of the proposed rule’s exemption); proposed rule 

203(m)–1(e)(4) (defining ‘‘private fund assets’’ as the 

investment adviser’s assets under management 

attributable to a qualifying private fund). 

307See proposed Form ADV: Instructions to Part 

1A, instr. 5.b(1). 

308See Shearman & Sterling Letter, supra note 

268. 

309See proposed rule 203(m)–1(c); Implementing 

Release, supra note 25, proposed Form ADV: 

Instructions to Part 1A, instr. 5.b(4). 

310See supra note 196. 

311See supra section II.B.2 of this Release; see, 

e.g., Breslow & Schwartz, supra note 144, at 

§ 2.8.2[C]. 

312As discussed above, the proposed rule looks 

to an adviser’s principal office and place of 

business as the location where it directs, controls 

and coordinates its global advisory activities. 

Proposed rule 203(m)–1(e)(3). See supra notes 202– 

203 and accompanying text. 

for an exemption from registration? 

Would advisers choose not to launch 

new funds or not enter the venture 

capital industry in order to avoid the 

costs associated with structuring 

venture capital funds to conform to the 

definition or registration? 304

B. Exemption for Investment Advisers 

Solely to Private Funds With Less Than 

$150 Million in Assets Under 

Management 

As discussed in Section II.B., 

proposed rule 203(m)–1 would exempt 

any investment adviser solely to private 

funds that has less than $150 million in 

assets under management in the United 

States. Our proposed rule is designed to 

implement the private fund adviser 

exemption, as directed by Congress, in 

section 203(m) of the Advisers Act and 

includes provisions for determining the 

amount of an adviser’s private fund 

assets for purposes of the exemption 

and when those assets are deemed 

managed in the United States.305

1. Benefits 

As discussed above and in the 

Implementing Release, we are proposing 

a uniform method of calculating assets 

under management in the instructions 

to Form ADV, which would be used to 

determine whether an adviser qualifies 

to register with the Commission rather 

than the states, and to determine 

eligibility for the private fund adviser 

exemption under section 203(m) of the 

Advisers Act and the foreign private 

adviser exemption under section 

203(b)(3) of the Advisers Act.306 We 

anticipate that this uniform approach 

would benefit regulators (both state and 

federal) as well as advisers, because 

only a single determination of assets 

under management would be required 

for purposes of registration and 

exemption from federal registration. 

The instructions to Form ADV 

currently permit, but do not require, 

advisers to exclude certain types of 

managed assets.307 As a result, it is not 

possible to conclude that two advisers 

reporting the same amount of assets 

under management are necessarily 

comparable because either adviser may 

elect to exclude all or some portion of 

certain specified assets that it manages. 

By specifying that assets under 

management must be calculated 

according to the instructions to Form 

ADV, our proposed approach should 

benefit advisers by increasing 

administrative efficiencies because 

advisers would have to calculate assets 

under management only once for 

multiple purposes.308 We expect this 

would minimize costs relating to 

software modifications, recordkeeping, 

and training required to determine 

assets under management for regulatory 

purposes. We also anticipate that the 

consistent calculation and reporting of 

assets under management would benefit 

investors and regulators because it 

would provide enhanced transparency 

and comparability of data, and allow 

investors and regulators to analyze on a 

more cost effective basis whether any 

particular adviser may be required to 

register with the Commission or is 

eligible for an exemption. 

We anticipate that the valuation of 

private fund assets under proposed rule 

203(m)–1 would benefit private fund 

advisers that seek to rely on the 

exemption.309 Under proposed rule 

203(m)–1, each adviser would 

determine the amount of its private fund 

assets based on the fair value of the 

assets at the end of each quarter. We 

propose that advisers use fair value of 

private fund assets in order to ensure 

that, for purposes of this exemption, 

advisers value private fund assets on a 

meaningful and consistent basis. We 

understand that many, but not all, 

advisers to private funds value assets 

based on their fair value in accordance 

with GAAP or other international 

accounting standards.310 We 

acknowledge that some advisers to 

private funds may not use fair value 

methodologies, which may be more 

difficult to apply when the fund holds 

illiquid or other types of assets that are 

not traded on organized markets. 

Proposed rule 203(m)–1(c) specifies 

that an adviser relying on the exemption 

would determine the amount of its 

private fund assets quarterly, which we 

believe would benefit advisers. We 

understand that a quarterly calculation 

of assets under management is 

consistent with business practice— 

many types of private funds calculate 

fees payable to advisers and other 

service providers on at least a quarterly 

basis.311 The quarterly calculation also 

would allow advisers that rely on the 

exemption to maintain the exemption 

despite short-term market value 

fluctuations that might result in the loss 

of the exemption if, for example, the 

rule required daily valuation. We expect 

that quarterly valuation would also 

benefit these advisers by allowing them 

to avoid the cost of more frequent 

valuations, including costs (such as 

third party quotes) associated with 

valuing illiquid assets, which may be 

particularly difficult to value more often 

because of the lack of frequency with 

which such assets are traded. 

Under proposed rule 203(m)–1(a), all 

of the private fund assets of an adviser 

with a principal office and place of 

business in the United States would be 

considered to be ‘‘assets under 

management in the United States,’’ even 

if the adviser has offices outside of the 

United States.312 A non-U.S. adviser 

would need only count private fund 

assets it manages from a place of 

business in the U.S. toward the $150 

million limit under the exemption. As 

discussed below, we believe that this 

interpretation of ‘‘assets under 

management in the United States’’ 

would offer greater flexibility to 

advisers and reduce many costs 

associated with compliance. These costs 

could include difficult attribution 

determinations that would be required if 

assets are managed by teams located in 

multiple jurisdictions or if portfolio 

managers located in one jurisdiction 

rely heavily on research or other 


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313See supra text following note 281 and 

preceding and accompanying text. 

314By contrast, a U.S. adviser could ‘‘solely 

advise private funds’’ as specified in the statute. 

Compare proposed rule 203(m)–1(a)(1) with 

proposed rule 203(m)–1(b)(1). 

315See supra note 208 and accompanying text. 

316See supra section II.B.3 of this Release. 

317See Implementing Release, supra note 25, at 

section II.B. 

318See supra paragraph accompanying note 205. 

319See supra note 202 and accompanying text. 

320We do not believe that the statutory text refers 

to where the assets themselves may be located or 

traded or the location of the account where the 

assets are held. In today’s market, using the location 

of assets would raise numerous questions of where 

a security with no physical existence is ‘‘located.’’ 

Although physical stock certificates were once sent 

to investors as proof of ownership, stock certificates 

are now centrally held by securities depositories, 

which perform electronic ‘‘book-entry’’ changes in 

their records to document ownership of securities. 

This arrangement reduces transmittal costs and 

increases efficiencies for securities settlements. See 

generally Bank for International Settlements, The 

Depository Trust Company: Response to the 

Disclosure Framework for Securities Settlement 

Systems (2002), http://www.bis.org/publ/ 

cpss20r3.pdf. An account also has no physical 

location even if the prime broker, custodian or other 

service that holds assets on behalf of the customer 

does. Each of these approaches would be confusing 

and extremely difficult to apply on a consistent 

basis. 

321We expect that a non-U.S. adviser would need 

no more than 10 hours of external legal advice (at 

$400 per hour) and 10 hours of internal review by 

a senior compliance officer (at $294 per hour) to 

evaluate whether the adviser would qualify for the 

exemption under section 203(l). 

advisory services performed by 

employees located in another 

jurisdiction. 

To the extent that this interpretation 

may increase the number of advisers 

subject to registration under the 

Advisers Act, we anticipate that our 

proposal also would benefit investors by 

providing more information about those 

advisers (e.g., information that would 

become available through Form ADV, 

Part I). We further anticipate that this 

would enhance investor protection by 

increasing the number of advisers 

registering pursuant to the Advisers Act 

and by improving the Commission’s 

ability to exercise its investor protection 

and enforcement mandates over those 

newly registered advisers. As discussed 

above, registration offers benefits to the 

investing public, including periodic 

examination of the adviser and 

compliance with rules requiring 

recordkeeping, custody of client funds 

and compliance programs.313

Under proposed rule 203(m)–1(b), a 

non-U.S. adviser with no U.S. place of 

business could avail itself of the 

exemption under section 203(m) even if 

it advised non-U.S. clients that are not 

private funds, provided that it did not 

advise any U.S. clients other than 

private funds.314 We anticipate that the 

proposed approach to the exemption 

under section 203(m) of the Advisers 

Act, which would look primarily to the 

principal office and place of business of 

an adviser to determine eligibility for 

the exemption, would increase the 

number of non-U.S. advisers that may 

be eligible for the exemption. As with 

other Commission rules that adopt a 

territorial approach, the private fund 

adviser exemption would be available to 

a non-U.S. adviser (regardless of its nonU.S. advisory activities) in recognition 

that non-U.S. activities of non-U.S. 

advisers are less likely to implicate U.S. 

regulatory interests and in consideration 

of general principles of international 

comity. This approach to the exemption 

is designed to encourage the 

participation of non-U.S. advisers in the 

U.S. market by applying the U.S. 

securities laws in a manner that does 

not impose U.S. regulatory and 

operational requirements on an 

adviser’s non-U.S. advisory business.315

We anticipate that our proposed 

interpretation of the availability of the 

private fund adviser exemption for nonU.S. advisers may benefit those advisers 

by facilitating their continued 

participation in the U.S. market with 

limited disruption to their non-U.S. 

advisory business practices.316 This 

approach also might benefit U.S. 

investors and facilitate competition in 

the market for advisory services to the 

extent that it would maintain or 

increase U.S. investors’ access to 

potential advisers. Furthermore, because 

non-U.S. advisers that elect to avail 

themselves of the exemption would be 

subject to certain reporting 

requirements,317 our proposed approach 

would increase the availability of 

information publicly available to U.S. 

investors who invest in the private 

funds advised by such exempt but 

reporting non-U.S. advisers. 

We request comment on the potential 

benefits we have identified above. Are 

there benefits of the proposed rule that 

we have not identified? 

2. Costs 

As noted above, under proposed rule 

203(m)–1, we would look to an adviser’s 

principal office and place of business as 

the location where the adviser directs, 

controls or has responsibility for, the 

management of private fund assets and 

therefore as the place where all the 

adviser’s assets are managed. Thus, a 

U.S. adviser would include all its 

private fund assets under management 

in determining whether it exceeds the 

$150 million limit under the exemption. 

We also look to where day-to-day 

management of private fund assets may 

occur for purposes of a non-U.S. 

adviser, whose principal office and 

place of business is outside the United 

States.318 A non-U.S. adviser therefore 

would count only the private fund 

assets it manages from a place of 

business in the United States in 

determining the availability of the 

exemption. This approach is similar to 

the way we have defined the location of 

the adviser for regulatory purposes 

under our current rules,319 and thus we 

believe it is the way in which most 

advisers would interpret the exemption 

without our proposed rule.320 We 

anticipate that our proposed approach 

would promote efficiency because 

advisers are familiar with it, and we do 

not anticipate that U.S. investment 

advisers to private funds would likely 

change their business models, the 

location of their private funds, or the 

location where they manage assets as a 

result of the proposed rule. We 

anticipate, however that non-U.S. 

advisers may incur minimal costs to 

determine whether they have assets 

under management in the U.S. We 

estimate that these costs would be no 

greater than $6,940 to hire U.S. counsel 

and perform an internal review to assist 

in this determination, in particular to 

assess whether a non-U.S. affiliate 

manages a discretionary account for the 

benefit of a United States person under 

the proposed rule.321

As noted above, because our rule is 

designed to encourage the participation 

of non-U.S. advisers in the U.S. market, 

we anticipate that it would have 

minimal regulatory and operational 

burdens on foreign advisers and their 

U.S. clients. Non-U.S advisers would be 

able to rely on proposed rule 203(m)–1 

if they manage U.S. private funds with 

more than $150 million in assets from 

a non-U.S. location as long as the 

private fund assets managed from a U.S. 

place of business are less than $150 

million. This could affect competition 

with U.S. advisers, which must register 

when they have $150 million in private 

fund assets under management 

regardless of where the assets are 

managed. 

To avail themselves of proposed rule 

203(m)–1, some advisers might choose 

to move their principal office and place 

of business outside the United States 

and manage private funds from that 

location. This might result in costs to 

U.S. investors in private funds that are 

managed by these advisers because they 

would not have the investor protection 

and other benefits that result from an 

adviser’s registration under the Advisers 

Act. We do not expect that many 

advisers would be likely to relocate for 


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322See supra note 310 and accompanying and 

following text. 

323See supra note 197. 

324For example, a hedge fund adviser may value 

fund assets for purposes of allowing new 

investments in the fund or redemptions by existing 

investors, which may be permitted on a regular 

basis after an initial lock-up period. An adviser to 

private equity funds may obtain valuation of 

portfolio companies in which the fund invests in 

connection with financing obtained by those 

companies. Advisers to private funds also may 

value portfolio companies each time the fund 

makes (or considers making) a follow-on investment 

in the company. Private fund advisers could use 

these valuations as a basis for complying with the 

fair valuation requirement we propose with respect 

to private fund assets. 

325This estimate is based upon the following 

calculation: 8 hours × $153/hour = $1,224. The 

hourly wage is based on data for a fund senior 

accountant from SIFMA’s Management and 

Earnings in the Securities Industry 2009, modified 

by Commission staff to account for an 1,800-hour 

work-year and multiplied by 5.35 to account for 

bonuses, firm size, employee benefits and overhead. 

326These estimates are based on conversations 

with valuation service providers. We understand 

that the cost of valuation for illiquid fixed income 

securities generally ranges from $1.00 to $5.00 per 

security, depending on the difficulty of valuation, 

and is performed for clients on weekly or monthly 

basis. We understand that appraisals of privately 

placed equity securities may cost from $3,000 to 

$5,000 with updates to such values at much lower 

prices. For purposes of this cost benefit analysis, we 

are estimating the range of costs for (i) a private 

fund that holds 50 fixed income securities at a cost 

of $5.00 to price and (ii) a private fund that holds 

privately placed securities of 15 issuers that each 

cost $5,000 to value initially and $1,000 thereafter. 

We believe that costs for funds that hold both fixedincome and privately placed equity securities 

would fall within the maximum of our estimated 

range. We note that funds that have significant 

positions in illiquid securities are likely to have the 

in-house capacity to value those securities or 

already subscribe to a third party service to value 

them. We note that many private funds are likely 

to have many fewer fixed income illiquid securities 

in their portfolios, some or all of which may cost 

less than $5.00 per security to value. Finally, we 

note that obtaining valuation services for a small 

number of fixed income positions on an annual 

basis may result in a higher cost for each security 

or require a subscription to the valuation service for 

those that do not already purchase such services. 

The staff’s estimate is based on the following 

calculations: (50 × $5.00 × 4 = $1,000; (15 × $5,000) 

+ (15 × $1,000 × 3) = $120,000). 

327See supra paragraph following note 210. 

328We expect that a private fund adviser would 

obtain between 2 and 12 hours of external legal 

advice (at a cost of $400 per hour) to determine 

whether it would be eligible for the private fund 

adviser exemption. 

329This range is attributable to the amount of 

assets under management, which affects the 

magnitude of filing fees associated with registration, 

and whether the adviser chooses to retain outside 

legal services to prepare its brochure. See supra 

notes 300–302 and accompanying text. 

330See supra note 303 and accompanying text. 

purposes of avoiding registration, 

however, because we understand that 

the primary reasons for advisers to 

locate in a particular jurisdiction 

involve tax and other business 

considerations. We also note that if an 

adviser did relocate, it would incur the 

costs of regulation under the laws of 

most of the foreign jurisdictions in 

which it may be likely to relocate. We 

do not believe, in any case, that the 

adviser would relocate if relocation 

would result in a material decrease in 

the amount of assets managed because 

that loss would likely not justify the 

benefits of avoiding registration, and 

thus we do not believe our proposed 

rule would have an adverse effect on 

capital formation. 

Our proposed rule incorporates the 

valuation methodology in the 

instructions to Form ADV. More 

specifically, proposed instruction 5.b(4) 

to Form ADV would require advisers to 

use fair value of private fund assets for 

determining regulatory assets under 

management. We acknowledge that 

there may be some private fund advisers 

that may not use fair value 

methodologies.322 The costs incurred by 

these advisers to use fair valuation 

methodology would vary based on 

factors such as the nature of the asset, 

the number of positions that do not have 

a market value, and whether the adviser 

has the ability to value such assets 

internally or would rely on a third party 

for valuation services.323 Nevertheless, 

we do not believe that the requirement 

to use fair value methodologies would 

result in significant costs for these 

advisers. We understand that private 

fund advisers, including those that may 

not use fair value methodologies for 

reporting purposes, perform 

administrative services, including 

valuing assets, internally as a matter of 

business practice.324 Commission staff 

estimates that such an adviser would 

incur $1,224 in internal costs to 

conform its internal valuations to a fair 

value standard.325 In the event a fund 

does not have an internal capability for 

valuing specific illiquid assets, we 

expect that it could obtain pricing or 

valuation services from an outside 

administrator or other service provider. 

In the event a fund does not have an 

internal capability for valuing specific 

illiquid assets, we expect that it could 

obtain pricing or valuation services from 

an outside administrator or other service 

provider. Staff estimates that the cost of 

such a service would range from $1,000 

to $120,000 annually, which could be 

borne by several funds that invest in 

similar assets or have similar 

investment strategies.326 We request 

comment on these estimates. Do 

advisers that do not use fair value 

methodologies for reporting purposes 

have the ability to fair value private 

fund assets internally? If not, what 

would be the costs to retain a third party 

valuation service? Are there certain 

types of advisers (e.g., advisers to real 

estate private funds) that would 

experience special difficulties in 

performing fair value analyses? If so, 

why? 

Our earlier discussion of the proposed 

rule also seeks comment on an 

alternative interpretation of ‘‘assets 

under management in the United 

States,’’ which would reference the 

source of the assets (i.e., U.S. private 

fund investors).327 Under this approach, 

a non-U.S. adviser would count the 

assets of private funds attributable to 

U.S. investors towards the $150 million 

threshold, regardless of the location 

where it manages private funds, and a 

U.S. adviser would exclude assets that 

are not attributable to U.S. investors. As 

a result, under this alternative more U.S. 

advisers might be able to rely on rule 

203(m)–1 than under our proposed 

approach. To the extent that non-U.S. 

advisers have U.S. investors in funds 

that they manage from a non-U.S. 

location, fewer non-U.S. advisers would 

be eligible for the exemption under this 

approach than under our proposal. 

Thus, this alternative could increase 

costs for those non-U.S. advisers who 

would have to register but reduce costs 

for those U.S. advisers who would not 

have to register. We seek comment on 

the number of U.S. advisers that would 

be able to avail themselves of the private 

fund adviser exemption under this 

alternative approach, but would not be 

able to rely on proposed rule 203(m)–1. 

This alternative approach could 

discourage U.S. advisers that may want 

to avoid registration from managing U.S. 

investor assets, which could affect 

competition for the management of 

those assets. We believe this is unlikely 

however, because to the extent the 

adviser would manage fewer assets we 

do not believe the loss of managed 

assets would justify the savings from 

avoiding registration. 

Under either the proposed approach 

or the alternative, each adviser may 

incur costs to evaluate whether it would 

be able to avail itself of the exemption. 

We estimate that each adviser may incur 

between $800 to $4,800 in legal advice 

to learn whether it may rely on the 

exemption.328 Each adviser that 

registers would incur registration costs, 

which we estimate would be $11,526.329

They also would incur estimated initial 

compliance costs ranging from $10,000 

to $45,000 and ongoing annual 

compliance costs from $10,000 to 

$50,000.330 Nevertheless, to the extent 

there would be an increase in registered 

advisers, as we have noted above, there 


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331See supra text following note 281. 

332See supra note 224 and accompanying text. 

The new exemption is codified as amended section 

203(b)(3). 

333See supra section II.C of this Release. 

334See supra section II.C.1 of this Release. Rule 

203(b)(3)–1, as currently in effect, provides a safe 

harbor for determining who may be deemed a single 

client for purposes of the private adviser 

exemption. We would not, however, carry over 

rules 203(b)(3)–1(b)(4), (5), or (7). See supra notes 

228 and 233 and accompanying text. 

335Proposed rule 202(a)(30)–1(c). See supra 

section II.C.2–4 of this Release. 

336Proposed rule 202(a)(30)–1(a)(1). 

337Proposed rule 202(a)(30)–1(a)(2)(i)–(ii). In 

addition, proposed rule 202(a)(30)–1(b)(1) through 

(3) would retain the following related ‘‘special 

rules’’: (1) An adviser must count a shareholder, 

partner, limited partner, member, or beneficiary 

(each, an ‘‘owner’’) of a corporation, general 

partnership, limited partnership, limited liability 

company, trust, or other legal organization, as a 

client if the adviser provides investment advisory 

services to the owner separate and apart from the 

legal organization; (2) an adviser is not required to 

count an owner as a client solely because the 

adviser, on behalf of the legal organization, offers, 

promotes, or sells interests in the legal organization 

to the owner, or reports periodically to the owners 

as a group solely with respect to the performance 

of or plans for the legal organization’s assets or 

similar matters; and (3) any general partner, 

managing member or other person acting as an 

investment adviser to a limited partnership or 

limited liability company must treat the partnership 

or limited liability company as a client. 

338See rule 203(b)(3)–1(b)(4); supra notes 233– 

235 and accompanying text. 

339See proposed rule 202(a)(30)–1(b)(4) 

(specifying that an adviser would not be required 

to count a private fund as a client if it counted any 

investor, as defined in the proposed rule, in that 

private fund as an investor in the United States in 

that private fund). 

340See proposed rule 202(a)(30)–1(c)(1); supra 

section II.C.2 of this Release. In order to avoid 

double-counting, we would allow an adviser to treat 

as a single investor any person that is an investor 

in two or more private funds advised by the 

investment adviser. See proposed rule 202(a)(30)– 

1(c)(1), at note to paragraph (c)(1). 

341See proposed rule 202(a)(30)–1(c)(1)(A); supra 

note 246 and accompanying text. 

342See proposed rule 202(a)(30)–1(c)(1)(B); supra 

notes 247–248 and accompanying text. 

343See rule 3c–5(b) under the Investment 

Company Act; section 3(c)(1) of the Investment 

Company Act. See also supra note 249 and 

accompanying text. 

344Proposed rule 202(a)(30)–1(c)(2). See supra 

notes 253–261 and accompanying paragraphs. 

345See 17 CFR 230.902(l). 

346See 17 CFR 230.902(k). We would allow 

foreign advisers to determine whether a client or 

investor is ‘‘in the United States’’ by reference to the 

time the person became a client or an investor. See 

proposed rule 202(a)(30)–1’s note to paragraph 

(c)(2)(i). 

347See 17 CFR 230.902(l). 

348See proposed rule 202(a)(30)–1(c)(3); proposed 

rule 222–1(a) (defining ‘‘place of business’’ of an 

investment adviser as: ‘‘(i) An office at which the 

investment adviser regularly provides investment 

advisory services, solicits, meets with, or otherwise 

communicates with clients; and (ii) Any other 

location that is held out to the general public as a 

location at which the investment adviser provides 

investment advisory services, solicit, meets with, or 

otherwise communicates with clients.’’). See supra 

section II.C.4 of this Release. 

349See proposed rule 202(a)(30)–1(c)(4); proposed 

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

also supra section II.C.5 of this Release. 

are benefits to registration for both 

investors and the Commission.331

We seek comment on our analysis of 

the costs associated with the approach 

we have proposed and the costs of the 

alternative on which we seek comment. 

Are there costs of the proposed rule or 

the alternative approach that we have 

not identified? 

C. Foreign Private Adviser Exemption 

Section 403 of the Dodd-Frank Act 

replaces the current private adviser 

exemption from registration under the 

Advisers Act with a new exemption for 

a ‘‘foreign private adviser,’’ as defined in 

new section 202(a)(30) of the Advisers 

Act.332 We are proposing new rule 

202(a)(30)–1, which would define 

certain terms in section 202(a)(30) for 

use by advisers seeking to avail 

themselves of the foreign private adviser 

exemption.333 Because eligibility for the 

new foreign private adviser exemption, 

like the current private adviser 

exemption, is determined, in part, by 

the number of clients an adviser has, we 

propose to include in rule 202(a)(30)–1 

the safe harbor and many of the client 

counting rules that appear in rule 

203(b)(3)–1, as currently in effect.334 In 

addition, we propose to define other 

terms used in the definition of ‘‘foreign 

private adviser’’ under section 202(a)(30) 

including: (i) ‘‘Investor;’’ (ii) ‘‘in the 

United States;’’ (iii) ‘‘place of business;’’ 

and (iv) ‘‘assets under management.’’ 335

Proposed rule 202(a)(30)–1 clarifies 

several provisions used in the statutory 

definition of ‘‘foreign private adviser.’’ 

First, the proposed rule would include 

the safe harbor for counting clients 

currently in rule 203(b)(3)–1, as 

modified to account for its use in the 

foreign private adviser context. Under 

the safe harbor, an adviser would count 

certain natural persons as a single client 

under certain circumstances.336

Proposed rule 202(a)(30)–1 would also 

retain another provision of rule 

203(b)(3)–1 that permits an adviser to 

treat as a single ‘‘client’’ an entity that 

receives investment advice based on the 

entity’s investment objectives and two 

or more entities that have identical 

owners.337 As mentioned above, we 

would not include the ‘‘special rule’’ that 

allows advisers not to count as a client 

any person for whom the adviser 

provides investment advisory services 

without compensation.338 Finally, we 

propose to add a provision that would 

permit advisers to avoid doublecounting private funds and their 

investors.339

Second, section 202(a)(30) provides 

that a ‘‘foreign private adviser’’ eligible 

for the new registration exemption 

cannot have more than 14 clients ‘‘or 

investors.’’ We propose to define 

‘‘investor’’ in a private fund in rule 

202(a)(30)–1 as any person that would 

be included in determining the number 

of beneficial owners of the outstanding 

securities of a private fund under 

section 3(c)(1) of the Investment 

Company Act, or whether the 

outstanding securities of a private fund 

are owned exclusively by qualified 

purchasers under section 3(c)(7) of that 

Act.340 We are also proposing to treat as 

investors beneficial owners (i) who are 

‘‘knowledgeable employees’’ with 

respect to the private fund; 341 and (ii) 

of ‘‘short-term paper’’ 342 issued by the 

private fund, even though these persons 

are not counted as beneficial owners for 

purposes of section 3(c)(1), and 

knowledgeable employees are not 

required to be qualified purchasers 

under section 3(c)(7).343

Third, proposed rule 202(a)(30)–1 

defines ‘‘in the United States’’ generally 

by incorporating the definition of a 

‘‘U.S. person’’ and ‘‘United States’’ under 

Regulation S.344 In particular, we would 

define ‘‘in the United States’’ in 

proposed rule 202(a)(30)–1 to mean: 

(i) With respect to any place of business 

located in the ‘‘United States,’’ as that 

term is defined in Regulation S; 345 (ii) 

with respect to any client or private 

fund investor in the United States, any 

person that is a ‘‘U.S. person’’ as defined 

in Regulation S,346 except that under the 

proposed rule, any discretionary 

account or similar account that is held 

for the benefit of a person ‘‘in the United 

States’’ by a non-U.S. dealer or other 

professional fiduciary is a person ‘‘in the 

United States’’ if the dealer or 

professional fiduciary is a related 

person of the investment adviser relying 

on the exemption; and (iii) with respect 

to the public in the ‘‘United States,’’ as 

that term is defined in Regulation S.347

Fourth, proposed rule 202(a)(30)–1 

defines ‘‘place of business’’ to have the 

same meaning as in Advisers Act rule 

222–1(a).348 Finally, for purposes of rule 

202(a)(30)–1 we propose to define 

‘‘assets under management’’ by reference 

to ‘‘regulatory assets under 

management’’ as determined under Item 

5 of Form ADV.349

1. Benefits 

We are proposing to define certain 

terms included in the statutory 

definition of ‘‘foreign private adviser’’ in 

order to clarify the meaning of these 

terms and reduce the potential 

administrative and regulatory burdens 

for advisers that seek to rely on the 


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350See Paul Hastings Letter, supra note 258 (in 

response to our request for public views, urging us 

to provide guidance on the interpretation of the 

terms of the statutory definition of ‘‘foreign private 

adviser’’). See generally supra note 24. 

351This is true for all of the proposed definitions 

except for ‘‘assets under management.’’ An adviser 

that relies on the foreign private adviser exemption 

would need to calculate its assets under 

management according to the proposed instructions 

to Item 5 of Form ADV only for purposes of the 

availability of the exemption. As discussed, above, 

proposed rule 202(a)(30)–1 includes a reference to 

Item 5 of Form ADV in order to ensure consistency 

in the calculation of assets under management for 

various purposes under the Advisers Act. See supra 

note 266 and accompanying text. 

352See supra section II.C.1 of this Release. 

353See supra paragraph accompanying note 240. 

354See supra notes 258–259 and accompanying 

paragraph. 

355See supra section II.C.3 of this Release. Under 

section 222 of the Advisers Act a state may not 

require an adviser to register if the adviser does not 

have a ‘‘place of business’’ within, and has fewer 

than 6 client residents of, the state. 

356See supra notes 238, 246–251, 253–257 and 

accompanying text. 

357See supra notes 336–339 and accompanying 

text. 

358See supra notes 246–251, 253–257 and 

accompanying text. See also infra notes 362–363 

and accompanying text for an estimate of the costs 

associated with registration. 

359See supra text accompanying and following 

note 281. 

360This estimate is based on consultation with 

outside counsel (at a cost of $400 per hour) of 10 

hours and an internal review of discretionary 

accounts owned by U.S. persons performed by a 

senior compliance officer (at a cost of $294 per 

hour) of 10 hours. The calculation is as follows: 

(10 hours × $400) + (10 hours × $294) = $6,940. 

361See proposed rule 202(a)(30)–1, at note to 

paragraph (c)(2)(i); supra notes 267–268 and 

accompanying text. 

foreign private adviser exemption. As 

discussed above, our proposed rule 

references definitions set forth in other 

Commission rules under the Advisers 

Act, the Investment Company Act and 

the Securities Act, all of which are 

likely to be familiar to foreign advisers 

active in the U.S. capital markets. We 

anticipate that by defining these terms, 

we would benefit foreign advisers by 

providing clarity with respect to the 

proposed terms that advisers would 

otherwise be required to interpret (and 

which they would likely interpret with 

reference to the rules we reference).350

The proposal would provide 

consistency among these other rules and 

the new exemption. This would limit 

foreign advisers’ need to undertake 

additional analysis with respect to these 

terms for purposes of determining the 

availability of the foreign private adviser 

exemption.351 We believe that the 

consistency and clarity that would 

result from the proposed rule would 

promote efficiency for foreign advisers 

and the Commission. 

For example, for purposes of 

determining eligibility for the foreign 

private adviser exemption, advisers 

would count clients substantially in the 

same manner they count clients under 

the current private adviser 

exemption.352 In identifying ‘‘investors,’’ 

advisers could rely on the determination 

made to assess whether the private fund 

meets the counting or qualification 

requirements under sections 3(c)(1) and 

3(c)(7) of the Investment Company 

Act.353 In determining whether a client, 

an investor, or a place of business is ‘‘in 

the United States,’’ or whether it holds 

itself out as an investment adviser to the 

public ‘‘in the United States,’’ an adviser 

would apply the same analysis it would 

otherwise apply under Regulation S.354

In identifying whether it has a place of 

business in the United States, an adviser 

would use the definition of ‘‘place of 

business’’ under section 222 of the 

Advisers Act, which is used to 

determine whether a state may assert 

regulatory jurisdiction over the 

adviser.355

As noted above, the proposed 

definitions of ‘‘investor’’ and ‘‘United 

States’’ under our proposed rule would 

rely on existing definitions, with slight 

modifications.356 Our proposed rule 

also would incorporate the current safe 

harbor in rule 203(b)(3)–1 for counting 

clients, except that it would no longer 

allow an adviser to disregard clients for 

whom the adviser provides services 

without compensation.357 We propose 

these modifications in order to preclude 

some advisers from excluding certain 

assets or clients from their calculation 

so as to avoid registration with the 

Commission and the regulatory 

requirements associated with 

registration.358 We believe that without 

a definition of these terms, advisers 

would likely rely on the same 

definitions we propose to cross 

reference in rule 202(a)(30)–1, but 

without the proposed modifications. 

Our proposal, therefore, would likely 

have the practical effect of narrowing 

the scope of the exemption, and thus 

would result in more advisers 

registering. 

We believe that any increase in 

registration as compared to the number 

of foreign advisers that might register if 

we did not propose rule 202(a)(30)–1 

would benefit investors. Investors 

whose assets are, directly or indirectly, 

managed by the foreign advisers that 

would be required to register would 

benefit from the increased protection 

afforded by federal registration of the 

adviser and application to the adviser of 

all of the requirements of the Advisers 

Act. As noted above, registration offers 

benefits to the investing public, 

including periodic examination of the 

adviser and compliance with rules 

requiring recordkeeping, custody of 

client funds and compliance 

programs.359

We request comment on the potential 

benefits we have identified above. Are 

there benefits of the proposed rule that 

we have not identified? 

2. Costs 

We do not believe that the proposed 

definitions would result in significant 

costs for foreign advisers. We anticipate 

that each foreign adviser that seeks to 

avail itself of the foreign private adviser 

exemption may incur costs to determine 

whether it is eligible for the exemption. 

We expect that these advisers would 

consult with outside U.S. counsel and 

perform an internal review of the extent 

to which an advisory affiliate manages 

discretionary accounts owned by a U.S. 

person that would be counted toward 

the limitation on clients and investors 

in the United States. We estimate these 

costs would be $6,940.360

Without the proposed rule, we expect 

that most advisers would interpret the 

new statutory provision by reference to 

the same rules we propose to cross 

reference in rule 202(a)(30)–1. Without 

our proposal, some advisers would 

likely incur additional costs because 

they would seek guidance in 

interpreting the terms used in the 

statutory exemption. By defining the 

statutory terms in a rule, we believe that 

we can provide certainty for foreign 

advisers and limit the time, compliance 

costs and legal expenses foreign 

advisers might incur in seeking an 

interpretation, all of which costs could 

inhibit capital formation or reduce 

efficiency. We expect that advisers also 

would be less likely to seek additional 

assistance from us because they could 

rely on relevant guidance we have 

previously provided with respect to the 

definitions we propose to cross 

reference. We also believe that foreign 

advisers’ ability to rely on the 

definitions that we have referenced in 

the proposed rule and the guidance 

provided with respect to the referenced 

rules may reduce Commission resources 

that would be otherwise applied to 

administering the private foreign 

adviser exemption, which resources 

could be allocated to other matters. 

We anticipate that our proposed 

instruction allowing foreign advisers to 

determine whether a client or investor 

is ‘‘in the United States’’ by reference to 

the time the person became a client or 

an investor, would also reduce advisers’ 

costs.361 Advisers would make the 

determination only once and would not 

be required to monitor changes in the 


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362See supra note 299 and accompanying text. 

363See supra note 303 and accompanying text. 

364See supra section II.C.5 of this Release. 

365See supra note 310 and accompanying and 

following text. 366See supra notes 322–325 and accompanying 

paragraph. 367See supra note 324 and accompanying text. 

368See supra note 325. 

369See supra note 326 and accompanying text. 

370Public Law 104–121, Title II, 110 Stat. 857 

(1996) (codified in various sections of 5 U.S.C., 

15 U.S.C. and as a note to 5 U.S.C. 601). 

371 5 U.S.C. 605(b). 

372Rule 0–7(a) (17 CFR 275.0–7(a)). 

373Section 203A of the Advisers Act (prohibiting 

an investment adviser that is regulated or required 

to be regulated as an investment adviser in the State 

in which it maintains its principal office and place 

of business from registering with the Commission 

unless the adviser has $25 million or more in assets 

under management or is an adviser to a registered 

investment company). 

status of each client and private fund 

investor. Moreover, if a client or an 

investor moved to the United States, 

under our approach the adviser would 

not be forced to choose among 

registering with us, terminating the 

relationship with the client, or forcing 

the investor out of the the private fund. 

The proposed modifications may 

result in some costs for foreign advisers 

who might change their business 

practices in order to rely on the 

exemption. Some foreign advisers may 

have to choose to limit the scope of their 

contacts with the United States in order 

to rely on the statutory exemption for 

foreign private advisers or to register 

with us. As noted above, we have 

estimated the costs of registration to be 

$11,526.362 In addition, registered 

advisers would incur initial costs to 

establish a compliance infrastructure, 

which we estimate would range from 

$10,000 to $45,000 and ongoing annual 

costs of compliance and examination, 

which we estimate would range from 

$10,000 to $50,000.363 In either case, 

foreign advisers would assess the costs 

of registering with the Commission 

relative to relying on the exemption. 

This assessment, however, would take 

into account many factors, which would 

vary from one adviser to another, to 

determine whether registration, relative 

to other options, is the most costeffective business option for the adviser 

to pursue. If a foreign adviser limited its 

activities within the United States in 

order to rely on the exemption, the 

modifications might have the effect of 

reducing competition in the market for 

advisory services. Were the foreign 

adviser to register, competition among 

registered advisers would increase. 

Furthermore, to the extent that the 

modifications included in the definition 

of ‘‘investor’’ (in particular the one 

concerning knowledgeable employees) 

would limit a foreign adviser’s ability to 

attract certain private fund investors, 

those modifications may have an 

adverse effect on capital formation. 

By referencing the method of 

calculating assets under management 

under Form ADV, certain foreign private 

advisers would use the valuation 

method provided in the instructions to 

Form ADV to verify compliance with 

the $25 million asset threshold included 

in the foreign private adviser 

exemption.364 More specifically, 

proposed instruction 5.b(4) to Form 

ADV would require advisers to use fair 

value of private fund assets for 

determining regulatory assets under 

management. Some foreign advisers to 

private funds may value assets based on 

their fair value in accordance with 

GAAP or other international accounting 

standards, while other advisers to 

private funds may not use fair value 

methodologies.365 As discussed above, 

the costs associated with fair valuation 

would vary based on factors such as the 

nature of the asset, the number of 

positions that do not have a market 

value, and whether the adviser has the 

ability to value such assets internally or 

would rely on a third party for valuation 

services.366 Nevertheless, we do not 

believe that the requirement to use fair 

value methodologies would result in 

significant costs for these advisers to 

these funds.367 Commission staff 

estimates that such advisers would each 

incur $1,224 in internal costs to 

conform its internal valuations to a fair 

value standard.368 In the event a fund 

does not have an internal capability for 

valuing illiquid assets, we expect that it 

could obtain pricing or valuation 

services from an outside administrator 

or other service provider. Staff estimates 

that the annual cost of such a service 

would range from $1,000 to $120,000 

annually which could be borne by 

several funds that invest in similar 

assets or have similar investment 

strategies.369 We request comment on 

these estimates. Do foreign advisers that 

do not use fair value methodologies for 

reporting purposes have the ability to 

fair value private fund assets internally? 

If not, what would be the costs to retain 

a third party valuation service? Are 

there certain types of foreign advisers 

(e.g., advisers to real estate private 

funds) that would experience special 

difficulties in performing fair value 

analyses? If so, why? 

We request comment on the potential 

costs we have identified above. Are 

there costs of the proposed rule that we 

have not identified? 

D. Request for Comment 

The Commission requests comments 

on all aspects of the cost-benefit 

analysis, including the accuracy of the 

potential costs and benefits identified 

and assessed in this Release, as well as 

any other costs or benefits that may 

result from the proposals. We encourage 

commenters to identify, discuss, 

analyze, and supply relevant data 

regarding these or additional costs and 

benefits. For purposes of the Small 

Business Regulatory Enforcement 

Fairness Act of 1996,370 the Commission 

also requests information regarding the 

potential annual effect of the proposals 

on the U.S. economy. Commenters are 

requested to provide empirical data to 

support their views. 

VI. Regulatory Flexibility Act 

Certification 

Pursuant to section 605(b) of the 

Regulatory Flexibility Act,371 the 

Commission hereby certifies that 

proposed rules 203(l)–1 and 203(m)–1 

under the Advisers Act would not, if 

adopted, have a significant economic 

impact on a substantial number of small 

entities. Under Commission rules, for 

the purposes of the Advisers Act and 

the Regulatory Flexibility Act, an 

investment adviser generally is a small 

entity if it: (i) Has assets under 

management having a total value of less 

than $25 million; (ii) did not have total 

assets of $5 million or more on the last 

day of its most recent fiscal year; and 

(iii) does not control, is not controlled 

by, and is not under common control 

with another investment adviser that 

has assets under management of 

$25 million or more, or any person 

(other than a natural person) that had 

$5 million or more on the last day of its 

most recent fiscal year (‘‘small 

adviser’’).372

Investment advisers solely to venture 

capital funds and advisers solely to 

private funds in each case with assets 

under management of less than 

$25 million would remain generally 

ineligible for registration with the 

Commission under section 203A of the 

Advisers Act.373 We expect that any 

small adviser solely to existing venture 

capital funds that would not be 

ineligible to register with the 

Commission would be able to avail itself 

of the exemption from registration 

under the grandfathering provision. If 

an adviser solely to a new venture 

capital fund could not avail itself of the 

exemption because, for example, the 

fund it advises did not meet the 

proposed definition of ‘‘venture capital 

fund,’’ we anticipate that the adviser 

could avail itself of the exemption in 

section 203(m) of the Advisers Act as 


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374See supra section II.B.2 of this Release. 

implemented by proposed rule 

203(m)–1. Similarly, we expect that any 

small adviser solely to private funds 

would be able to rely on the exemption 

in section 203(m) of the Advisers Act as 

implemented by proposed rule 

203(m)–1. We further believe that these 

advisers would be able to avail 

themselves of the exemption for private 

fund advisers regardless of whether our 

implementing rules required them to 

calculate assets under management as 

proposed approach or under the 

alternative method on which we request 

comment.374

Thus, we believe that small advisers 

solely to venture capital funds and 

small advisers to other private funds 

would generally be ineligible to register 

with the Commission. Those small 

advisers that may not be ineligible to 

register with the Commission, we 

believe, would be able to rely on the 

venture fund exemption under section 

203(l) of the Advisers Act or the private 

fund adviser exemption under section 

203(m) of that Act as implemented by 

our proposed rules. For these reasons, 

we are certifying that proposed rules 

203(l)–1 and 203(m)–1 under the 

Advisers Act would not, if adopted, 

have a significant economic impact on 

a substantial number of small entities. 

The Commission requests written 

comments regarding this certification. 

The Commission requests that 

commenters describe the nature of any 

impact on small businesses and provide 

empirical data to support the extent of 

the impact. 

VII. Statutory Authority 

The Commission is proposing rule 

202(a)(30)–1 under the authority set 

forth in sections 403 and 406 of the 

Dodd-Frank Act, to be codified at 

sections 203(b) and 211(a) of the 

Advisers Act, respectively (15 U.S.C. 

80b–3(b), 80b–11(a)). The Commission 

is proposing rule 203(l)–1 under the 

authority set forth in sections 406 and 

407 of the Dodd-Frank Act, to be 

codified at sections 211(a) and 203(l) of 

the Advisers Act, respectively (15 U.S.C. 

80b–11(a), 80b–3(l)). The Commission is 

proposing rule 203(m)–1 under the 

authority set forth in sections 406 and 

408 of the Dodd-Frank Act, to be 

codified at sections 211(a) and 203(m) of 

the Advisers Act, respectively (15 U.S.C. 

80b–11(a), 80b–3(m)). 

List of Subjects in 17 CFR Part 275 

Reporting and recordkeeping 

requirements; Securities. 

Text of Proposed Rules 

For reasons set out in the preamble, 

the Commission proposes to amend 

Title 17, Chapter II of the Code of 

Federal Regulations as follows: 

PART 275—RULES AND 

REGULATIONS, INVESTMENT 

ADVISERS ACT OF 1940 

1 . The general authority citation for 

Part 275 is revised to read as follows: 

Authority: 15 U.S.C. 80b–2(a)(11)(G), 80b– 

2(a)(11)(H), 80b–2(a)(17), 80b–3, 80b–4, 80b– 

6(4), 80b–6(a), and 80b–11, unless otherwise 

noted. 

* * * * * 

2. Section 275.202(a)(30)–1 is added 

to read as follows: 

§ 275.202(a)(30)–1 Foreign private 

advisers. 

(a) Client. You may deem the 

following to be a single client for 

purposes of section 202(a)(30) of the Act 

(15 U.S.C. 80b–2(a)(30)): 

(1) A natural person, and: 

(i) Any minor child of the natural 

person; 

(ii) Any relative, spouse, or relative of 

the spouse of the natural person who 

has the same principal residence; 

(iii) All accounts of which the natural 

person and/or the persons referred to in 

this paragraph (a)(1) are the only 

primary beneficiaries; and 

(iv) All trusts of which the natural 

person and/or the persons referred to in 

this paragraph (a)(1) are the only 

primary beneficiaries; 

(2)(i) A corporation, general 

partnership, limited partnership, 

limited liability company, trust (other 

than a trust referred to in paragraph 

(a)(1)(iv) of this section), or other legal 

organization (any of which are referred 

to hereinafter as a ‘‘legal organization’’) 

to which you provide investment advice 

based on its investment objectives rather 

than the individual investment 

objectives of its shareholders, partners, 

limited partners, members, or 

beneficiaries (any of which are referred 

to hereinafter as an ‘‘owner’’); and 

(ii) Two or more legal organizations 

referred to in paragraph (a)(2)(i) of this 

section that have identical owners. 

(b) Special rules regarding clients. For 

purposes of this section: 

(1) You must count an owner as a 

client if you provide investment 

advisory services to the owner separate 

and apart from the investment advisory 

services you provide to the legal 

organization, provided, however, that 

the determination that an owner is a 

client will not affect the applicability of 

this section with regard to any other 

owner; 

(2) You are not required to count an 

owner as a client solely because you, on 

behalf of the legal organization, offer, 

promote, or sell interests in the legal 

organization to the owner, or report 

periodically to the owners as a group 

solely with respect to the performance 

of or plans for the legal organization’s 

assets or similar matters; 

(3) A limited partnership or limited 

liability company is a client of any 

general partner, managing member or 

other person acting as investment 

adviser to the partnership or limited 

liability company; and 

(4) You are not required to count a 

private fund as a client if you count any 

investor, as that term is defined in 

paragraph (c)(1) of this section, in that 

private fund as an investor in the United 

States in that private fund. 

Note to paragraphs (a) and (b): These 

paragraphs are a safe harbor and are not 

intended to specify the exclusive method for 

determining who may be deemed a single 

client for purposes of section 202(a)(30) of 

the Act (15 U.S.C. 80b–2(a)(30)). 

(c) Definitions. For purposes of 

section 202(a)(30) of the Act (15 U.S.C. 

80b–2(a)(30)), 

(1) Investor means any person that 

would be included in determining the 

number of beneficial owners of the 

outstanding securities of a private fund 

under section 3(c)(1) of the Investment 

Company Act of 1940 (15 U.S.C. 80a– 

3(c)(1)), or whether the outstanding 

securities of a private fund are owned 

exclusively by qualified purchasers 

under section 3(c)(7) of that Act (15 

U.S.C. 80a–3(c)(7)), except that any of 

the following persons is also an 

investor: 

(i) Any beneficial owner of the private 

fund that pursuant to § 270.3c–5 of this 

title would not be included in the above 

determinations under section 3(c)(1) 

and 3(c)(7) of the Investment Company 

Act of 1940 (15 U.S.C. 80a–3(c)(1), (7)); 

and 

(ii) Any beneficial owner of any 

outstanding short-term paper, as 

defined in section 2(a)(38) of the 

Investment Company Act of 1940 

(15 U.S.C. 80a–2(a)(38)), issued by the 

private fund. 

Note to paragraph (c)(1): You may treat as 

a single investor any person that is an 

investor in two or more private funds you 

advise. 

(2) In the United States means with 

respect to: 

(i) Any client or investor, any person 

that is a ‘‘U.S. person’’ as defined in 

§ 230.902(k) of this title, except that any 

discretionary account or similar account 

that is held for the benefit of a person 

in the United States by a dealer or other 


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professional fiduciary is in the United 

States if the dealer or professional 

fiduciary is a related person of the 

investment adviser relying on this 

section and is not organized, 

incorporated, or (if an individual) 

resident in the United States. 

Note to paragraph (c)(2)(i): A person that 

is in the United States may be treated as not 

being in the United States if such person was 

not in the United States at the time of 

becoming a client or, in the case of an 

investor in a private fund, at the time the 

investor acquires the securities issued by the 

fund. 

(ii) Any place of business, in the 

United States, as that term is defined in 

§ 230.902(l) of this chapter; and 

(iii) The public, in the United States, 

as that term is defined in § 230.902(l) of 

this chapter. 

(3) Place of business has the same 

meaning as in § 275.222–1(a). 

(4) Assets under management means 

the regulatory assets under management 

as determined under Item 5.F of Form 

ADV (§ 279.1 of this chapter). 

(d) Holding out. If you are relying on 

this section, you shall not be deemed to 

be holding yourself out generally to the 

public in the United States as an 

investment adviser, within the meaning 

of section 202(a)(30) of the Act (15 

U.S.C. 80b–2(a)(30)), solely because you 

participate in a non-public offering in 

the United States of securities issued by 

a private fund under the Securities Act 

of 1933 (15 U.S.C. 77a). 

3. Section 275.203(l)–1 is added to 

read as follows: 

§ 275.203(l)–1 Venture capital fund 

defined. 

(a) Venture capital fund defined. For 

purposes of section 203(l) of the Act (15 

U.S.C. 80b–3(l)), a venture capital fund 

is any private fund that: 

(1) Represents to investors and 

potential investors that it is a venture 

capital fund; 

(2) Owns solely: 

(i) Equity securities issued by one or 

more qualifying portfolio companies, 

and at least 80 percent of the equity 

securities of each qualifying portfolio 

company owned by the fund was 

acquired directly from the qualifying 

portfolio company; and 

(ii) Cash and cash equivalents, as 

defined in § 270.2a51–1(b)(7)(i), and 

U.S. Treasuries with a remaining 

maturity of 60 days or less; 

(3) With respect to each qualifying 

portfolio company, either directly or 

indirectly through each investment 

adviser not registered under the Act in 

reliance on section 203(l) thereof: 

(i) Has an arrangement whereby the 

fund or the investment adviser offers to 

provide, and if accepted, does so 

provide, significant guidance and 

counsel concerning the management, 

operations or business objectives and 

policies of the qualifying portfolio 

company; or 

(ii) Controls the qualifying portfolio 

company; 

(4) Does not borrow, issue debt 

obligations, provide guarantees or 

otherwise incur leverage, in excess of 15 

percent of the private fund’s aggregate 

capital contributions and uncalled 

committed capital, and any such 

borrowing, indebtedness, guarantee or 

leverage is for a non-renewable term of 

no longer than 120 calendar days; 

(5) Only issues securities the terms of 

which do not provide a holder with any 

right, except in extraordinary 

circumstances, to withdraw, redeem or 

require the repurchase of such securities 

but may entitle holders to receive 

distributions made to all holders pro 

rata; and 

(6) Is not registered under section 8 of 

the Investment Company Act of 1940 

(15 U.S.C. 80a–8), and has not elected 

to be treated as a business development 

company pursuant to section 54 of that 

Act (15 U.S.C. 80a–53). 

(b) Certain pre-existing venture 

capital funds. For purposes of section 

203(l) of the Act (15 U.S.C. 80b–3(l)) 

and in addition to any venture capital 

fund as set forth in paragraph (a) of this 

section, a venture capital fund also 

includes any private fund that: 

(1) Has represented to investors and 

potential investors at the time of the 

offering of the private fund’s securities 

that it is a venture capital fund; 

(2) Prior to December 31, 2010, has 

sold securities to one or more investors 

that are not related persons, as defined 

in § 275.204–2(d)(7), of any investment 

adviser of the private fund; and 

(3) Does not sell any securities to 

(including accepting any committed 

capital from) any person after July 21, 

2011. 

(c) Definitions. For purposes of this 

section: 

(1) Committed capital means any 

commitment pursuant to which a 

person is obligated to acquire an interest 

in, or make capital contributions to, the 

private fund. 

(2) Equity securities has the same 

meaning as in section 3(a)(11) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(11)) and § 240.3a11–1 of 

this chapter. 

(3) Publicly traded means, with 

respect to a company, being subject to 

the reporting requirements under 

section 13 or 15(d) of the Securities 

Exchange Act of 1934 (15 U.S.C. 78m or 

78o(d)), or having a security listed or 

traded on any exchange or organized 

market operating in a foreign 

jurisdiction. 

(4) Qualifying portfolio company 

means any company that: 

(i) At the time of any investment by 

the private fund, is not publicly traded 

and does not control, is not controlled 

by or under common control with 

another company, directly or indirectly, 

that is publicly traded; 

(ii) Does not borrow or issue debt 

obligations, directly or indirectly, in 

connection with the private fund’s 

investment in such company; 

(iii) Does not redeem, exchange or 

repurchase any securities of the 

company, or distribute to pre-existing 

security holders cash or other company 

assets, directly or indirectly, in 

connection with the private fund’s 

investment in such company; and 

(iv) Is not an investment company, a 

private fund, an issuer that would be an 

investment company but for the 

exemption provided by § 270.3a–7, or a 

commodity pool. 

4. Section 275.203(m)–1 is added to 

read as follows: 

§ 275.203(m)–1 Private fund adviser 

exemption. 

(a) United States investment advisers. 

For purposes of section 203(m) of the 

Act (15 U.S.C. 80b–3(m)), an investment 

adviser with its principal office and 

place of business in the United States is 

exempt from the requirement to register 

under section 203 of the Act if the 

investment adviser: 

(1) Acts solely as an investment 

adviser to one or more qualifying 

private funds; and 

(2) Manages private fund assets of less 

than $150 million. 

(b) Non-United States investment 

advisers. For purposes of section 203(m) 

of the Act (15 U.S.C. 80b–3(m)), an 

investment adviser with its principal 

office and place of business outside of 

the United States is exempt from the 

requirement to register under section 

203 of the Act if: 

(1) The investment adviser has no 

client that is a United States person 

except for one or more qualifying 

private funds; and 

(2) All assets managed by the 

investment adviser from a place of 

business in the United States are solely 

attributable to private fund assets, the 

total value of which is less than $150 

million. 

(c) Calculations. For purposes of this 

section, private fund assets are 

calculated as the total value of such 

assets as of the end of each calendar 

quarter. 

(d) Transition rule. With respect to 

the calendar quarter period immediately 


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following the calendar quarter end date 

that the investment adviser ceases to be 

exempt from registration under section 

203(m) of the Act (15 U.S.C. 80b–3(m)) 

due to having $150 million or more in 

private fund assets, the Commission 

will not assert a violation of the 

requirement to register under section 

203 of the Act (15 U.S.C. 80b–3) by an 

investment adviser that was previously 

exempt in reliance on section 203(m) of 

the Act; provided that such investment 

adviser has complied with all applicable 

Commission reporting requirements. 

(e) Definitions. For purposes of this 

section, 

(1) Assets under management means 

the regulatory assets under management 

as determined under Item 5.F of Form 

ADV (§ 279.1 of this chapter). 

(2) Place of business has the same 

meaning as in § 275.222–1(a). 

(3) Principal office and place of 

business of an investment adviser 

means the executive office of the 

investment adviser from which the 

officers, partners, or managers of the 

investment adviser direct, control, and 

coordinate the activities of the 

investment adviser. 

(4) Private fund assets means the 

investment adviser’s assets under 

management attributable to a qualifying 

private fund. 

(5) Qualifying private fund means any 

private fund that is not registered under 

section 8 of the Investment Company 

Act of 1940 (15 U.S.C 80a–8) and has 

not elected to be treated as a business 

development company pursuant to 

section 54 of that Act (15 U.S.C. 80a– 

53). 

(6) Related person has the meaning set 

forth in § 275.204–2(d)(7). 

(7) United States has the meaning set 

forth in § 230.902(l) of this chapter. 

(8) United States person means any 

person that is a ‘‘U.S. person’’ as defined 

in § 230.902(k) of this chapter, except 

that any discretionary account or similar 

account that is held for the benefit of a 

United States person by a dealer or 

other professional fiduciary is a United 

States person if the dealer or 

professional fiduciary is a related 

person of the investment adviser relying 

on this section and is not organized, 

incorporated, or (if an individual) 

resident in the United States. 

By the Commission. 

Dated: November 19, 2010. 

Elizabeth M. Murphy, 

Secretary. 

[FR Doc. 2010–29957 Filed 12–9–10; 8:45 am] 

BILLING CODE P 


srobinson on DSKHWCL6B1PROD with PROPOSALS2