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News May 9, 2011 Issue

Schapiro Confirms Likely Extension Of Registration Deadline For Private Fund Advisers, Registration Gap May Give Rise To State Compliance Issues

Division of Investment Management associate director Robert Plaze said it on April 8. Now SEC Chairman Mary Schapiro has said it, too.

Private fund advisers that must register pursuant to the Dodd-Frank Act will likely have until the first quarter of 2012 before they must be registered with the SEC.

In an April 27 letter believed to have been delivered to one or more members of Congress, Schapiro said she expects the Commission will consider extending the date by which private fund advisers must register and come into compliance with the obligations of a registered adviser until the first quarter of 2012. She confirmed that the anticipated extension of time was communicated in the April 8 letter from Plaze to David Massey, President of the North American Securities Administrators Association (NASAA).

As Plaze had written, Schapiro noted in her letter that she anticipates the SEC will issue final rules implementing the private fund adviser registration provisions of the Dodd-Frank Act "in advance of the July 21, 2011 one-year anniversary of passage of the Dodd-Frank Act." Until the SEC takes formal action, July 21 remains the registration deadline.

However, the compliance requirements of these newly registering private fund advisers "vary significantly depending on the nature and complexity of the adviser’s business," said Schapiro. The extension of time for advisers to comply with the new regulations is expected in part based on "the time needed for private equity and other private fund advisers to register and come fully into compliance with the obligations applicable to them once they are registered."

Also, for advisers transitioning from federal to state registration, the IARD system will require re-programming to accept the transition filings. Plaze said "we understand that the re-programming process will take until the end of the year to complete."

Registration gap may give rise to state compliance issues.

The anticipated extension of time to comply with new SEC regulations may be welcome news for affected advisers. Advisers that have been scrambling to comply with the July 21 registration deadline will be able to breathe easier for a few months – at least at the federal level. The SEC relief however, may create a regulatory gap at the state level that states may not be willing – or able – to fill.

What will happen at the state level to these advisers that will soon be but are not yet registered with the SEC?

If you’re the lucky adviser that conducts business only in Wyoming, the one state without a registration requirement, read no more – you’re set. Otherwise, you may have a few issues to noodle through.

Many states that require adviser registration allow advisers to avoid registration with the state based on the adviser’s registration at the federal level. Typically identified as "Federal covered advisers" in state statutes, these advisers may have a notice or other filing requirement, with or without a fee, but substantive regulation remains at the federal level.

Similarly, advisers exempted from federal registration by Advisers Act section 203(b)(3) are often also exempted from registration in many states with a registration requirement – until that provision is repealed in July.

For example, the state of Massachusetts defines a "Federal covered adviser" as "a person who is registered with the Securities and Exchange Commission under section 203 of the Investment Advisers Act of 1940." (Ch. 110A Uniform Securities Act Section 401(o))

New York, Maryland, California and Georgia, among others, follow the same definition.

Florida’s Division of Securities states that "You are a federal covered investment adviser if you are registered with the SEC as an investment adviser, or if you are not registered with the SEC because you are excluded from the definition of investment adviser." With the repeal of the section 203(b)(3) exemption, come July 21 it’s registration or bust in Florida, too.

The state of Virginia however, defines a "Federal covered advisor" as "any person who is registered or required to be registered under Section 203 of the Investment Advisers Act of 1940 as an ‘investment adviser.’" (21VAC5-10-40 Definitions)

Registered or required to be registered.

Advisers conducting business in states with regulations that say "registered or required to be registered" should be fine, said one senior industry attorney. Section 403 (and all of Title IV) of the Dodd-Frank Act, which removes the section 203(b)(3) exclusion, is effective one year after the enactment of the Dodd-Frank Act. After July 21, the private fund advisers that previously relied on the section 203(b)(3) exclusion will be "required to be registered" with the SEC. Even if the compliance date is pushed back by the SEC, the registration requirement is still in place, said the attorney.

Advisers in such states would not be required to register there, but would still have a notice filing requirement. Typically, the state notice filing is made by submitting Form ADV Part 1 through the IARD system. The filing adviser checks a box for each state it wishes to notify and pays that state’s filing fee.

That may have advisers feeling they’re back at ‘square one’ and needing to have a filing-ready Form ADV on July 21. A fully prepared Form ADV may not necessarily be required, however.

"There are a lot of people who file draft Form ADV Part 1s at the state level," said one Virginia attorney. "It’s not perfect," the attorney observed, but the adviser has paid the fee that comes with filing and it puts them on the state regulator’s radar, which are both good things.

States aligning with SEC action.

Some states have recognized the regulatory gap that may exist after July 21. They are taking action to align state regulation with SEC regulation.

California, for example, has posted a special "Dodd-Frank Act" link under the Securities Regulation Division area on its website. That area notes the likely extension of the compliance deadline for registering private fund advisers at the federal level and links to the SEC’s April 8 letter to NASAA. A correspondence area highlights a January 21 "Commissioner’s update" that says "In light of the repeal of the Section 203(b)(3) exemption under the Investment Advisers Act of 1940, the Commissioner is considering amending Rule 260.204.9 of Title 10 of the California Code of Regulations" that would preserve the exemption from state registration for those private fund advisers now required to register with the SEC.

California’s website also includes this statement: "The Department will continue to work with the SEC and registered investment advisers to ensure the smooth and timely implementation of Dodd-Frank.  Updates will be posted to this website as additional information becomes available."

Many states, however, enact conforming or updating legislation only once a year. The Dodd-Frank Act’s effective date may just miss some of those cycles, causing state statutes and regulations to fail to conform to federal legislation for upwards of a year. Some state securities commissions are without the authority to act in the absence of conforming state legislation. Some states may not feel action on this issue is an effective use of resources for them and decline to offer advisers relief.

What’s an adviser facing this dilemma supposed to do?

According to a number of compliance and legal experts, here are some of the options that are out there.

Advisers can:

  • Register with the state or states (which several observers concluded is often little different from the federal registration process);
  • Register with the SEC and notice file with the state or states as appropriate;
  • Request the state equivalent of a no-action letter;
  • Hope the states choose not to (or are de facto unable to) enforce their statutes and regulations during any SEC compliance extension;
  • Lobby the state or states to act in concert with the SEC’s compliance delay; or
  • Do nothing, and take a "wait and see" approach. Advisers doing so may risk disciplinary action, fines, or both. Even if an adviser could absorb a fine as a cost of doing business, observed one legal expert, should a state sanction an adviser in the compliance gap, that sanction would be a reporting obligation and available to the public. There is some reputational risk there, said the expert.

Several industry lawyers we spoke to said they believe the state securities divisions are generally overwhelmed and "significantly" overworked in the wake of the Dodd-Frank Act changes. As a result, the states "just don’t have the resources" to accommodate – or pursue – non-complying advisers during the stub period of the SEC’s compliance extension.

NASAA has a team of state securities commissioners exploring these and other issues related to the implementation of the Dodd-Frank Act. No word yet on any assessment of potential solutions.

Stay tuned for further developments.