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News November 28, 2011 Issue

Massachusetts Re-Proposes Private Fund Adviser Exemption

So many rules are being adopted or re-written, itís hard to keep up.

Massachusetts made its own effort to keep up when on November 1 it re-proposed several regulations originally proposed back in April. Since April however, a few developments have taken place. The SEC officially pushed back the compliance date for the registration of private fund advisers, and adopted final rules that among other things, defined exempt reporting advisers and venture capital funds, and raised the net worth standard for accredited investors.

All that plus a slew of public comments caused Massachusetts to issue an updated and modified proposal to allow advisers managing solely private funds that meet certain criteria to avoid registration in Massachusetts.

Put simply, advisers required to register with the SEC are outside the proposed relief, and must still notice file with the state.

Other advisers that exclusively manage private funds would be exempt from Massachusetts registration provided the private funds are owned exclusively by "qualified clients" as defined in SEC Rule 205-3. Private funds are those meeting the Investment Company Act exemptions under Section 3(c)(1) or Section 3(c)(7), and venture capital funds are excluded from the requirements that would apply to any Section 3(c)(1) funds under the proposed rule.

Exempt advisers would have certain affirmative duties to maintain their exempt status, including point-of-sale disclosures of all services provided, any duties owed by the adviser to the beneficial owners and "any other material information affecting the rights or responsibilities of the beneficial owners." If there are no duties owed or no services provided, the adviser must state that in the disclosures.

Exempt advisers would also be required to provide audited annual financial statements to beneficial owners for all private funds that are not venture capital funds.

Adviser representatives of exempt advisers would similarly be exempt from registration in Massachusetts.

Advisers that would be exempt from registration under the proposal:

  • May not have a history of certain disciplinary actions;
  • Would file with Massachusetts (through the SECís Investment Adviser Registration Depository system) all reports filed as an exempt reporting adviser with the SEC pursuant to Rule 204-4; and
  • Would be required to pay a $300 filing fee.

Grandfathering.

Private fund advisers managing Section 3(c)(1) funds (that are not venture capital funds) with non-qualified client investors would still be able to qualify for the exemption provided:

  • The fund existed prior to March 30, 2012;
  • As of March 30, 2012, the fund ceases to accept non-qualified client investors;
  • The adviser makes the disclosures required under the exemption; and
  • The adviser delivers audited annual financials as required under the exemption.

Proposal on custody requirements for advisers with discretion over client assets.

In addition to the private fund adviser exemption, Massachusetts has also proposed subjecting its registered advisers to a version of the SECís custody rule. Advisers that are registered or required to be registered in Massachusetts and have discretionary authority over client funds or securities would be required to maintain a fidelity bond in the amount of at least $10,000.

Advisers would look to the SECís custody rule for the definition of "custody," and would be required to comply with the SEC rule upon falling within the definition. An adviser otherwise eligible for exemption from the independent asset verification requirements however, would be additionally required in Massachusetts to obtain written authorization from the client to deduct fees, and to provide an invoice to the client and the clientís qualified custodian each time a deduction occurs.

Massachusetts will hold a hearing on the re-proposal January 5, 2012, and will accept comments on the re-proposed rule through January 6, 2012.