The SBIC Advisers Relief Act: Impact and Opportunities
May 23, 2016
By Robert Sawyer, Partner, Foley Hoag
For many managers to private investment funds, the 2010 adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) changed the landscape of how they do business by subjecting these managers to registration requirements with the SEC and/or state securities regulators, or requiring them to qualify for one of several newly established exemptions from registration under the Investment Advisers Act of 1940 (the “Advisers Act”). Immediately following the passage of Dodd-Frank, the private fund industry’s primary focus fell on the exemptions established for advisers solely to venture capital funds (the “VC Fund Adviser Exemption”)1 and for advisers solely to private funds having less than $150 million in regulatory assets (the “Private Fund Adviser Exemption”)2. Both of these exemptions allowed advisers who qualified to operate under the less restrictive “exempt reporting adviser” notice filing regime. A further and less discussed exemption (the “SBIC Exemption”),3 exempted from registration with the SEC advisers to small business investment companies (“SBICs”) - private funds that have qualified for a license from the U.S. Small Business Administration (“SBA”) to operate as an SBIC. SBICs invest in debt and/or equity securities of U.S. small businesses, and typically may supplement their investor capital with low-interest leverage in the form of SBA-issued debentures (up to an aggregate amount of 2 times the capital commitments of the SBIC’s investors). As originally adopted, the SBIC Exemption was of somewhat limited utility, providing only a federal exemption and only for advisers whose business solely consisted of managing SBICs.
In December of 2015, the SBIC Advisers Relief Act (the “SAR Act”) was adopted into law, which (i) preempts state registration requirements for advisers relying on SBIC Exemption, providing a full, self-executing exemption from registration with securities regulators for advisers solely to SBICs, and (ii) amends several key provisions of the Advisers Act to provide additional exemptive relief for advisers who manage both SBICs and non-SBIC private funds, as summarized below.
Expansion of the Venture Capital Fund Adviser Exemption.
As initially adopted under Dodd-Frank, neither the VC Fund Adviser Exemption nor the SBIC Exemption was available to an adviser that managed both venture capital funds and SBICs. The SBIC Advisers Relief Act provides relief to such advisers, by providing that SBICs will be considered to qualify as “venture capital funds” for purposes of the VC Fund Adviser Exemption, thereby allowing advisers to SBICs and venture capital funds to operate in reliance on the VC Fund Adviser Exemption at the federal level.
Expansion of Private Fund Adviser Exemption.
The SBIC Advisers Relief Act will also provide additional exemptive relief for certain investment advisers that advise an SBIC Fund and other non-venture capital private funds. As referenced above, the Private Fund Adviser Exemption exempts advisers whose clients are solely private funds and whose regulatory assets under management (“RAUM”) in the United States are less than $150 million. This $150 million calculation includes the gross value of the assets of all private funds managed by the adviser, including any uncalled capital commitments, without deduction for any liabilities of the private funds. The SBIC Advisers Relief Act expands the Private Fund Adviser Exemption by excluding assets of SBICs managed by the adviser from the assets included in the $150 million threshold. As a result, an adviser whose non-SBIC private funds have gross assets of less than $150 million may qualify for the exemption, regardless of the AUM of the adviser’s SBIC funds. By way of example, the maximum size of a typical levered SBIC is $225 million (assuming that the SBIC qualifies for and maintains 2:1 leverage on $75 million of capital commitments). Thus an adviser relying on the Private Fund Adviser Exemption could, with the introduction of a single levered SBIC, increase their maximum permitted assets under management to $375 million.
Interaction with State Regulation.
Neither the Venture Capital Fund Adviser Exemption nor the Private Fund Adviser Exemption will preempt state regulation of fund managers, and state level exemptions are not uniform. Private fund managers must examine the laws of each state in which they do business, or intend to do business, in order to determine the availability of state level exemptions. However, several states have adopted a private fund adviser exemption, based on a model rule developed by the North American Securities Administrators Association (“NASAA”), which requires filing with the applicable state securities regulator a copy of the exempt reporting adviser filing submitted to the SEC. In addition, the NASAA model rule requires that, in order to claim the exemption provided thereby, each private fund that is not a venture capital fund or a 3(c)(7) fund (also known as a “qualified purchaser” fund) must (i) limit investors to those that satisfy the “qualified client” standard set forth in SEC Rule 205-3 (the SEC’s performance fee rule), a higher standard than the “accredited investor” definition, and (ii) deliver to each fund investor annual audited financial statements for the private fund. One current area of uncertainly with respect to NASAA model rule jurisdictions is the extent that an SBIC will be considered to be a “venture capital fund” for purposes of the additional “qualified client” and audit requirements. The SAR Act introduced the change to treat an SBIC as a venture capital fund directly into Section 203(l) of the Advisers Act. The NASAA model rule on the other hand solely cross-references the definition of “venture capital fund” set forth in SEC Rule 203(l)-1. Several state securities regulators have informally indicated that they are considering whether a harmonizing amendment will be introduced to resolve this uncertainty.
As a result of the amendments introduced by the SAR Act, advisers with both SBIC and non-SBIC private funds, and advisers pursuing investment strategies focused on investments in smaller private companies for whom SBICs may be an alternative to expand their advisory business, should consider the effect of these amendments carefully.
1 Section 203(l) of the Advisers Act and SEC Rule 203(l)-1
2 Section 203(m) of the Advisers Act and SEC Rule 203(m)-1
3 Section 203(b)(7) of the Advisers Act.