California: An Illustrative Example of Dodd-Frank’s Impact upon Investment Advisers at the State Level
Although most investment advisers are aware of the adjusted thresholds for federal and state registration under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”), one of the ongoing challenges for advisers is complying with registration requirements at the state level, especially as state regulators scramble to recalibrate their investment adviser laws to better comport with federal law. Each state presents its own unique, evolving set of registration requirements and available exemptions from registration to advisers prohibited from registering with the Securities and Exchange Commission (“SEC”) (generally advisers with less than $100 million in assets under management (“AUM”)) and with a place of business in the state. With that in mind, it is especially important in the post-Dodd-Frank regulatory environment that advisers remain informed and up-to-date with respect to applicable state requirements.
Take California, for example. Prior to Dodd-Frank, California-based advisers avoided registration by a state analogue to a federal exemption. The exemption allowed a private advisor that did not hold itself out to the public as an investment adviser and had fewer than fifteen clients in the preceding twelve months to avoid registration, provided that the advisor had at least $25 million in AUM. Dodd-Frank repealed the federal exemption, which led to a state-level abandonment of the exemption, as well. Many states, including California, sought to create a replacement rule to exempt private funds from registration. On August 27, 2012 the California Department of Corporations (“CDC”) adopted a new exemption from the state’s investment adviser registration requirements for advisers to only “qualified private funds.”
Qualifying private funds include any fund relying on the exemptions from registration found in Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940, as amended, as well as venture capital funds. The adviser seeking exemption must only manage qualifying funds; any non-qualifying funds or managed accounts prevent the adviser from seeking exemption under the private fund exemption.
Additionally, private funds must be owned entirely by accredited investors and provide audited annual reports by an independent accountant. Further, a private fund adviser may only rely on the exemption if:
- neither the adviser nor its advisory affiliates have any “bad actor” disqualifications;
- the adviser files a truncated Form ADV for exempt reporting advisers with the CDC; and
- the adviser pays the required registration and annual renewal fees.
In addition, an investment advisers relying on a now-defunct exemption is grandfathered in to the foregoing exemption provided that the adviser stops selling interests in applicable funds to non-accredited investors, does not charge performance fees to subsequent non-qualified clients, and complies with all relevant registration and reporting requirements.
Keep in mind that the foregoing analysis is a high-level overview of the new exemption and its impact upon affected advisers only. For a more comprehensive analysis of updated investment adviser laws and their potential impact on your firm – whether based in California or another affected state – please feel free to contact us for a free consultation.
 The full revision text is available at http://www.corp.ca.gov/Regulations/Licensees/1811B.pdf.
 Jason Wallace, IA brief: California broadens scope of private-adviser exemption, Reuters, Sept. 12 2012; available at http://blogs.reuters.com/financial-regulatory-forum/2012/09/12/ia-brief-california-broadens-scope-of-private-adviser-exemption/