21VAC5-80 Investment Advisors

REGULATIONS

Vol. 28 Iss. 14 - March 12, 2012

TITLE 21. SECURITIES AND RETAIL FRANCHISING

STATE CORPORATION COMMISSION

Chapter 80

Proposed Regulation

REGISTRAR'S NOTICE: The State Corporation Commission is exempt from the Administrative Process Act in accordance with § 2.2-4002 A 2 of the Code of Virginia, which exempts courts, any agency of the Supreme Court, and any agency that by the Constitution is expressly granted any of the powers of a court of record.

Title of Regulation: 21VAC5-80. Investment Advisors (amending 21VAC5-80-215).

Statutory Authority: §§ 12.1-13, 13.1-523, and 13.1-523.1 of the Code of Virginia.

Public Hearing Information: A public hearing will be scheduled upon request.

Public Comment Deadline: April 12, 2012.

Agency Contact: Timothy O'Brien, Chief Examiner, Division of Securities and Retail Franchising, State Corporation Commission, Tyler Building, 9th Floor, P.O. Box 1197, Richmond, VA 23218, telephone (804) 371-9415, FAX [phone], or email timothy.o'[e-mail].

Summary:

The State Corporation Commission's Division of Securities and Retail Franchising proposes substantial changes to 21VAC5-80-215, which currently exempts investment advisors to certain private funds from registration as an investment advisor under the Virginia Securities Act, § 13.1-501 et seq. of the Code of Virginia. The proposed amendments effectively repeal the stopgap provisions of the current regulation and adopt in substantial part the model regulation developed by members of the North American Securities Administrators Association, Inc. (the trade association of state securities regulators) to comply with the statutory requirements of the Dodd-Frank Wall Street Reform and Consumer Protections Act. Proposed 21VAC5-80-215 would generally exempt an investment advisor from state registration requirements if the advisor (i) is not subject to disqualification for registration based upon the advisor's prior disciplinary history and (ii) solely advises certain types of funds that meet the definition of a qualifying private fund under the provisions of 17 CFR 275.203(m)-1. The exemption covers advisors to venture capital funds and, in specific circumstances, advisors to funds that are eligible for exclusion from the definition of an investment company under section 3(c)(1) of the Investment Company Act of 1940. The proposed amendments to 21VAC5-80-215 also contain a grandfather clause that would allow currently exempt private fund advisors to remain exempt provided the advisor meets certain specified conditions. Private fund advisors that are registered with the Securities and Exchange Commission are not eligible for the proposed exemption. In addition, to qualify for the proposed exemption, advisors must make certain notice filings and pay a notice filing fee.

AT RICHMOND, FEBRUARY 14, 2012

COMMONWEALTH OF VIRGINIA, ex rel.

STATE CORPORATION COMMISSION

CASE NO. SEC-2012-00009

Ex Parte: In the matter of
Adopting a Revision to the Rules
Governing the Virginia Securities Act

ORDER TO TAKE NOTICE

Section 12.1-13 of the Code of Virginia provides that the State Corporation Commission ("Commission") shall have the power to promulgate rules and regulations in the enforcement and administration of all laws within its jurisdiction. Section 13.1-523 of the Virginia Securities Act ("Act"), § 13.1-501 et seq. of the Code of Virginia, provides that the Commission may issue any rules and regulations necessary or appropriate for the administration and enforcement of the Act.

The rules and regulations issued by the Commission pursuant to the Act are set forth in Title 21 of the Virginia Administrative Code. A copy also may be found at the Commission's website: www.scc.virginia.gov/case.

On September 7, 2011, the Commission adopted a new regulation, 21 VAC 5-80-215, to recognize changes in federal laws and regulations governing investment advisors adopted under the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). The adopted regulation addressed the regulatory gap created by the Dodd-Frank Act for certain advisors. During the interim, the Division of Securities and Retail Franchising ("Division"), working as a member in conjunction with the other member states of the North American Securities Administrators Association, has developed a regulation to complete the transition from prior law to conform to the Dodd-Frank Act.

Accordingly, the Division has submitted to the Commission proposed revisions to Chapter 80 of Title 21 of the Virginia Administrative Code entitled "Rules and Forms Governing the Virginia Securities Act" ("Rules").

Rule 21 VAC 5-80-215 will be amended to repeal the stopgap provision adopted last year in Case No. SEC-2011-00034 and adopt the new model rule exemption for investment advisors to private funds. The purpose of this proposed regulation is to provide for an exemption for certain types of investment advisors who advise private funds from the requirement to be registered under § 13.1-504 A of the Act. The advisors exempted by this rule will still be subject to the anti-fraud provisions of the Act.

The rule adopted in Case No. SEC-2011-00034 will be extensively revised.

Rule 21 VAC 5-80-215 will be amended to add the new exemption provisions. Section A, subsections 1-5 define key terms specific to this exemption. The definitions are structured such that the types of private funds covered under the rule will include funds excluded from the definition of investment company under Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940, along with other private funds that would satisfy the statutory requirements found in these exclusions.

Section B 1 of the proposed new rule explains that in order to claim the exemption from registration, the advisor and its affiliates must not be subject to a "bad boy" disqualification. A "bad boy" disqualification is defined in Rule 262 of SEC Regulation A, 17 C.F.R. § 230.262. In addition, Section B 2 requires that the private advisor file a report to the Commission as required by the Securities and Exchange Commission ("SEC") for advisors to venture capital funds and private funds with less than $150 million in assets under management. Section B 3 requires that the advisor pay a notice filing fee of $250.

Section C of the proposed new rule and its subsections place additional conditions upon advisors to 3(c)(1) funds. Specifically, in order to qualify for the exemption from investment advisor registration, the 3(c)(1) fund must be comprised entirely of "qualified clients" under SEC Rule 205-3. This means that individual investors must have either $1 million in investments managed by the advisor or at least $2 million in net worth. The rule states that the value of the primary residence is not included in calculating net worth. The value of the primary residence will be an estimate of the fair market value at the time the net worth calculation is conducted. Section C also requires the advisor to deliver annual audited financial statements to investors in the fund, along with specific disclosures to those investors.

Section D of the proposed new rule notes that federal covered advisors who are registered with the SEC are not eligible for this exemption.

Section E of the proposed new rule establishes an exemption from registration for investment advisor representatives who are employed by the exempt investment advisor.

Section F of the proposed new rule requires the reports filed by the advisors to be filed with the Commission through the Investment Advisor Registration Depository ("IARD"). IARD is the registration system operated by the Financial Industry Regulatory Authority that maintains the registration and regulatory records for the state regulatory jurisdictions. The report will be accompanied by the annual $250 filing fee.

Section G of the proposed new rule provides a grace period for exempt advisors to become registered if that advisor no longer qualifies for the exemption.

Section H of the proposed new rule is a grandfather provision that would allow advisors to private funds currently exempt under the Act to remain exempt provided that the advisor files the reports required under the rule, and the advisor no longer accepts new investors that do not meet the financial requirements imposed by the rule, and provides the required disclosures to investors.

The Division has recommended to the Commission that the proposed revisions should be considered for adoption with an effective date of May 1, 2012, in order to allow private fund investment advisors to make the transition or be registered once the stopgap regulation expires. The Division also has recommended to the Commission that a hearing should be held only if requested by those interested parties who specifically indicate that a hearing is necessary and the reasons therefore.

A copy of the proposed revisions may be requested by interested parties from the Division by telephone, mail, or e-mail request and also can be found at the Division's website: www.scc.virginia.gov/srf. Any comments to the proposed rules must be received by April 12, 2012.

Accordingly, IT IS ORDERED that:

(1) The proposed revisions are appended hereto and made a part of the record herein.

(2) Comments or requests for hearing on the proposed revisions must be submitted in writing to Joel H. Peck, Clerk of the Commission, c/o Document Control Center, P. O. Box 2118, Richmond, Virginia 23218, on or before April 12, 2012. A request for hearing shall state why a hearing is necessary and why the issues cannot be adequately addressed in written comments. All correspondence shall contain reference to Case No. SEC-2012-00009. Interested persons desiring to submit comments electronically may do so by following the instructions available at the Commission's website: http://www.scc.virginia.gov/case.

(3) The proposed revisions shall be posted on the Commission's website at http://www.scc.virginia.gov/case and on the Division's website at http://www.scc.virginia.gov/srf. Interested persons may also request a copy of the proposed revisions from the Division by telephone, mail, or e-mail.

AN ATTESTED COPY HEREOF, together with a copy of the proposed revisions, shall be sent to the Registrar of Regulations for publication in the Virginia Register.

AN ATTESTED COPY HEREOF shall be sent by the Clerk of the Commission to the Division's Director, who shall forthwith mail a copy of this Order to any interested persons as he may designate.

21VAC5-80-215. Exemption for certain private advisors.

Registration under the Act shall not be required of any investment advisor or its investment advisor representative whose only client is or clients are a corporation, general partnership, limited partnership, limited liability company, trust, or other legal organization that:

1. Has assets of not less than $5,000,000 and

2. Receives investment advice based on its investment objectives rather than the individual investment objectives of its shareholders, partners, limited partners, members, or beneficiaries, provided the investment advisor was exempt from registration pursuant to § 203(b)(3) of the Investment Advisors Act of 1940 immediately prior to July 21, 2011, and the investment advisor is subject to SEC Rule 203-1(e) granting an extension to investment advisors formerly exempt from registration under § 203(b)(3) of the Investment Advisers Act of 1940 until March 30, 2012, who would otherwise have been required to register with the SEC by July 21, 2011.

A. For purposes of this section, the following definitions shall apply:

1. "Value of primary residence" means the fair market value of a person's primary residence, subtracted by the amount of debt secured by the property up to its fair market value.

2. "Private fund advisor" means an investment advisor who provides advice solely to one or more qualifying private funds.

3. "Qualifying private fund" means a private fund that meets the definition of a qualifying private fund in SEC Rule 203(m)-1, 17 CFR 275.203(m)-1.

4. "3(c)(1) fund" means a qualifying private fund that is eligible for the exclusion from the definition of an investment company under § 3(c)(1) of the Investment Company Act of 1940, 15 USC § 80a-3(c)(1).

5. "Venture capital fund" means a private fund that meets the definition of a venture capital fund in SEC Rule 203(l)-1, 17 CFR 275.203(l)-1.

B. Subject to the additional requirements of subsection C of this section, a private fund advisor shall be exempt from the registration requirements of § 13.1-504 of the Act if the private fund advisor satisfies each of the following conditions:

1. Neither the private fund advisor nor any of its advisory affiliates are subject to a disqualification as described in Rule 262 of SEC Regulation A, 17 CFR 230.262;

2. The private fund advisor files with the commission each report and amendment thereto that an exempt reporting advisor is required to file with the Securities and Exchange Commission pursuant to SEC Rule 204-4, 17 CFR 275.204-4; and

3. The private fund advisor pays a notice fee in the amount of $250.

C. In order to qualify for the exemption described in subsection B of this section, a private fund advisor who advises at least one (3)(c)(1) fund that is not a venture capital fund shall, in addition to satisfying each of the conditions specified in subsection B of this section, comply with the following requirements:

1. The private fund advisor shall advise only those 3(c)(1) funds (other than venture capital funds) whose outstanding securities (other than short-term paper) are beneficially owned entirely by persons who, after deducting the value of the primary residence from the person's net worth, would each meet the definition of a qualified client in SEC Rule 205-3, 17 CFR 275.205-3, at the time the securities are purchased from the issuer;

2. At the time of purchase, the private fund advisor shall disclose the following in writing to each beneficial owner of a 3(c)(1) fund that is not a venture capital fund:

a. All services, if any, to be provided to individual beneficial owners;

b. All duties, if any, the investment advisor owes to the beneficial owners; and

c. Any other material information affecting the rights or responsibilities of the beneficial owners; and

3. The private fund advisor shall obtain on an annual basis audited financial statements of each 3(c)(1) fund that is not a venture capital fund, and shall deliver a copy of such audited financial statements to each beneficial owner of the fund.

D. If a private fund advisor is registered with the Securities and Exchange Commission, the advisor shall not be eligible for this exemption and shall comply with the notice filing requirements applicable to federal covered investment advisors in § 13.1-504 of the Act.

E. A person is exempt from the registration requirements of § 13.1-504 of the Act if he is employed by or associated with an investment advisor that is exempt from registration in this Commonwealth pursuant to this section and does not otherwise act as an investment advisor representative.

F. The report filings described in subdivision B 2 of this section shall be made electronically through the IARD system. A report shall be deemed filed when the report and the notice fee required by subdivision B 3 of this section are filed and accepted by the IARD system on the commission's behalf.

G. An investment advisor who becomes ineligible for the exemption provided by this section must comply with all applicable laws and regulations requiring registration or notice filing within 90 days from the date the investment advisor's eligibility for this exemption ceases.

H. An investment advisor to a 3(c)(1) fund (other than a venture capital fund) that has one or more beneficial owners who are not qualified clients as described in subdivision C 1 of this section is eligible for the exemption contained in subsection B of this section if the following conditions are satisfied:

1. The subject fund existed prior to May 1, 2012;

2. As of May 1, 2012, the subject fund ceases to accept beneficial owners who are not qualified clients, as described in subdivision C 1 of this section;

3. The investment advisor discloses in writing the information described in subdivision C 2 of this section to all beneficial owners of the fund; and

4. As of May 1, 2012, the investment advisor delivers audited financial statements as required by subdivision C 3 of this section.

VA.R. Doc. No. R12-3113; Filed February 16, 2012, 11:16 a.m.