California Requests Input on IA Exemption Changes

Seeks to Raise IA Exemption Threshold to $100MM AUM

In an Invitation for Comments released today, California officially seeks comments to change its rules with respect to hedge fund managers and a certain exemption from investment adviser registration.  California currently exempts from registration those investment advisers with a place of business in California and more than $25MM of AUM (please see our post on the California IA exemption).  California may, however, increase the asset threshold for the exemption because of the changes under the Dodd-Frank Act.

Prior to Dodd-Frank, hedge fund managers could not register with the SEC unless they had $25MM of AUM.  Now, the threshold will be $100MM of AUM.  Accordingly, some states are proposing to amend current laws so they reflect the changes at the federal level.  The invitation for comments seems to be based on a recent NASAA proposed hedge fund model rule which would require all non-SEC registered hedge fund managers (to Section 3(c)(1) funds) to register with the state securities commission.   The proposed model rule was a natural step for NASAA to take considering that the Dodd-Frank Act did, with respect to some states, leave a regulatory gap.  Connecticut is another state which has an exemption for managers with more than $25MM of AUM (please see our post on the Connecticut IA exemption).

California Invitation

California provided the following as a reason for the invitation:

As a result of Dodd-Frank, on July  21, 2011, Section  260.204.9 will no longer provide an exemption from California licensing requirements.  In anticipation of these changes, the California Corporations Commissioner will be amending Section 260.204.9 to reflect the changes in the corresponding federal rules.  The Commissioner seeks input on the issue of how best to regulate advisers to alternative investment vehicles, while balancing the regulatory burden on such advisers, with any corresponding investor protections issues.

The following are the items which California asks interested parties to discuss:

1.  To avoid the “retailization” of private alternative investment funds, should the exemption apply exclusively to advisers to Section 3(c)(7) funds (i.e., not to Section 3(c)(1) funds)?
2.  Should all persons investing in a Section 3(c)(1) fund be required to be qualified clients? If so, should the Department issue an order that “grandfathers” Section 3(c)(1) funds organized prior to July 21, 2010?
3. Should the proposed statutory disqualification provisions be expanded to include additional factors?
4.  Should the proposed asset under management threshold (AUM) be a different amount than that set forth in the proposed rule (i.e. $100 million)?  If so, what is the basis for a different threshold?
5.  Are there criteria other than AUM that the Commissioner should consider to determine whether an adviser should be exempt (e.g., the fund is subject to an annual audit)?
6.  Should the Department’s definition of venture capital company/fund conform to the proposed SEC definition?
7.  Should the Department adopt the North American Securities Administrators Association (NASAA) proposed model rule for an exemption for Private Fund Advisers?

What this means

Right now this does not mean anything.  The division will take comments into consideration when they begin to draft the proposed amendment to the current hedge fund registration exemption.  After the proposed amendment is drafted, there will be a public comment period prior to any new regulation being officially adopted.  This means that interested parties will have the ability to have their comments heard now and after a proposed rule has been announced.  Comments on this particular release are due by March 28, 2011.

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Bart Mallon is an attorney who works with both state and SEC registered fund managers.  His firm, Cole-Frieman & Mallon LLP, routinely provides regulatory and compliance services to registered investment advisers.  He can be reached directly at 415-868-5345.

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