The Alabama Securities Commission recently issued an order exempting Alabama-based “private fund” investment advisers from the requirement to register as investment advisers with the ASC. The order is relevant to Alabama asset managers for several reasons:
- The ASC has made its position clear that fund managers in Alabama who manage less than $100 million in assets must be registered as investment advisers in Alabama.
- Effective July 8, 2024, fund managers in Alabama may benefit from a new exemption from full registration requirements.
- The new exemption still requires advisers to make their data publicly available and to meet limited compliance obligations.
- The ASC will not take action against historical registration failures of private fund managers that meet registration or exemption requirements before November 5, 2024..
The vast majority of companies strive to comply with all applicable laws. Unfortunately, historical approaches to regulating private funds contribute to an underestimation of the need to consider certain aspects of applicable securities laws. Therefore, this article focuses on the importance of determining whether Alabama’s requirements apply to your company and the substantive regulatory requirements of the new exemption.
It is crucial to assess whether you are indeed managing a “private fund” and therefore need to take advantage of the grace period to comply with the rules.
Are you an investment advisor for a private fund?
We frequently encounter individuals and companies who do not realize that they are acting as an “investment adviser” to a “private fund.” The Alabama Securities Commission’s order makes clear that Alabama requires private fund advisers who meet the definition of an “investment adviser” to register in Alabama. Acting as an unregistered investment adviser can result in significant civil, regulatory and criminal consequences.
The Alabama Securities Act defines an “investment adviser” as “(a)ny person who, for a fee, professionally advises others, directly or through publications or writings, on the value of securities or on the advisability of investing in, buying or selling securities, or who, for a fee and in the course of his regular business, publishes or disseminates analyses or reports on securities.”(1)
A key consideration for fund advisers is whether the fund invests in “securities.” This analysis is generally simpler when the fund invests in equities. However, in other situations the analysis may be more complicated. For example, a fund investing in a real estate project may have an investment structure that makes the fund’s investment appear to be an investment in a “security,” and therefore requires the fund manager to assess whether it is actually acting as an investment adviser.
Although a sophisticated legal analysis is often required, we recommend that business people involved in investing funds of several persons in an investment company seek advice.
Common investment vehicles that fit into this broad category include hedge funds, private equity funds, venture capital funds and real estate funds.
To be clear, there may be reasons why individuals who fit the above description are not considered “private fund advisers” or are otherwise exempt from registration requirements. However, individuals who manage investment pools should not blindly assume that registration is not required simply because other, similar entities operate without a license.
The registration requirement and the corresponding grace period for compliance
With its order, the Alabama Securities Commission makes clear that persons/entities in Alabama who receive compensation for advising private funds on the funds’ securities investments must comply with Alabama’s investment adviser registration requirements.
But instead of simply confirming the registration requirement, the regulator has introduced a grace period to allow private fund managers to comply with the rules. without fear of sanctions for not registering. Given the history of private fund regulation and the confusion we often see among asset managers across the country, this compliance window is a very smart and effective measure. Of course, there is a time limit to this grace period – 5 November 2024.
If you fail to register by the deadline or comply with the exemption requirements, the Alabama Securities Commission can impose penalties for the entire period of the violation. That is, if you were required to register as an investment adviser for a private fund starting in 2020 and fail to comply by November 5.thAlabama could impose penalties for registration violations starting in 2020 – not only those after 5 Novemberth.
To take into account the time required to conduct legal analyses, prepare the necessary documentation and undergo regulatory review, we recommend that persons who may need to take advantage of this grace period act promptly.
The exemption for private fund advisors
In confirming that registration requirements must be followed by private fund advisers in Alabama, the order also establishes a new exception to the registration requirement for investment advisers. The Alabama exception bears close similarities to the exceptions available under the federal Investment Advisers Act of 1940 as well as the laws of numerous states, where these exceptions are generally referred to as “excepted reporting adviser” exceptions.
Generally, Alabama’s private fund adviser exemption applies to any investment adviser that manages a fund that either (1) has 100 or fewer beneficial owners who meet the “qualified client” standard or (2) is owned only by persons who meet the “qualified purchaser” standard.(2).
While the requirements are less stringent than those for registered investment advisers, those who rely on the exemption are still subject to various obligations, including filing a report with the Alabama Securities Commission, preparing specific disclosures, preparing and filing financial reports with investors and the Alabama Securities Commission, and responding to requests for information and records from the agency.
In practice, the exemption approach will reduce the burden on smaller asset managers in accessing sophisticated investors, who often require the fund manager to be registered or an “exempt reporting adviser”.
Diploma
The Alabama Securities Commission’s approach is commendable. The agency recognized that it needed to reaffirm its position on the registration requirement, but also recognized that previous regulatory approaches as well as complex legal analysis may have compromised compliance, and is therefore giving Alabama residents the opportunity to bring their funds into compliance. To reduce the regulatory burden, Alabama ultimately implemented an exemption from all regulatory requirements. We expect that as a result of these actions, Alabama investors will benefit from increased transparency and investment managers will have additional options.
(1) This definition is consistent with the definition of the term “investment adviser” in other jurisdictions, including the Investment Advisers Act of 1940.
(2) The “qualified client” standard is set by federal law and requires a minimum net worth that is different from and in many ways higher than that of an “accredited investor.” The “qualified purchaser” standard is also set by federal law but includes higher investment portfolio thresholds.
