In a recent administrative order, the Securities Division (the “Division”) of the South Carolina Office of the Attorney General has adopted a new exemption from investment adviser registration for private fund advisers. This move is significant as, until now, South Carolina was one of fewer than 10 states not providing some form of exemptive relief to private fund advisers. New private fund advisers seeking to set up operations in South Carolina may utilize the new exemption immediately. Additionally, existing private fund advisers currently registered with the Division may invoke the exemption and de-register so long as such advisers are in compliance with the exemption’s provisions and all other applicable law. As the southeastern United States has become an increasingly popular venue for private fund advisers in recent years, South Carolina’s new exemption should be well-received by the private capital industry.
As noted, most states exempt private fund advisers from registration obligations arising under those states’ “Blue Sky” investment advisory laws. Such obligations arise as a result of the fund manager (typically a separate legal entity serving as the fund’s General Partner or Managing Member) exercising control over and managing the fund’s securities portfolio. In other words, because the fund manager has discretionary authority to manage the fund’s investment portfolio, and receives compensation for this service (typically in the form of a management fee and a performance allocation), the fund manager generally satisfies the definition of an “investment adviser” under prevailing law.
Exemptive relief often comes in the form of fitting within a state’s “de minimis” exemption for investment advisers. For example, in Georgia, fund managers typically fit within that state’s exemption accorded to advisers having fewer than 6 advisory clients over the last 12 months (under such an exemptive scheme, the fund—and not its constituent investors—is the sole “client” of the adviser). Other states—South Carolina included—have chosen to adopt a variant of the model private fund adviser exemption created by the North American Securities Administrators Association (“NASAA”), an association of securities regulators. Notably, the NASAA model exemption has no force of law unless and until it is adopted by a particular state’s securities administrator.
In generally adopting the NASAA model rule’s provisions, the new South Carolina exemption (known as Order No. 19003, or the “Order”) sets out a familiar set of requirements. In order to satisfy the Order, a private fund adviser must meet the following conditions:
- The adviser must provide advice solely to one or more “qualifying private funds,” generally defined under SEC rules as funds that meet either the section 3(c)(1) or 3(c)(7) exemptions from Investment Company Act regulation;
- The adviser must not be subject to disqualification under the “bad boy” provisions of SEC Regulation D (generally due to criminal, civil and administrative sanctions);
- The adviser must file those reports via the IARD system that are required to be filed by Exempt Reporting Advisers (“ERAs”) (certain sections of Form ADV, Part 1A); and
- The adviser must pay a filing fee as set by the Division.
Under the Order, a private fund adviser must satisfy a number of additional conditions to the extent that it is an adviser to a fund relying on section 3(c)(1) exemption from Investment Company Act regulation. Generally, funds relying on that provision are limited to investment by no more than 100 persons meeting the SEC definition of an “accredited investor.” The additional conditions applicable to 3(c)(1) fund advisers are as follows:
- All fund investors must be either “accredited investors” or “qualified clients,” as defined under SEC rules;
- The adviser must disclose in writing, to all fund investors, all services provided or duties owed to such persons, and all material information impacting such persons;
- The fund must be audited annually, and such audit must be distributed to all fund investors; and
- If the adviser will receive performance fees or allocations from the capital accounts of fund investors that are not “qualified clients,” then the adviser must provide additional written conflict-of-interest disclosures as mandated by the Order.
Note that the last point above (permitting performance fees/allocations to be levied on the capital accounts of a non-qualified client) is a significant departure from both the NASAA model exemption and SEC/Blue Sky advisory law, which generally restricts the collection of performance-based compensation to qualified clients exclusively.
Additional relief is provided by the Order for private fund advisers managing aggregate fund assets of less than $25 million. Notably, such private fund advisers are not required to either (i) file ERA reports; (ii) pay any filing fee; or (iii) obtain and distribute audits for their funds.
As we have observed above, the Order is a positive development for the private capital industry in the southeast. Prior to this point, South Carolina-based private fund advisers were at a distinct disadvantage vis-à-vis neighboring states, and the country at large, as a result of investment adviser registration with the Division being a necessity. With that added burden now lifted, we would not be surprised to see a thriving private capital industry take hold in South Carolina.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Hedge Fund Practice Group provides advice to entrepreneurial or “emerging” investment managers in connection with the structuring, formation, and operation of private investment funds. Our Investment Adviser Practice Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Hedge Fund and Investment Adviser Practice Group pages for more information.