The Alabama Securities Commission recently issued an Order exempting Alabama based investment advisers to “private funds” from the requirement to register as investment advisers with the ASC. The Order is relevant to asset managers in Alabama for several reasons:
- The ASC has made explicit its position that fund managers in Alabama managing less than $100 million in assets need to be registered with Alabama as investment advisers.
- Effective July 8, 2024, Alabama fund managers can avail themselves of a new exemption from the full registration requirements.
- The new exemption will still require advisers to make a public filing and satisfy limited compliance obligations.
- The ASC will not enforce historical failures to register by private fund managers that come into compliance with the registration or exemption requirements before November 5, 2024.
The vast majority of businesses seek to comply with all applicable laws. Unfortunately, historical approaches to the regulation of private funds contribute to an underappreciation of the need to factor in certain aspects of applicable securities laws. Thus, this article focuses on the importance of determining if the Alabama requirements apply to your business and the substantive regulatory requirements of the new exemption.
It is critically important to assess whether you are in fact managing a “private fund” and, therefore, need to take advantage of the compliance grace period.
Are you an Investment Adviser to a Private Fund?
We frequently encounter individuals and entities that do not recognize they are acting as “investment advisers” to a “private fund.” The Alabama Securities Commission’s Order makes it abundantly clear that Alabama requires private fund advisers that meet the “investment adviser” definition to register with Alabama. Acting as an unregistered investment adviser can result in significant civil, regulatory, and criminal liabilities.
The Alabama Securities Act defines an “investment adviser” as “[a]ny person, who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as a part of a regular business, issues or promulgates analyses or reports concerning securities.”[1]
For purposes of fund advisers, a central consideration is whether the fund is investing in “securities.” This analysis is generally simpler where the fund is investing in stocks. However, the analysis can be more complicated in other situations. For example, a fund that is investing in a real estate project may involve an investment structure that renders the fund’s investment to constitute an investment in a “security” and thereby requires the fund manager to assess if they are in fact acting as an investment adviser.
Although a nuanced legal analysis is often required, we encourage business-persons involved in investing the funds pooled by more than one persons into an investment entity to seek counsel.
Common investment vehicles that fit in this broad category include hedge funds, private equity funds, venture capital funds and real estate funds.
To be clear, there may be reasons why persons fitting the above description would not be considered “private fund advisers” or may otherwise be exempt from the registration requirements. But persons managing pooled investment entities should not blindly assume that registration is not required simply because other, similar businesses are operating without being licensed.
The Registration Requirement and Corresponding Grace Period for Compliance
With its Order, the Alabama Securities Commission is clearly communicating that persons/entities in Alabama receiving compensation for advising private funds on the funds’ investments in securities are required to consider the Alabama investment adviser registration requirements.
But instead of simply confirming the registration requirement, the regulator has thoughtfully implemented a grace period to allow private fund managers to get into compliance without facing sanctions for not being registered previously. Considering the history of private fund regulation and the confusion we often observe with asset managers around the country, this compliance window is a very smart and effective measure. Of course, there is a limit to this grace period – November 5, 2024.
Failing to register or satisfy the exemption requirements by the deadline may result in the Alabama Securities Commission seeking sanctions for the entire period of violation. That is, if one was required to register as an investment adviser to a private fund beginning in 2020 and fails to get into compliance by November 5th, Alabama may seek penalties based on registration violations beginning in 2020 – not just those after November 5th.
In order to account for the time necessary to complete legal analyses, prepare necessary paperwork and complete the regulatory review, we encourage prompt action by persons that believe they may need to take advantage of this grace period.
The Private Fund Adviser Exemption
In confirming that the registration requirements must be considered by private fund advisers in Alabama, the Order also establishes a new exemption from the investment adviser registration requirement. The Alabama exemption bears strong resemblance to exemptions available under the federal Investment Advisers Act of 1940 as well as the laws of numerous states, where those exemptions are commonly referred to as an “exempt reporting adviser” exemption.
As a very general matter, the Alabama private fund adviser exemption is available to any investment adviser managing 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 less than the requirements applicable to registered investment advisers, those relying on the exemption will still have various obligations, such as making a filing with the Alabama Securities Commission, preparing specific disclosures, preparing and submitting financial statements to investors and the Alabama Securities Commission, and responding to information and records requests from the agency.
In practical terms, the exemption approach will lower the burden for smaller asset managers to access sophisticated investors who often require the fund manager to be registered or a “exempt reporting adviser.”
Conclusion
The approach taken by the Alabama Securities Commission is commendable. The agency identified a need to confirm its position on the registration requirement. But, in doing so, it also recognized that prior regulatory approaches as well as complex legal analyses may have impacted compliance and is therefore affording Alabamians an opportunity to bring their funds into compliance. Finally, to lower the regulatory burden, Alabama has implemented an exemption from the complete set of regulatory requirements. As a result of these measures, we expect the Alabama investing public will benefit from increased transparency and the investment managers will gain additional opportunities.
[1] This definition is consistent with how “investment adviser” is defined in other jurisdictions, including under the Investment Advisers Act of 1940.
[2] The “qualified client” standard is established under the federal law and requires minimum net worths that are different, and in many regards, higher than that of an “accredited investor.” The “qualified purchaser” standard is also established under federal law but involves more significant investment portfolio thresholds.