IVCA Profile Q&A: Michele Gibbons and Olga Loy, Partners at Mayer Brown, LLP on the Impact of the Private Fund Investment Advisers Act of 2010

IVCA Profile Q&A: Michele Gibbons and Olga Loy, Partners at Mayer Brown, LLP on the Impact of the Private Fund Investment Advisers Act of 2010

August 4, 2010

CHICAGO - “ On July 21st, President Obama signed into law the - œPrivate Fund Investment Advisers Act of 2010-  (the - œRegistration Act- ), part of the recent Wall Street Re-form Bill. The impact of this law will affect advisers of private equity and venture capital funds in different and essential ways.

Michele Gibbons and Olga Loy, both partners at the global law firm of Mayer Brown LLP, are experts in the new law, sifting through the regulatory maze to interpret what influence the Registration Act will have on certain key elements of private funds. The IVCA interviewed Ms. Gibbons and Ms. Loy regarding these distinctions.

IVCA: The Wall Street Reform Bill includes the Private Funds Investment Advisers Act of 2010. How does it affect the Private Equity/Venture Capital world, and what is the immediate impact?

Michele Gibbons: Without a doubt, many private equity fund advisers will need to come into the fold and be registered with the Securities and Exchange Commission (the - œSEC- ) within one year from enactment date (by July 22nd, 2011), unless they meet an exemption from registration.

IVCA: How is the SEC defining the term - ˜adviser'?

MG: There is no indication that the definition of investment adviser under the Investment Advisers Act of 1940 (- œAdvisers Act- ) is going to change. Under the current interpretation, an investment adviser is anyone, who, for compensation, provides advice regarding securities for the accounts of others. The term - ˜advice regarding securities' has been very broadly defined through SEC interpretations.

Olga Loy: For practical purposes, that would include the management companies and the general partners of the funds.

IVCA: What exemptions should PE/VC funds be aware of in this act?

MG: The most common exemption is gone. The exemption on which the majority of private fund advisers have been relying (having fewer than 15 clients) has gone away. There are only a few ways left for advisers to private funds to be considered exempt if they are U.S. based advisers. The clearest way is assets under management. Under this test, the aggregate assets under management need to be taken into account, so not just one fund but all of the funds a particular adviser controls, even if it controls them with affiliates. Between $50 million and $150 million, full registration may not be required, but these advisers will need to provide certain reports to the SEC. But once an adviser has over $150 million of assets under management, there are very few exemptions.

IVCA: What is the background as to why private equity suddenly became in-cluded into the Registration Act but "venture capital" is exempt?

MG: The Senate version first gave both VC & PE exemptions and but the PE exemption was taken away by the House. In our minds there is not really a good explanation in the Congressional Record for why they got included as an exempted class in the first place. There was an argument made that the venture capital industry has been cooperative, that lawmakers believed VC funds posed less risk and that the regulators get enough information from those funds through their Regulation D filings, so that their advisers should be exempt from registration. This reasoning maybe problematic in that most venture capital funds and private equity funds don't file Form Ds, so the idea that VC funds are more cooperative and Congress has the information they need, speaks to the idea that they didn't know most of these funds don't make those filings.

IVCA: So " venture capital" fund advisers are exempt from registration, but without a clear definition for how that type of fund will be defined. How do you envision a VC fund being defined by the SEC?

MG: I'm not so sure the SEC knows how they're going to define it. There are few examples of definitions in other regulation of this industry. They will look into Congress's intent as to levels of systemic risk. They also will figure out what types of companies will meet that definition. It's probably one of the biggest questions out there.

OL: Basically the law requires that the venture capital fund has to be defined one year after the enactment of the Registration Act. The SEC has to come up with a definition, and as Michele pointed out, the reason for the exemption of those funds, is the belief that venture capital funds don't pose the risk as the other funds. I wonder if the definition will explore that a little more.

IVCA: From an investor perspective, if you are an LP in a fund now and its adviser is required to be registered, what questions should you asking your fund adviser?

MG: Hopefully most advisers to PE funds already have policies that are mostly in line with what is required once they are registered. This is more of a matter of formalizing these procedures and making some adjustments to comply with some rules. Some of which probably aren't as important to a private equity fund but still need to be addressed. For example, the Adviser's Act and the Advisers Act forms talk about trading, brokerage and best execution, that kind of thing. And the PE industry will need to deal with how it can address the spirit of those types of requirements, where before it hadn't been much of a concern. The LPs don't have as much a question as a worry that this added registration will be a preoccupation to the time demands of the adviser, and will be added expense. PE advisers will want to show that they hired someone capable to get it done quickly, so the focus can go back to investment.

IVCA: Given the scrutiny and bureaucracy of government agencies like the SEC, how much oversight increase do you foresee with the new Registration Act powers?

MG: This is to be determined. A lot of things have to come together at the same time. Some of the smaller advisers will deregister and go to the states. Some of the plans call for the SEC to make more targeted teams and examiners. And to have more transparency and sharing so that there is a more informed and sophisticated manner in their monitoring, plus more risk assessments to guide who they will look at. Right now, there is frustration that advisers are really not being examined on nearly the schedule that SEC said they were going to examine them, and there is a worry that the agency will have to show they have the capacity to take on the advisers, plus create some system of doing it. The other question is that they will be collecting more information, but will they have someone on the back end looking at the information?

IVCA: Family Office Funds are exempt from registration. What are the characteristics that define a Family Office Fund. Can you convert other funds to a Family Office?

MG: No, you won't be able to convert because it had to be a Family Office Fund as of a certain date, the time to declare yourself a private office to "grandfather in" is over. There are some very specific requirements and I think they are well-defined, to narrowly remove Family Offices that are really other funds. Especially the issue that most Family Offices pool together the interest of the related persons, and they may have someone who helps them find other people to invest their money. Having them register is beyond the focus of where the SEC's attention was meant to go.

IVCA: What are the exemption parameters for Off-Shore funds?

MG: Offshore funds are exempt from registration, provided that they have no place of business in the US (which is yet to be defined); have fewer than 15 clients and investors in the US in private funds advised by the advisers; have less than $25 million of assets under management attributable to clients in the US and investors in the US in private funds advised by the advisers; and do not advise business development companies or US registered investment companies.

IVCA: It seems that the definition of "client" is important in these new rules, why is that?

MG: I think that is confusing to many people. The definition of "client" was very important in the first round when the SEC was trying to register the advisers to hedge funds. They tried to do that by saying the client is not a fund, the client is the underlying investor if you're trying to count to 15 for the private adviser exemption. And the Goldstein court decision struck that down, saying the SEC had no right to suddenly redefine "client." So this time, Congress said fine, we're getting rid of that private adviser exemption and that won't be an issue anymore. Now the rule says you have to count all of your clients, so that's now there.

But there is a provision in the Registration Act that Congress and the SEC cannot redefine the investor as the client. And that is important because when an adviser is looking at a fund, it's looking holistically at the investment objective set by the fund. It shouldn't take into account the interests of the underlying investor. If for fiduciary purposes, the investor were considered the client that would twist around the purpose of having a fund. The idea is to pool everyone and treat them equally.

IVCA: What are the estimated costs associated with fund registration?

MG: The SEC will have to come up with that. When the SEC drafts these rules, they must, by law, come up with how much time the new rule willrequire of the adviser and how much, on average, that will cost. There are currently some revisions being made to the original legislation, I imagine that costs will increase from the original proposals.