This blog is the first in a series of blogs focused on the differences and similarities of the compliance regimes applicable to SEC’s exempt reporting advisors (ERAs) and registered investment advisors (RIAs).
The notion of an ERA emerged from a 2010 amendment to the Investment Advisers Act of 1940 and consists of two categories: advisors to certain small private funds and advisors to venture capital funds. While the total number of ERAs is relatively small compared to total RIAs, there is increased interest in these exemptions because of the popularity of such strategies and the fact that the regulatory requirements for ERAs are significantly less onerous than traditional RIAs.
What are the requirements for an ERA?
Advisors to one or more qualifying private funds can claim an ERA exemption if the aggregate value of the assets of their private funds is less than $150 million or if they are exempt under the venture capital fund rule. The term “private fund” is defined in the Advisers Act as an issuer that would be an investment company but for Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 – that is, the fund is limited to 99 accredited investors or offered exclusively to qualified purchasers. The asset value must be calculated pursuant to the instructions in Form ADV, which provides a standard method for calculating regulatory assets under management.
To be able to use the venture capital exemption, the fund or funds managed by the ERA must qualify as a “venture capital fund,” defined as a fund that meets four criteria: (i) qualifying investments, (ii) leverage limitations, (iii) lack of redemptions, and (iv) certain representations to investors. A detailed analysis of such conditions is beyond the scope of this blog, but robust procedures ensuring continued compliance with these criteria should be considered for all ERAs.
What applies to ERAs?
ERAs face fewer regulatory requirements than RIAs. However, ERAs are still subject to several substantive requirements. Three such conditions are described below, with the rest to be addressed in future installments in this series.
- Reporting requirements – ERAs must complete and file Form ADV with the SEC (and pay associated filing fees) within sixty (60) days of the date on which the adviser commences the advisory relationship with its first private fund or venture capital fund. Only Part 1A of Form ADV needs to be filed electronically through the Investment Advisory Registration Depository (IARD) system that FINRA operates. The initial submission covers only a subset of the items that RIAs must complete as part of their registration. These items include basic identifying information about the ERA, details about the size of the private funds it advises, other business interests of the ERA and its affiliates, and certain disciplinary history of the ERA and its employees. The ERA must also identify “control persons” that directly or indirectly control it.
- Similar to RIAs, ERAs are required to file an annual updating amendment to Form ADV and its schedules within ninety (90) days of the end of the adviser’s fiscal year. Moreover, interim filings are needed promptly if information in Items 1 (identifying information), 3 (form of organization), or 11 (disclosure information) becomes inaccurate. Material changes to Item 10 (control person) also trigger interim filings.
- If the ERA manages $150 million or more in private fund assets, then the firm has ninety (90) days to apply for full registration as an RIA. However, this grace period is not available if the ERA no longer satisfies the other conditions of the relevant exemption. Thus, if the ERA plans to manage clients other than private funds, or intends to make non-qualifying investments, the adviser needs to apply for RIA registration immediately, unless the adviser meets another exemption.
- Because of these requirements and the fact that all submitted information is publicly available, ERAs need to ensure that they have procedures to collect timely and accurate information and ensure all necessary updates.
- SEC anti-fraud rules – ERAs (and RIAs and unregistered advisors) are subject to the anti-fraud rules that prohibit the use of any device, scheme, or artifice to defraud any client or prospective client. ERAs must also refrain from engaging in any transaction, practice, or course of business that operates as fraud or deceit upon a client or a prospective client. Examples of prohibited conduct include promises of guaranteed returns, false statements about ERA’s investment history, unmanaged or undisclosed conflict of interest, selective cherry-picking, etc. Therefore, ERAs should review disclosures provided to investors or regulators, marketing materials, allocation of opportunities and expenses, and other areas where the firm may face conflicts.
- Pay-to-Play Rule – Rule 206(4)-5 under the Advisers Act (the “Pay-to-Play Rule”) applies to all advisors, including ERAs. The rule covers existing and past investors in the private funds or venture capital funds managed by the ERA and prohibits ERAs from receiving compensation for investment advisory services provided to a government entity or official after the advisor has made certain political contributions to said government entity or official. For example, the ERA and certain of its associates are generally subject to a two-year “cooling off” period after contributing to an official or government entity before the advisor can receive compensation for providing advice to the government entity. Also, ERAs are not allowed to use solicitors who are subject to pay-to-play restrictions, solicit or coordinate campaign contributions from others for officials of a government entity to which the advisor provides or seeks to provide services.
The compliance burden imposed on ERAs is significantly less than the burden imposed on RIAs. ERAs should build a reasonable compliance program to ensure compliance with the applicable requirements. Furthermore, they should also consider the benefits of expanding their compliance efforts by adopting additional best practices for mitigating additional risks. For example, ERAs are not required to comply with Rule 206(4)-7 under the Advisers Act (the Compliance Rule) that requires RIAs to designate a Chief Compliance Officer (CCO). However, ERAs may consider naming a CCO to respond to questions from the SEC about the firm’s registration or help with compliance efforts for the rules that apply to them. The SEC has made it clear that ERAs are considered subject to routine examinations by its staff, and having a robust compliance program goes a long way toward avoiding issues with the regulator and, ultimately investors.
 The SEC implemented the new ERA exemptions in 2011 by adopting the new Rule 203(l)-1 and 203(m)-1 under the Advisers Act.
 A review of data made publicly available by the SEC shows that as of April 2021 there were approximately 3,000 ERAs and 13,000 RIAs domiciled in the U.S.
 A 2017 study by the National Venture Capital Association estimated the annual compliance costs for ERAs to be around $60,000 versus $330,000 for RIAs.