February 9, 2016 | Fund Forum

What Does "Exempt" Mean, Anyway?

10 min

Five years have passed since the imposition of new requirements for Exempt Reporting Advisers under the Dodd-Frank Act. At the time the rules were enacted, they were controversial in that the burden imposed on foreign Exempt Reporting Advisers was substantially similar to that of Registered Investment Advisers. Even with the passage of time, they have become no less controversial or cumbersome. Because these regulations are not widely understood, especially by newly formed foreign Exempt Reporting Advisers, we revisit these rules below.

Exemption for Foreign Advisers

Typically, in a regulatory setting, the word "exempt" means free from obligation. But when the Securities and Exchange Commission uses the term with respect to "exempt reporting advisers," "exempt" means, ironically, that the entity in question has an obligation to report. This new designation came about as a result of Dodd-Frank requirements promulgated in 2011, which created a class of foreign advisers that were exempted from the need to register with the SEC, but are still subject to reporting requirements, including books and records, and other requirements, and to SEC examinations. This article focuses on two types of foreign Exempt Reporting Advisers: Exempt Reporting Advisers with no U.S. presence and Exempt Reporting Advisers with a U.S. presence.1 Neither is, unfortunately, truly exempt.

Investor Advisers to a private equity fund with over $150 million in limited partner commitments must register with the SEC as an investment advisor. If you are required to register with the SEC, the regulatory burden is considerable. Initially, you must file Form ADV and keep it current by filing periodic amendments. You must also comply with the brochure rule, which requires most advisers to provide clients and prospective clients with information about the adviser's business practices and educational and business background. The fund must also maintain accurate and current books and records, as specified by SEC rules. Not only must the general partner have a compliance manual, but annually the Chief Compliance Officer must certify that there are policies, procedures, and controls reasonably designed to prevent and detect violations of law. In addition, the fund must comply with other requirements, such as the "pay-to-play" rule and the anti-fraud provisions of the federal securities laws.2 Finally, the SEC can inspect and examine the fund whenever it wants to do so.

Foreign Exempt Reporting Adviser

A private equity manager based in, for example, Mexico or Brazil with no U.S. office may manage an unlimited number of U.S. assets from an unlimited number of U.S. investors without having to become a registered investment adviser. Such a foreign adviser qualifies for the Private Fund Adviser Exemption as an "Exempt Reporting Adviser." However, the regulatory burden placed on a foreign Exempt Reporting Adviser is not that different from that on a Registered Investment Adviser.

  1. Reporting Requirements

    Since Dodd-Frank imposed new requirements on foreign advisers, the actual benefit foreign advisers receive from the "exempt" status is a matter of debate. In fact, at the time the new rules were enacted, two dissenting SEC Commissioners raised concerns that the requirements for Exempt Reporting Advisers generally are too similar to those for Registered Investment Advisers.3 However, there has been no action to lessen these requirements to date.

    While a foreign manager has an exemption from registration under the Advisers Act, there still are numerous requirements they need to satisfy. For example, Exempt Reporting Advisers are required to file annual updating amendments to Form ADV within 90 days of the firm's fiscal year end, as well as when there is a material change in circumstances for the firm. While Exempt Reporting Advisers are not required to fill out a complete Form ADV, they are required to fill out many items within the form.4 In addition, Exempt Reporting Advisers with a nonresident general partner must go through a slightly more cumbersome process and submit a separate form ADV-NR, as distinguished from the standard form ADV submitted via the IARD/FINRA system.5

  2. SEC Examinations and Other Federal Requirements 

    Exempt Reporting Advisers are also subject to requirements of examination, books and records, certain limited policy and procedures, and potential examinations by the SEC.6 Section 204 of the Advisers Act requires investment advisers to "make and keep records and to make and disseminate such reports as the SEC may require by rule."7 The combination of reporting requirements, recordkeeping requirements, and the SEC's jurisdiction for examination purposes means that Exempt Reporting Advisers, including foreign Exempt Reporting Advisers, face regulatory burdens similar to those of their registered counterparts for compliance and risk purposes.

    Section 204A of the Advisers Act includes a general requirement that all advisers develop policies and procedures reasonably designed to prevent the misuse of "material, non-public information by such investment adviser or persons associated with such investment adviser." Exempt Reporting Advisers are also subject to the same federal requirements as registered investment advisers in terms of "pay-to-play" requirements, Patriot Act Requirements, and the general anti-fraud provisions of the Investment Advisers Act. As discussed below, Exempt Reporting Advisers should carefully consider creating and periodically updating a compliance manual that covers all of these requirements. Apart from pure regulatory considerations, limited partners have expressed concern about the nature of compliance and risk controls for funds in which they invest. Accordingly, more robust internal controls, such as compliance manuals and operating procedures, generate both regulatory and practical benefits.

Foreign Exempt Reporting Advisers with U.S. Presence

Foreign advisers who advise "qualifying private funds" with less than $150 million in U.S. assets qualify for the Private Fund Exemption and thus also become Exempt Reporting Advisers.8 The trade-off is a $150 million threshold in exchange for the ability to maintain a domestic presence. For example, an adviser that is based in Mexico or Brazil with a Miami office may avail itself of the Private Fund Exemption if it maintains assets under management under $150 million.9

From a compliance and risk standpoint, the effect for foreign advisers with a domestic presence is largely the same as that for foreign advisers managing unlimited assets with no U.S. presence. They are exempt for purposes of registration; however, all of the reporting, books and records, examination, pay-to-play, Patriot Act, and anti-fraud provisions still apply. In both instances, these foreign advisers are for the most part regulated entities subject to ongoing requirements and the possibility that the SEC could perform an on-site examination and subject their books and records as well as controls to the same manner of testing as the Commission would for a Registered Investment Adviser.

Best Practices for Foreign Exempt Reporting Advisers

As we have seen, foreign Exempt Reporting Advisers are subject to many of the same requirements as registered domestic counterparts. Given this fact, the better practice from a compliance standpoint is to develop an infrastructure that can withstand the eventual regulatory scrutiny the adviser may well receive from the SEC. Over the last few years, the SEC has elevated its surveillance and examination techniques, resulting in a record number of enforcement actions. Its jurisdiction has increased considerably across the board, not only with respect to foreign Exempt Reporting Advisers. Because we expect the trend toward stronger regulation and increased jurisdiction to continue, we recommend that foreign Exempt Reporting Advisers take steps to improve internal controls regarding retention of requisite books and records, anti-fraud and pay-to-play provisions, and conflict of interest and insider trading rules, and put a program into place to ensure they can perform effectively during a regulatory examination.

With respect to the books and records requirements as they apply to Exempt Reporting Advisers, the better practice, in our view, is to conform to the books and records requirements in Section 204 of the Investment Advisers Act. In other words, foreign Exempt Reporting Advisers should retain records of communications, as well as financial records, purchase and sales journals, code of ethics policies, bank and custodial statements, documentation of decisions regarding the purchase or sale of securities, evidence of political contributions, disciplinary records, policies and procedures, supervisory or operational procedures, and anything else one would expect an SEC examination team to request during an on-site inspection.10

Foreign Exempt Reporting Advisers should also develop compliance manuals that are tailored to their business. Although some commentators point out that a compliance manual is not specifically mentioned in the requirements for Exempt Reporting Advisers, it is a required record under Section 204-2. Given that the SEC has been silent on the issue of whether Exempt Reporting Advisers have a lower burden with respect to books and records requirements than Registered Investment Advisers, it is unwarranted to advise a foreign Exempt Reporting Adviser that it has no obligation to maintain its books and records. Part and parcel of meeting this obligation should be to have a compliance manual.

Moreover, it would be difficult – if not impossible – for any adviser, exempt or otherwise, to demonstrate adherence to the anti-fraud provisions, inside trading rules, conflict of interest rules, record-keeping provisions, or pay-to-play requirements without a corresponding compliance manual and a system of controls.


In the aftermath of the sweeping Dodd-Frank Act, the word "exempt" is a misnomer when it is applied to various classes of Advisers, including Exempt Reporting Advisers with no U.S. presence and Exempt Reporting Advisers with a U.S. presence. Foreign Exempt Reporting Advisers are required to abide by many of the same requirements as Registered Investment Advisers. Given the fact that the books and records, as well as business practices, of these advisers are subject to inspection and examination by the SEC, a "best practices" approach dictates a compliance program that is robust enough to withstand scrutiny from the SEC. In addition, limited partners expect fund managers, whether registered or exempt, to create and maintain a professional and thoughtful internal compliance program.

[1] A third type of foreign Exempt Reporting Adviser is one that maintains U.S. assets below $25 million, a so-called small foreign Exempt Reporting Advisor. Unlike Exempt Reporting Advisers, they are not legally required to maintain their books and records and submit to SEC examination. However, they must conform, in addition to the $25 million threshold, to narrow standards: 1) have no U.S. place of business, 2) have fewer than 15 clients and/or investors in private funds, 3) do not hold themselves out to the public as an investment adviser, 4) and do not advise registered investment or business development companies.

[2] State regulations may also be relevant to a registered investment adviser.

[3] While the majority of Commissioners voted to approve the new requirements in 2011, two dissenting Commissioners expressed concern about the extent of the reporting obligations for Exempt Reporting Advisers and the possibility that, over time, there may be no meaningful distinction between the reporting obligations of an Exempt Reporting Advisor and a Registered Investment Advisor.

[4] Exempt Reporting Advisers are required to complete Form ADV Items 1 (Identifying Information), 2.B (SEC Reporting by Exempt Advisers), 3 (Form of Organization), 6 (Outside Business Activities), 7 (Financial Industry Affiliations and Private Fund Reporting), 10 (Control Persons), and 11 (Disclosure Information), along with the corresponding sections of Schedules A, B, C, and D.

[5] States may also require notice filings and fees for ERAs, depending upon the firm's nexus within that particular state.

[6] There is an express exemption from records and examination requirements for Small Exempt Private Reporting Advisers who maintain assets below $25 million (see footnote 1 above).

[7] Since the passage of this new requirement, we have awaited specific guidance from the SEC as to whether the books and records for Exempt Reporting Advisers are the same as those for Registered Investment Advisers. While the SEC has reserved the right to issue further rules on the matter, they have issued no guidance to date.

[8] A "qualifying private fund" means any private fund that is not registered under Section 8 of the Investment Company Act and has not been elected to be treated as a "business development company" pursuant to Section 54 of the same act.

[9] For purposes of calculating assets under management in accordance with this exemption, the SEC has referred to Item 5 of Form ADV, which would include the amount of any uncalled capital commitments and impose fair valuation of assets when no market value is available.

[10] See Section 17 CFR 275.204-2, books and records to be maintained by investment advisers.