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    \143\ Schell, supra note 101, at Sec.  1.03[8] (``The typical
Venture Capital Fund calls for Capital Contributions from time to
time as needed for investments.''); id. at Sec.  2.05[2] (stating
that ``[venture capital funds] begin operation with Capital
Commitments but no meaningful assets. Over a specific period of
time, the Capital Commitments are called by the General Partner and
used to acquire Portfolio Investments.'').
    \144\ See Loy Testimony, supra note 40, at 5 (``[Limited
partners] make their investment in a venture fund with the full
knowledge that they generally cannot withdraw their money or change
their commitment to provide funds. Essentially they agree to ``lock-
up'' their money for the life of the fund.''). See also Stephanie
Breslow & Phyllis Schwartz, Private Equity Funds, Formation and
Operation 2010 (``Breslow & Schwartz''), at Sec.  2:5.6 (discussing
the various remedies that may be imposed in the event an investor
fails to fund its contractual capital commitment, including, but not
limited to, ``the ability to draw additional capital from non-
defaulting investors;'' ``the right to force a sale of the
defaulting partner's interests at a price determined by the general
partner;'' and ``the right to take any other action permitted at law
or in equity'').
    \145\ See, e.g., Breslow & Schwartz, supra note 144, at Sec.
2:5.7 (noting that a cap of 10% to 25% of remaining capital
commitments is a common limitation on follow-on investments). See
also Schell, supra note 101, at Sec.  1.01 (noting that capital
contributions made by the investors are used to ``make investments *
* * in a manner consistent with the investment strategy or
guidelines established for the Fund.''); id. at Sec.  1.03
(``Management fees in a Venture Capital Fund are usually an annual
amount equal to a fixed percentage of total Capital Commitments.'');
see also Dow Jones, Private Equity Partnership Terms and Conditions,
2007 edition (``Dow Jones Report'') at 15.
    \146\ See, e.g., NVCA Yearbook 2010, supra note 41, at 16; John
Jannarone, Private Equity's Cash Problem, Wall St. J., June 23,
2010, http://online.wsj.com/article/SB10001424052748704853404575323073059041024.html#printMode.
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    The proposed 15 percent threshold would be determined based on the
venture capital fund's aggregate capital commitments. In practice, this
means that a venture capital fund relying on the exemption could
leverage an investment transaction up to 100 percent when acquiring
equity securities of a particular portfolio company as long as the
investment amount does not exceed 15 percent of the fund's total
capital commitments, albeit on a short-term basis that did not exceed
120 days. Should the 15 percent calculation be determined with respect
to the total investment amount for each portfolio company? Would this
standard be easier to apply?
    Our proposed rule defines a venture capital fund by reference to a
maximum of 15 percent of borrowings based on our understanding that
venture capital funds typically would not incur borrowings in excess of
10 to 15 percent of the fund's total capital contributions and uncalled
capital commitments.\147\ We believe that imposing a maximum at the
upper range of borrowings typically used by venture capitals may
accommodate existing practices of the vast majority of industry
participants.
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    \147\ See Loy Testimony, supra note 40, at 6 (``[M]any venture
capital funds significantly limit borrowing such that all
outstanding capital borrowed by the fund, together with guarantees
of portfolio company indebtedness, does not exceed the lesser of (i)
10-15% of total limited partner commitments to the fund and (ii)
undrawn limited partner commitments.'').
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3. No Redemption Rights
    Proposed rule 203(l)-1 would define a venture capital fund as a
fund that issues securities that do not provide investors redemption
rights except in ``extraordinary circumstances'' but that do entitle
investors generally to receive pro rata distributions.\148\ Unlike
hedge funds, venture capital funds do not typically permit investors to
redeem their interests during the life of the fund,\149\ but rather
distribute assets generally as investments mature.\150\ Although
venture capital funds typically return capital and profits to investors
only through pro rata distributions, such funds may also provide
extraordinary rights for an investor to withdraw from the fund under
foreseeable but unexpected circumstances or rights to be excluded from
particular investments due to regulatory or other legal
requirements.\151\ These events may be ``foreseeable'' because they are
circumstances that are known to occur (e.g., changes in law, corporate
events such as mergers) but are unexpected in their timing or scope.
Thus, withdrawal or exclusion rights might be triggered by a change in
the tax law after an investor invests in the fund, or the enactment of
laws that may prohibit an investor's participation in the fund's
investment in particular countries or industries.\152\ The trigger
events for these rights are typically beyond the control of the adviser
and fund investor (e.g., tax and regulatory changes).
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    \148\ Proposed rule 203(l)-1(a)(5) (limiting venture capital
funds to funds that ``[o]nly issue[] securities the terms of which
do not provide a holder with any right, except in extraordinary
circumstances, to withdraw, redeem or require the repurchase of such
securities but may entitle holders to receive distributions made to
all holders pro rata'').
    \149\ See Schell, supra note 101, at Sec.  1.03[7] (venture
capital fund ``redemptions and withdrawals are rarely allowed,
except in the case of legal compulsion''); Breslow & Schwartz, supra
note 144, at Sec.  2:14.2 (``the right to withdraw from the fund is
typically provided only as a last resort'').
    \150\ Loy Testimony, supra note 40, at 2-3 (``As portfolio
company investments are sold in the later years of the [venture
capital] fund--when the company has grown so that it can access the
public markets through an initial public offering (an IPO) or when
it is an attractive target to be bought--the liquidity from these
`exits' is distributed back to the limited partners. The timing of
these distributions is subject to the discretion of the general
partner, and limited partners may not otherwise withdraw capital
during the life of the venture [capital] fund.''). Id. at 5
(Investors ``make their investment in a venture [capital] fund with
the full knowledge that they generally cannot withdraw their money
or change their commitment to provide funds. Essentially they agree
to `lock-up' their money for the life of the fund, generally 10 or
more years as I stated earlier.''). See also Dow Jones Report, supra
note 145, at 60 (noting that an investor in a private equity or
venture capital fund typically does not have the right to transfer
its interest).
    \151\ See Hedge Fund Adviser Registration Release, supra note
17, at n.240 and accompanying text (``Many partnership agreements
provide the investor the opportunity to redeem part or all of its
investment, for example, in the event continuing to hold the
investment became impractical or illegal, in the event of an owner's
death or total disability, in the event key personnel at the fund
adviser die, become incapacitated, or cease to be involved in the
management of the fund for an extended period of time, in the event
of a merger or reorganization of the fund, or in order to avoid a
materially adverse tax or regulatory outcome. Similarly, some
investment pools may offer redemption rights that can be exercised
only in order to keep the pool's assets from being considered `plan
assets' under ERISA [Employee Retirement Income Security Act of
1974].''). See, e.g., Breslow & Schwartz, supra note 144, at Sec.
2:14.1 (``Private equity funds generally provide for mandatory
withdrawal of a limited partner [i.e., investor] only in the case
where the continued participation by a limited partner in a fund
would give rise to a regulatory or legal violation by the investor
or the fund (or the general partner [i.e., adviser] and its
affiliates). Even then, it is often possible to address the
regulatory issue by excusing the investor from particular
investments while leaving them otherwise in the fund.'').
    \152\ See, e.g., Breslow & Schwartz, supra note 144, at Sec.
2:14.2 (``The most common reason for allowing withdrawals from
private equity funds arises in the case of an ERISA violation where
there is a substantial likelihood that the assets of the fund would
be treated as `plan assets' of any ERISA partner for purposes of
Title I of ERISA or section 4975 of the Code.''). See also Schell,
supra note 101, at Sec.  9.04[3] (``Exclusion provisions allow the
General Partner to exclude a Limited Partner from participation in
any or all investments if a violation of law or another material
adverse effect would otherwise occur.''); id. at Appendix D-31
(attaching model limited partnership agreement providing ``The
General Partner at any time may cancel the obligations of all
Partners to make Capital Contributions for Portfolio Instruments if
* * * changes in applicable law * * * make such cancellation
necessary or advisable. * * * '').
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    For these purposes, for example, a fund that permits quarterly or
other periodic withdrawals would be considered to have granted
investors redemption rights in the ordinary course even if those rights
may be subject to an initial lock-up or suspension or restrictions on
redemption. Is the phrase ``extraordinary circumstances'' sufficiently
clear to distinguish the investor liquidity terms of venture capital
funds, as they operate today,

from hedge funds? Congressional testimony cited an investor's inability
to withdraw from a venture capital fund as a key characteristic of
venture capital funds and a factor for reducing their potential for
systemic risk.\153\ Although a fund prohibiting redemptions would be a
venture capital fund for purposes of the exemption, the rule does not
specify a minimum period of time for an investor to remain in the fund.
Should the rule define when withdrawals by investors would be
``extraordinary?'' Should the rule specify minimum investment periods
for investors? Could venture capital funds provide investors with
``extraordinary'' rights to redeem that could effectively result in
redemption rights in the ordinary course? \154\ Should we address this
potential for circumvention of the definition by establishing a maximum
amount that may be redeemed during any period of time (e.g., 10 percent
of an investor's total capital commitments)? Would such a limit
constrain investors in a way so as to prevent them from complying with
other legal or regulatory requirements?
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    \153\ See supra notes 149-150 and accompanying text.
    \154\ For example, a private fund's governing documents may
provide that investors do not have any right to redeem without the
consent of the general partner. In practice, if the general partner
typically permits investors to redeem or transfer their otherwise
non-redeemable, non-transferable interests on a periodic basis, then
the fund would not be considered to have issued securities that ``do
not provide a holder with any right, except in extraordinary
circumstances, to withdraw.''
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4. Represents Itself as a Venture Capital Fund
    Proposed rule 203(l)-1 would limit the definition of venture
capital fund for the purposes of the exemption to a private fund that
represents itself as being a venture capital fund to its investors and
potential investors.\155\ A private fund could satisfy this
definitional element by, for example, describing its investment
strategy as venture capital investing or as a fund that is managed in
compliance with the elements of our proposed rule. Without this
element, a fund that did not engage in typical venture capital
activities could be treated as a venture capital fund simply because it
met the other elements specified in our proposed rule (because for
example it only invests in short term Treasuries, controls portfolio
companies, does not borrow, does not offer investors redemption rights,
and is not a registered investment company).\156\ We believe that only
funds that do not significantly differ from the common understanding of
what a venture capital fund is,\157\ and that are actually offered to
investors as venture capital funds, should qualify for the exemption.
Thus, an adviser to a venture capital fund that is otherwise relying on
the exemption could not identify the fund as a hedge fund or multi-
strategy fund (i.e., venture capital is one of several strategies used
to manage the fund) or include the fund in a hedge fund database or
hedge fund index.
---------------------------------------------------------------------------

    \155\ Proposed rule 203(l)-1(a)(1).
    \156\ We also note that a fund that represents to investors that
it is one type of fund while pursuing a different type of fund
strategy may raise concerns under rule 206(4)-8 of the Advisers Act.
    \157\ See Gompers, supra note 110, at 6-7.
---------------------------------------------------------------------------

    We request comment on a venture capital fund's representations
regarding itself as a criterion under the proposed definition. Is our
criterion inconsistent with current practice? Does the proposed
criterion regarding venture capital fund representations adequately
address our concern that advisers should not be eligible for the
exemption if they advise funds that otherwise meet the definitional
criteria in the rule but engage in activities that do not constitute
venture capital investing?
5. Is a Private Fund
    We propose to define a venture capital fund for the purposes of the
exemption as a private fund, which is defined in the Advisers Act,\158\
and exclude from the proposed definition funds that are registered
investment companies (e.g., mutual funds) or have elected to be
regulated as BDCs.\159\ There is no indication that Congress intended
this exemption to apply to advisers to these publicly available
funds,\160\ referring to venture capital funds as a ``subset of private
investment funds.'' \161\ We request comment on this requirement and
whether it appropriately reflects the expectation of Congress.
---------------------------------------------------------------------------

    \158\ See section 202(a)(29) of the Advisers Act.
    \159\ Proposed rule 203(l)-1(a)(6).
    \160\ Legislative history does not indicate that Congress
addressed this matter, nor does testimony before Congress suggest
that this was contemplated. See, e.g., McGuire Testimony, supra note
41, at 3 (noting that venture capital funds are not directly
accessible by individual investors); Loy Testimony, supra note 40,
at 2 (``Generally * * * capital for the venture fund is provided by
qualified institutional investors such as pension funds,
universities and endowments, private foundations, and to a lesser
extent, high net worth individuals.''). See generally supra note 158
(definition of ``private fund'').
    \161\ See S. Rep. No. 111-176, supra note 7, at 74 (describing
venture capital funds as a subset of ``private investment funds'').
---------------------------------------------------------------------------

6. Other Factors
    We request comment on whether the proposed rule should include
other elements that were described in testimony as characteristic of
venture capital funds or that distinguish venture capital funds from
other types of private equity or private funds.\162\ For example,
testimony presented to Congress indicated that venture capital funds
typically have capital contributions from their advisers, generally up
to five percent of the fund's total capital commitments.\163\ Congress
also received testimony that venture capital funds are generally not
open to retail investors,\164\ have long investment periods, generally
of at least ten years,\165\ and contribute to the U.S. economy by
creating jobs, fostering competition and facilitating innovation.\166\
---------------------------------------------------------------------------

    \162\ See, e.g., Heesen, supra note 104 (generally describing
characteristics that distinguish venture capital funds from hedge
funds and buyout funds).
    \163\ See Loy Testimony, supra note 40, at 2 (``[g]enerally, 95
to 99 percent of capital for the venture fund is provided by * * *
investors * * * and we supply the rest of the capital for the fund
from our own personal assets''); McGuire Testimony, supra note 41,
at 3. Industry data confirm that such investments are typical in the
venture capital industry. See, e.g., Dow Jones Report, supra note
145, at 23-24 (showing that, in a survey of 110 North American
general partners, at least 83% contributed at least 1% of venture
capital fund capital). We note that certain investors perceive an
investment in the fund as aligning the interest of investors and
advisers. See Institutional Limited Partners Association Private
Equity Principles, September 9, 2009, at 3 (recommending that the
``general partner should have a substantial equity interest in the
fund to maintain a strong alignment of interest with the limited
partners, and a high percentage of the amount should be in cash as
opposed to being contributed through the waiver of the management
fee.''); Mercer Investment Consulting, Inc., Key Terms and
Conditions for Private Equity Investing, 1996 at 13 (``Many limited
partners view the 1% standard as an inadequate sharing of risk * * *
.'').
    \164\ See McGuire Testimony, supra note 41, at 3 (``Venture
capital funds are not sold directly to retail investors like mutual
funds.''); Loy Testimony, supra note 40, at 2 (``Generally, 95 to 99
percent of capital for the venture fund is provided by qualified
institutional investors such as pension funds, universities and
endowments, private foundations, and to a lesser extent, high net
worth individuals.'').
    \165\ See Loy Testimony, supra note 40, at 2; McGuire Testimony,
supra note 41, at 3.
    \166\ See Loy Testimony, supra note 40, at 4; McGuire Testimony,
supra note 41, at 5.
---------------------------------------------------------------------------

    Are any of these characteristics appropriate to include as elements
in the definition? If so, which elements should be included and what
would be appropriate thresholds for application? Do venture capital
advisers typically invest in the funds they manage? Should we modify
the proposed rule to include as a condition that advisers relying on
the exemption under section 203(l) would invest in the venture capital
fund at a specified minimum threshold? If so, what is an appropriate
investment threshold--less than one percent, one percent, three
percent, five percent, or somewhere in between? Should the proposed
rule be modified to

specify that venture capital funds have a minimum term, for example, of
10 years? Should the proposed rule be modified to specify that a
venture capital fund is one that does not have retail investors? If so,
how should ``retail investor'' be defined? Should ``retail investor''
exclude persons who are not ``qualified clients'' for purposes of the
Advisers Act?\167\
---------------------------------------------------------------------------

    \167\ Rule 205-3 generally defines a qualified client as any
person who has at least $750,000 under management with an adviser
immediately after entering into the contract or who has a net worth
of more than $1,500,000 at the time the contract is entered into.
---------------------------------------------------------------------------

7. Application to Non-U.S. Advisers
    Neither the statutory text of section 203(l) nor the legislative
reports gives an indication of whether Congress intended the exemption
to be available to advisers that operate principally outside of the
United States but that invest in U.S. companies or solicit U.S.
investors.\168\ Testimony before Congress presented by members of the
U.S. venture capital industry discussed the industry's role primarily
in the U.S. economy including its lack of interconnection with the U.S.
financial markets and ``interdependence'' with the world financial
system.\169\ Nevertheless, we expect that venture capital funds with
advisers operating principally outside of the United States may seek to
access the U.S. capital markets by investing in U.S. companies or
soliciting U.S. investors; investors in the United States may also have
an interest in venture capital opportunities outside of the United
States. We request comment on whether the proposed rule should specify
that an adviser with its principal office and place of business outside
of the United States (a ``non-U.S. adviser'') is eligible to rely on
the exemption even if it advises funds that do not meet our proposed
definition of venture capital fund.
---------------------------------------------------------------------------

    \168\ See section 203(l) of the Advisers Act; H. Rep. No. 111-
517, supra note 7, at 867; S. Rep. No. 111-176, supra note 7, at 74-
75.
    \169\ See Loy Testimony, supra note 40, at 4-5; McGuire
Testimony, supra note 41, at 5-6.
---------------------------------------------------------------------------

    A non-U.S. adviser currently may rely on the private adviser
exemption, if it meets the conditions of current section 203(b)(3) of
the Advisers Act, including advising no more than 14 clients.\170\ We
have permitted such an adviser to count only clients that are residents
of the United States,\171\ and for this purpose permitted the adviser
to treat a private fund incorporated outside of the United States as a
non-resident of the United States, even if some or all of the investors
in the private fund are residents of the United States.\172\ A non-U.S.
adviser may rely on the venture capital exemption if all of its
clients, whether U.S. or non-U.S., are venture capital funds. In
effecting the new venture capital exemption, should we specifically
provide that a non-U.S. adviser may avail itself of the exemption even
if it advises clients other than venture capital funds, provided such
clients are non-United States persons, under the definition we propose
for purposes of the other exemptions discussed below? \173\ If we take
this approach, should the non-U.S. adviser be able to rely on the
venture capital exemption if it advises these other clients from within
the United States?
---------------------------------------------------------------------------

    \170\ See supra note 5 and accompanying text.
    \171\ See rule 203(b)(3)-1(b)(5).
    \172\ See rule 203(b)(3)-1(a)(2). See also ABA Subcommittee on
Private Investment Companies, SEC Staff No-Action Letter (Aug. 10,
2006) (``ABA Letter''). In the ABA Letter, Commission staff
expressed the view that the substantive provisions of the Advisers
Act do not apply to offshore advisers with respect to such advisers'
dealings with offshore funds and other offshore clients to the
extent described in prior staff no-action letters and the Hedge Fund
Adviser Registration Release, supra note 17. The staff took the
position, however, that an offshore adviser registered with the
Commission under the Advisers Act must comply with the Advisers Act
and the Commission's rules thereunder with respect to any U.S.
clients (and any prospective U.S. clients) it may have.
    \173\ See proposed rule 203(m)-1(e)(8); proposed rule
202(a)(30)-1(c)(2)(i).
---------------------------------------------------------------------------

    If a non-U.S. adviser must advise solely venture capital funds
(even those advisers that principally operate outside of the United
States) our proposed definition may have the result of subjecting non-
U.S. advisers to United States regulatory oversight because they advise
funds offered only outside the United States. Under our proposed rule,
only a private fund as defined under section 202(a)(29) may be a
venture capital fund.\174\ A non-U.S. fund that uses U.S.
jurisdictional means in the offering of the securities it issues and
relies on sections 3(c)(1) or 3(c)(7) would be a private fund.\175\ A
non-U.S. fund that does not make such a U.S. offering would not be a
private fund and therefore could not qualify as a venture capital fund,
even if operated as a venture capital fund in a manner that would
otherwise meet the criteria under our proposed definition. If we adopt
the approach we are proposing today, should we allow an adviser to
treat such a non-U.S. fund as a private fund and, to the extent that
the fund meets all of the other conditions of our proposed definition,
as a venture capital fund for purposes of the exemption? If so, under
what conditions? For example, should a non-U.S. fund be a private fund
under the proposed rule if the non-U.S. fund would be deemed a private
fund upon conducting a private offering in the United States in
reliance on sections 3(c)(1) or 3(c)(7)?
---------------------------------------------------------------------------

    \174\ See proposed rule 203(l)-1(a).
    \175\ An issuer that is organized under the laws of the United
States or of a state is a private fund if it is excluded from the
definition of an investment company for most purposes under the
Investment Company Act pursuant to sections 3(c)(1) or 3(c)(7).
Section 7(d) of the Investment Company Act prohibits a non-U.S. fund
from using U.S. jurisdictional means to make a public offering,
absent an order permitting registration. A non-U.S. fund may conduct
a private U.S. offering without violating section 7(d) only if the
fund complies with either section 3(c)(1) or 3(c)(7) with respect to
its U.S. investors (or some other available exemption or exclusion).
Consistent with this view, a non-U.S. fund is a private fund if it
makes use of U.S. jurisdictional means to, directly or indirectly,
offer or sell any security of which it is the issuer and relies on
either section 3(c)(1) or 3(c)(7). See Hedge Fund Adviser
Registration Release, supra note 17, at n.226; Offer and Sale of
Securities to Canadian Tax-Deferred Retirement Savings Accounts,
Securities Act Release No. 7656 (Mar. 19, 1999) [64 FR 14648 (Mar.
26, 1999)], at nn.10, 20, 23; Statement of the Commission Regarding
Use of Internet Web Sites to Offer Securities, Solicit Securities
Transactions or Advertise Investment Services Offshore, Securities
Act Release No. 7516 (Mar. 23, 1998) [63 FR 14806 (Mar. 27, 1998)],
at n.41. See also Dechert LLP, SEC Staff No-Action Letter (Aug. 24,
2009) at n.8; Goodwin, Procter & Hoar LLP, SEC Staff No-Action
Letter (Feb. 28, 1997) (``Goodwin Procter Letter''); Touche Remnant
& Co., SEC Staff No-Action Letter (Aug. 27, 1984).
---------------------------------------------------------------------------

8. Grandfathering Provision
    We propose to include in the definition of ``venture capital fund''
any private fund that: (i) Represented to investors and potential
investors at the time the fund offered its securities that it is a
venture capital fund; (ii) has sold securities to one or more investors
prior to December 31, 2010; and (iii) does not sell any securities to,
including accepting any additional capital commitments from, any person
after July 21, 2011 (the ``grandfathering provision'').\176\ The
grandfathering provision thus would include any fund that has accepted
capital commitments by the specified dates even if none of the
commitments has been called.\177\ As a result, any investment adviser
that solely advises private funds that meet the definitions in either
proposed rule 203(l)-1(a) or (b) would be exempt from registration.
---------------------------------------------------------------------------

    \176\ Proposed rule 203(l)-1(b).
    \177\ See also Electronic Filing and Revision of Form D,
Securities Act Release No. 8891(Feb. 6, 2008) [73 FR 10592 (Feb. 27,
2008)], at section VIII, Form D, General Instructions--When to File
(noting that a Form D is required to be filed within 15 days of the
first sale of securities which would include ``the date on which the
first investor is irrevocably contractually committed to invest''),
n.159 (``a mandatory capital commitment call would not constitute a
new offering, but would be made under the original offering'').
---------------------------------------------------------------------------

    We believe that most funds previously sold as venture capital funds
likely would satisfy all or most of the conditions in the proposed
rule.

Nevertheless, we recognize that investment advisers currently seeking
to sponsor new funds before the adoption of the final version of
proposed rule 203(l)-1 will continue to face uncertainty regarding the
precise terms of the definition and hence uncertainty regarding their
eligibility for the new exemption. Thus, our proposed rule presumes
that a fund that has commenced its offering (i.e., has initially sold
securities by December 2010) and that also concludes its offering by
the effective date of Title IV of the Dodd-Frank Act (i.e., July 21,
2011) is unlikely to have been structured to circumvent the intended
scope of the exemption. Moreover, requiring existing venture capital
funds to modify their investment conditions or characteristics,
liquidate portfolio company holdings or alter the rights of investors
in the funds in order to satisfy the proposed definition of a venture
capital fund would likely be impossible in many cases and yield
unintended consequences for the funds and their investors.
    Thus, we propose that an investment adviser may treat any existing
private fund as a venture capital fund for purposes of section 203(l)
of the Advisers Act if the fund meets the elements of the
grandfathering provision. The current private adviser exemption does
not require an adviser to identify or characterize itself as any type
of adviser (or impose limits on advising any type of funds).
Accordingly, we believe that advisers have not had an incentive to mis-
characterize existing venture capital funds that have already been
marketed to investors. As we note above, a fund that ``represents''
itself to investors as a venture capital fund is typically one that
discloses it pursues a venture capital investing strategy and
identifies itself as such. We do not expect funds identifying
themselves as ``private equity'' or ``hedge'' would be able to rely on
this exemption.
    We request comment on this grandfathering provision. Should we
include other conditions in addition to the fund representing itself as
a venture capital fund? For example, should a fund seeking to be
grandfathered also provide that its investors do not have any
redemption rights except in extraordinary circumstances,\178\ not incur
leverage except on a short-term basis,\179\ limit the securities that
it acquires from portfolio companies to equity securities,\180\ or
provide significant managerial assistance to the portfolio companies in
which the fund invests? \181\ Should the grandfathering provision be
modified to exclude other types of funds, such as funds of venture
capital funds or publicly available venture capital funds? \182\ We
understand that venture capital funds may be in the planning and
initial offering stage for a considerable period of time.\183\ Should
funds that have their first sale of securities within a period of time
such as 180 days after the final rule is adopted be able to rely on the
proposed grandfathering provision? Does our grandfathering provision
unnecessarily encourage the formation of new funds before December 31,
2010, and therefore should the grandfathering provision only apply to
funds in existence on the date of this proposal or some other time
before December 31, 2010? Would the dates specified in the
grandfathering provision significantly shorten the fundraising periods
for venture capital funds? Should we specify a date later than December
31, 2010 or earlier than July 21, 2011? Do venture capital fund
advisers need more time or flexibility to determine eligibility for the
grandfathering provision? Alternatively, would exempt advisers consider
registering with the Commission in order to retain flexibility to raise
capital for new venture capital funds without regard to the
grandfathering provision?
---------------------------------------------------------------------------

    \178\ See proposed rule 203(l)-1(a)(5); supra discussion in
section II.A.4 of this Release.
    \179\ See proposed rule 203(l)-1(a)(4); supra discussion in
section II.A.3 of this Release.
    \180\ See proposed rule 203(l)-1(a)(1); supra discussion in
section II.A.1.b of this Release.
    \181\ See proposed rule 203(l)-1(a)(3); supra discussion in
section II.A.2 of this Release.
    \182\ See supra discussion in sections II.A.1.e and II.A.6 of
this Release.
    \183\ See Breslow & Schwartz, supra note 144, at Sec.  2:4.1
(private equity fundraising may take six to 12 months following the
initial closing, depending upon whether the adviser has an existing
investor base or a successful performance record).
---------------------------------------------------------------------------

B. Exemption for Investment Advisers Solely to Private Funds With Less
Than $150 Million in Assets Under Management

    Section 203(m) of the Advisers Act directs the Commission to exempt
from registration any investment adviser solely to private funds that
has less than $150 million in assets under management in the United
States.\184\ We are proposing a new rule 203(m)-1 that would provide
the exemption and address several interpretive questions raised by
section 203(m). We will refer to this exemption as the ``private fund
adviser exemption.''
---------------------------------------------------------------------------

    \184\ Section 408 of the Dodd-Frank Act, which is codified in
section 203(m) of the Advisers Act. See supra note 22.
---------------------------------------------------------------------------

1. Advises Solely Private Funds
    Proposed rule 203(m)-1 would, like section 203(m) of the Advisers
Act, limit an adviser relying on the exemption to advising ``private
funds'' as that term is defined in that Act.\185\ An adviser that
acquires a different type of client would have to register under the
Advisers Act unless another exemption is available. An adviser could
advise an unlimited number of private funds, provided the aggregate
value of the adviser's private fund assets is less than $150 million.
---------------------------------------------------------------------------

    \185\ See proposed rule 203(m)-1(a) and (b). A ``private fund''
includes a private fund that invests in other private funds.
---------------------------------------------------------------------------

    In the case of an adviser with a principal office and place of
business outside of the United States (a ``non-U.S. adviser''), we
propose to provide the exemption as long as all of the adviser's
clients that are United States persons are qualifying private
funds.\186\ As a consequence, a non-U.S. adviser could enter the U.S.
market and take advantage of the exemption without regard to the type
or number of its non-U.S. clients. Under this approach, a non-U.S.
adviser would not lose the private fund adviser exemption as a result
of its business activities outside the United States. Recognizing that
non-U.S. activities of non-U.S. advisers are less likely to implicate
U.S. regulatory interests and in consideration of general principles of
international comity, our rules have taken a similar approach by
permitting a non-U.S. adviser to count only clients that are U.S.
persons when determining whether it has 14 or fewer clients, and is
thus eligible for the private adviser exemption.\187\
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    \186\ Proposed rule 203(m)-1(b)(1).
    \187\ Rule 203(b)(3)-1(b)(5) (``If you have your principal
office and place of business outside the United States, you are not
required to count clients that are not United States residents, but
if your principal office and place of business is in the United
States, you must count all clients.''). See infra note 207.
---------------------------------------------------------------------------

    We request comment on our proposed application of the statute to
non-U.S. advisers. Should we, alternatively, interpret section 203(m)
as denying the private fund adviser exemption to a non-U.S. adviser
that has other types of clients outside of the United States? This
interpretation would have the effect of treating non-U.S. and U.S.
advisers equally with respect to the types of clients they may have,
but could also have the result of requiring many non-U.S. advisers to
register because of the scope and nature of their non-U.S. advisory
business, an outcome which the ``assets under management in the United
States'' limitation in section 203(m) suggests was not a consideration
relevant to the scope of the exemption.

Under such an approach, moreover, the exemption would be unavailable to
a non-U.S. adviser unless all of the non-U.S. funds it manages are
offered to investors in the United States (and therefore meet the
definition of ``private fund'').\188\ If we adopt this alternative
approach, should the exemption apply to a non-U.S. adviser even if not
all of the non-U.S. funds it manages are offered in the United States?
---------------------------------------------------------------------------

    \188\ See supra note 174-175 and accompanying paragraph.
---------------------------------------------------------------------------

2. Private Fund Assets
    Under proposed rule 203(m)-1, an adviser would have to aggregate
the value of all assets of private funds it manages in the United
States to determine if the adviser remains below the $150 million
threshold.\189\ Proposed rule 203(m)-1 would require advisers to
calculate the value of private fund assets by reference to Form ADV,
under which we propose to provide a uniform method of calculating
assets under management for regulatory purposes under the Advisers
Act.\190\ In the case of a sub-adviser, it would have to count only
that portion of the private fund assets for which it has
responsibility.\191\
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    \189\ Proposed rule 203(m)-1(c).
    \190\ See proposed rules 203(m)-1(a)(2); 203(m)-1(b)(2); 203(m)-
1(e)(1) (defining ``assets under management'' to mean ``regulatory
assets under management'' in proposed item 5.F of Form ADV, Part
1A); 203(m)-1(e)(4) (defining ``private fund assets'' to mean the
assets under management attributable to a qualifying private fund).
This uniform method of calculation would be used to determine
whether an adviser qualifies to register with the Commission rather
than the states, as well as to determine eligibility for the private
fund adviser exemption and the foreign private adviser exemption
discussed in this Release. Under the proposed Form ADV instructions,
advisers would include in their ``regulatory assets under
management'' any proprietary assets, assets managed without
receiving compensation, and assets of non-U.S. clients, all of which
an adviser may currently exclude, as well as, in the case of private
funds, uncalled capital commitments. Moreover, the adviser could not
deduct liabilities, such as accrued fees and expenses or the amount
of any borrowing. See Implementing Release, supra note 25, at
section II.A.3 (discussing the rationale underlying the proposed new
instructions for calculating assets under management under Form
ADV).
    \191\ See proposed Form ADV: Instructions for Part 1A, instr.
5.b(2).
---------------------------------------------------------------------------

    In addition to assets appearing on a private fund's balance sheet,
advisers would include any uncalled capital commitments, which are
contractual obligations of an investor to acquire an interest in, or
provide the total commitment amount over time to, a private fund, when
called by the fund.\192\ Advisers to private funds that use capital
commitments seek investments early in the life of the fund in
anticipation of all investors fully paying in these capital commitments
during the life of the fund, and fees payable to the adviser are
calculated as a percentage of total capital commitments.\193\ Many of
these types of private funds are managed following investment
guidelines and restrictions that are determined as a percentage of
overall capital commitments, rather than as a percentage of current net
asset value.\194\ We request comment on whether the method for
calculating the relevant assets under management should deviate from
the method in the proposed amendments to Form ADV instructions by, for
example, excluding proprietary assets, assets managed without
compensation, or uncalled capital commitments.
---------------------------------------------------------------------------

    \192\ See proposed Form ADV: Instructions for Part 1A, instr.
5.b(1).
    \193\ See supra notes 143-145.
    \194\ Id.
---------------------------------------------------------------------------

    Under proposed rule 203(m)-1, each adviser would have to determine
the amount of its private fund assets quarterly, based on the fair
value of the assets at the end of the quarter.\195\ We propose that
advisers use the fair value of private fund assets in order to ensure
that, for purposes of this exemption, advisers value private fund
assets on a meaningful and consistent basis. Use of the cost basis
(i.e., the value at which the assets were originally acquired), for
example, could under certain circumstances understate significantly the
value of appreciated assets, and thus result in advisers availing
themselves of the exemption. Use of the fair valuation method by all
advisers, moreover, would result in more consistent asset calculations
and reporting across the industry and, therefore, in a more coherent
application of the Advisers Act's regulatory requirements and of our
staff's risk assessment program.
---------------------------------------------------------------------------

    \195\ See proposed rule 203(m)-1(c); supra note 190; proposed
Form ADV: Instructions for Part 1A, instr. 5.b(4). As discussed in
the Implementing Release, we are proposing to require advisers to
value private fund assets using fair value when calculating their
assets under management for several purposes under the Advisers Act.
See Implementing Release, supra note 25, at section II.A.3. A fund's
governing documents may provide for a specific process for
calculating fair value (e.g., that the general partner, rather than
the board of directors, determines the fair value of the fund's
assets). An adviser would be able to rely on such a process also for
purposes of calculating its assets under management.
---------------------------------------------------------------------------

    We understand that many, but not all, private funds value assets
based on their fair value in accordance with U.S. generally accepted
accounting principles (``GAAP'') or other international accounting
standards.\196\ Some private funds do not use fair value methodologies,
which may be more difficult to apply when the fund holds illiquid or
other types of assets that are not traded on organized markets.\197\
Would the proposed approach result in advisers valuing their private
fund assets in a generally uniform manner and in comparability of the
valuations? We are not proposing to require advisers to determine fair
value in accordance with GAAP. Should we adopt such a requirement? If
not, should we specify that advisers may only determine the fair value
of private fund assets in accordance with a body of accounting
principles used in preparing financial statements? We understand that
GAAP does not require some funds to fair value certain investments.
Should we provide for an exception from the proposed fair valuation
requirement with respect to any of those investments?
---------------------------------------------------------------------------

    \196\ See, e.g., Comment Letter of National Venture Capital
Association (July 28, 2009), at 2 (the ``vast majority of venture
capital funds provide their LPs [i.e., investors] quarterly and
audited annual financial reports. These reports are prepared under
generally accepted accounting principles, or GAAP, and audited under
the standards established for all investment companies, including
the largest mutual fund complexes.''); Comment Letter of Managed
Funds Association (July 28, 2009), at 3 (a ``substantial proportion
of hedge fund managers, whether or not they are registered with the
Commission, provide independently audited financial statements of
the [hedge] fund to investors.''). These comment letters were
submitted in connection with the Commission's proposed amendments to
the custody rule, Custody of Funds or Securities of Clients by
Investment Advisers, Investment Advisers Act Release No. 2876 (May
20, 2009) [74 FR 25354 (May 27, 2009)], and are available on the
Commission's Internet Web site at http://www.sec.gov/comments/s7-09-09/s70909.shtml.
    \197\ Those assets include, for example, ``distressed debt''
(such as securities of companies or government entities that are
either already in default, under bankruptcy protection, or in
distress and heading toward such a condition) or certain types of
emerging market securities that are not readily marketable. See
Gerald T. Lins et al., Hedge Funds and Other Private Funds: Reg and
Comp Sec.  5:22 (2009) (``At any given time, some portion of a hedge
fund's portfolio holdings may be illiquid and/or difficult to value.
This is particularly the case for certain types of hedge funds, such
as those focusing on distressed securities, activist investing,
etc.'').
---------------------------------------------------------------------------

    Should we adopt a different approach altogether and allow advisers
to use a method other than fair value? Are there other methods that
would not understate the value of fund assets? Should the rule permit
advisers to rely exclusively on the method set forth in a fund's
governing documents, or the method used to report the value of assets
to investors or to calculate fees (or other compensation) for
investment advisory services? What method should apply if a fund uses
different methods for different purposes? Should we modify the proposed
rule to require that the valuation be derived from audited financial
statements or subject to review

by auditors or another independent third party?
    As discussed above, we are proposing that funds value assets no
less frequently than quarterly, although such values are not subject to
quarterly reporting to us.\198\ As a consequence, short-term market
value fluctuations would not affect the availability of the exemption
between the ends of calendar quarters. We request comment on our
proposed quarterly calculation. Should compliance with the $150 million
threshold be determined more or less frequently than quarterly? For
purposes of reporting on proposed amendments on Form ADV, registered
investment advisers (and exempt reporting advisers) would be required
to report their regulatory assets under management annually.\199\
Should the availability of the exemption under proposed rule 203(m)-1
be conditioned on annual valuation rather than quarterly valuation?
---------------------------------------------------------------------------

    \198\ The proposed frequency of the calculation is consistent
with section 2(a)(41)(A) of the Investment Company Act, which
specifies the valuation of the assets of an issuer for purposes of
determining whether it meets the definition of investment company
under section 3 of that Act.
    \199\ See proposed rules 204-1(a) and 204-4(a) and proposed
General Instruction 3 to Form ADV. See Implementing Release, supra
note 25, at section II.B.3. See also Form ADV Release, supra note
132, at 15 (``Advisers must update the amount of their assets under
management annually (as part of their annual updating amendment) and
make interim amendments only for material changes in assets under
management when they are filing an `other than annual amendment' for
a separate reason.'').
---------------------------------------------------------------------------

3. Assets Managed in the United States
    Under proposed rule 203(m)-1, all of the private fund assets of an
adviser with a principal office and place of business in the United
States would be considered to be ``assets under management in the
United States,'' even if the adviser has offices outside of the United
States.\200\ A non-U.S. adviser, however, would need only count private
fund assets it manages from a place of business in the United States
toward the $150 million asset limit under the exemption.\201\
---------------------------------------------------------------------------

    \200\ Proposed rule 203(m)-1(a). The proposed rule also would
define the United States to have the same meaning as in rule 902(l)
of Regulation S under the Securities Act, which is ``the United
States of America, its territories and possessions, any State of the
United States, and the District of Columbia.'' Proposed rule 203(m)-
1(e)(7).
    \201\ Proposed rule 203(m)-1(b). Any assets managed from a U.S.
place of business for clients other than private funds would make
the exemption unavailable. We understand that others have supported
a jurisdictional approach to regulation, which focuses on the
primary market in which an adviser conducts its business. See, e.g.,
G20 Working Group Report, supra note 136, at 16; Testimony of W.
Todd Groome, Chairman, The Alternative Investment Management
Association, before the House Subcommittee on Capital Markets,
Insurance and Government Sponsored Enterprises, May 7, 2009, at 3.
These commenters propose an approach that looks to the location
where the primary business is conducted, which is similar to our
territorial approach.
---------------------------------------------------------------------------

    Rule 203(m)-1 would deem all of the assets managed by an adviser to
be managed ``in the United States'' if the adviser's ``principal office
and place of business'' is in the United States. We would look to an
adviser's principal office and place of business as the location where
the adviser controls, or has ultimate responsibility for, the
management of private fund assets, and therefore as the place where all
the advisers' assets are managed, although day-to-day management of
certain assets may also take place at another location. This approach
is similar to the way we have identified the location of the adviser
for regulatory purposes under our current rules,\202\ which define an
adviser's principal office and place of business as the location where
it ``directs, controls and coordinates'' its global advisory
activities, regardless of the location where some of the advisory
activities might occur.\203\ For most advisers, this approach would
avoid difficult attribution determinations that would be required if
assets are managed by teams located in multiple jurisdictions, or if
portfolio managers located in one jurisdiction rely heavily on research
or other advisory services performed by employees located in another
jurisdiction.
---------------------------------------------------------------------------

    \202\ See rule 203A-3(c); rule 222-1. Both rules define
``principal place of business'' of an investment adviser as the
executive office of the investment adviser from which the officers,
partners or managers of the investment adviser direct, control and
coordinate the activities of the investment adviser.
    \203\ See proposed rule 203(m)-1(e)(3) (defining ``principal
office and place of business'' as the adviser's executive office
from which the officers, partners, or managers of the adviser
direct, control, and coordinate the adviser's activities); proposed
rule 203(m)-1(e)(2) (defining ``place of business,'' by reference to
proposed rule 222-1(a), as (i) an office where the investment
adviser regularly provides investment advisory services, solicits,
meets with, or otherwise communicates with clients, and (ii) any
other location that it holds out to the general public as a place
where those activities take place).
---------------------------------------------------------------------------

    We considered but decided not to propose an approach that would
presume that a non-U.S. adviser to private funds offered in the United
States would have no assets managed from a location in the United
States if its principal office and place of business is not ``in the
United States.''\204\ Such an interpretation of the statute would treat
U.S. advisers the same as non-U.S. advisers, but would seem to ignore
the fact that day-to-day management of some assets of the private fund
does in fact take place ``in the United States,'' even though that
management is ultimately controlled from outside of the United States.
Moreover, it would permit an adviser engaging in substantial advisory
activities in the United States to escape our regulatory oversight
merely because the adviser's principal office and place of business is
outside the United States. This consequence seems at odds not only with
section 203(m), but also with the ``foreign private adviser'' exemption
discussed below in which Congress specifically set forth circumstances
under which a non-U.S. adviser may be exempt provided it does not have
any place of business in the United States, among other
conditions.\205\
---------------------------------------------------------------------------

    \204\ Under our proposed rule, assets under management for
purposes of the exemption are those assets for which the adviser
provides ``continuous and regular supervisory or management
services.'' See proposed rule 203(m)-1(e)(1); proposed Form ADV:
Instructions for Part 1A, instr. 5.b(3). For a non-U.S. adviser, the
assets for which the adviser provides such services from a place of
business in the United States would count towards the $150 million
asset threshold under the exemption. See proposed rule 203(m)-
1(b)(2). See also supra note 203 for the definition of ``place of
business'' under proposed rule 203(m)-1(e)(2).
    \205\ See section II.C of this Release.
---------------------------------------------------------------------------

    We request comment on our proposed approach, which is similar to
the way we have administered the current private adviser exemption in
section 203(b)(3) of the Advisers Act with respect to non-U.S.
advisers. Under that exemption (as discussed above), an adviser with a
principal office and place of business outside of the United States
need only count clients that are residents of the United States towards
the 14 client limit.\206\ As with other Commission rules that adopt a
territorial approach, the private adviser exemption is available to a
non-U.S. adviser (regardless of its non-U.S. advisory activities) in
recognition of the fact that non-U.S. activities of non-U.S. advisers
are less likely to implicate U.S. regulatory interests and in
consideration of general principles of international comity.\207\ This
approach to the exemption is designed to encourage the participation of
non-U.S. advisers in the

U.S. market by applying the U.S. securities laws in a manner that does
not impose U.S. regulatory and operational requirements on an adviser's
non-U.S. advisory business.\208\
---------------------------------------------------------------------------

    \206\ Rule 203(b)(3)-1(b)(5) (adviser with principal office and
place of business outside of the United States not required to count
clients that are not United States residents, but adviser with
principal office and place of business is in the United States must
count all clients). Our staff has taken the position that under the
existing private adviser exemption, a non-U.S. adviser need not
count its non-U.S. clients, including an offshore fund, even if
there are U.S. investors in the fund. See ABA Letter, supra note
172, at 2 and discussion infra section II.C.1 of this Release.
    \207\ See, e.g., Regulation S (adopting a territorial approach
to offers and sales of securities); rule 15a-6 under the Exchange
Act (17 CFR 240.15a-6) (providing an exemption from U.S.
registration for non-U.S. broker-dealers who limit their activities
and satisfy certain conditions).
    \208\ See generally Division of Investment Management, SEC,
Protecting Investors: A Half Century of Investment Company
Regulation, May 1992, at 223-227 (recognizing that non-U.S. advisers
that registered with the Commission were arguably subject to all of
the substantive provisions of the Advisers Act with respect to their
U.S. and non-U.S. clients, which could result in inconsistent
regulatory requirements or practices imposed by the regulations of
their local jurisdiction and the U.S. securities laws; in response,
advisers could form separate and independent subsidiaries but this
could result in U.S. clients having access to a limited number of
advisory personnel and reduced access by the U.S. subsidiary to
information or research by non-U.S. affiliates).
---------------------------------------------------------------------------

    Should we adopt a different approach that more broadly applies the
availability of the private fund adviser exemption to U.S. advisers? We
could treat U.S. and non-U.S. advisers alike, in which case a U.S.
adviser could exclude assets it manages through non-U.S. offices. Under
the proposed rule, would some or most advisers with non-U.S. branch
offices re-organize those offices as subsidiaries in order to avoid
attributing assets managed to the non-U.S. office? We understand that
U.S. advisers that manage private fund assets in a non-U.S. country
typically do so through one or more separate subsidiaries organized in
such non-U.S. jurisdictions.\209\ If so, the proposed rule may have a
limited effect on multi-national advisory firms, which for tax or
business reasons keep their non-U.S. advisory activities separate from
their U.S. advisory activities. Is this understanding correct? Such
U.S. advisers would not generally have to count the assets managed by
the non-U.S. affiliates under the proposed rule.\210\ Should our rule
determine ``private fund assets'' on an aggregated basis if, for
example, U.S. and non-U.S. affiliates share advisory duties for a
private fund, or if one affiliate provides subadvisory services to
another affiliate?
---------------------------------------------------------------------------

    \209\ See, e.g., James D. Rosener, Legal Considerations for
Establishing Operations in the United States, Pepper Hamilton LLP,
June 25, 2002, http://www.pepperlaw.com/publications_article.aspx?ArticleKey=186 (creating separate subsidiaries offers
benefits, including the ability to offset profits from one
subsidiary against losses in another); see also Edward F. Greene, et
al., U.S. Regulation of the International Securities and Derivatives
Markets, Sec.  11.02[2].
    \210\ See infra note 270.
---------------------------------------------------------------------------

    Alternatively, should we interpret ``assets under management in the
United States'' by reference to the source of the assets (i.e., U.S.
private fund investors)? Under this approach, a non-U.S. adviser would
count the assets of private funds attributable to U.S. investors
towards the $150 million threshold, regardless of the location where it
manages the private funds. We note that this approach could have the
result that fewer non-U.S. advisers would be eligible for the exemption
if there are significant assets of U.S. investors in those funds that
the advisers manage from a non-U.S. location. This approach could also
mean that a U.S. adviser managing assets from, for example, an office
in New York City, could manage substantially in excess of $150 million
in assets of one or more private funds as long as the investors in
those funds were not U.S persons.
    Do commenters view either of these alternatives, separately or in
combination with our proposed approach, as more closely reflecting the
intent of Congress in using the term ``assets under management in the
United States'' and our regulatory interests? Would either alternative
approach be easier for advisers to comply with than the one we are
proposing to adopt? Would it be easier for investors to understand the
rationale for why an adviser is eligible for the exemption under the
proposed approach or either of the alternative approaches?
4. United States Person
    Under proposed rule 203(m)-1(b), a non-U.S. adviser could not rely
on the exemption if it advised any client that is a United States
person other than a private fund.\211\ We propose to define a ``United
States person'' generally by incorporating the definition of a ``U.S.
person'' in our Regulation S.\212\ Regulation S looks generally to the
residence of an individual to determine whether the individual is a
United States person,\213\ and also addresses the circumstances under
which a legal person, such as a trust, partnership or a corporation, is
a United States person.\214\ Regulation S generally treats legal
partnerships and corporations as Unites States persons if they are
organized or incorporated in the United States, and trusts by reference
to the residence of the trustee.\215\ It treats discretionary accounts
generally as United States persons if the fiduciary is a resident of
the United States.\216\
---------------------------------------------------------------------------

    \211\ Proposed rule 203(m)-1(b)(1).
    \212\ Proposed rule 203(m)-1(e)(8).
    \213\ 17 CFR 230.902(k)(1)(i).
    \214\ See, e.g., 17 CFR 230.902(k)(1) and (2).
    \215\ 17 CFR 230.902(k)(1)(ii) and (iv).
    \216\ 17 CFR 230.902(k)(1)(vii).
---------------------------------------------------------------------------

    We are proposing to incorporate Regulation S because it would
provide a well-developed body of law that would, in our view,
appropriately address many of the questions that will arise under rule
203(m)-1. Moreover, managers to private funds and their counsel must
today be familiar with the definition of ``U.S. person'' under
Regulation S in order to comply with other provisions of the federal
securities laws.\217\ We ask comment on the proposed use of the
Regulation S definition of U.S. person. Should we use a different
definition of United States person? We have previously suggested that
advisers may rely on an alternative to Regulation S for certain types
of clients.\218\ Would that approach be less prone to abuse or
circumvention or provide greater clarity?
---------------------------------------------------------------------------

    \217\ For instance, our staff has generally taken the
interpretive position that an investor that is not a U.S. person
under Regulation S is not a U.S. person when determining whether a
non-U.S. private fund meets the counting or qualification
requirements that apply to U.S. beneficial owners or owners of a
private fund under sections 3(c)(1) or 3(c)(7) of the Investment
Company Act. We understand that many U.S. and non-U.S. advisers
currently follow our staff's guidance and rely on this definition
when determining whether a pooled investment vehicle qualifies as a
private fund. See Goodwin Procter Letter, supra note 175; ABA
Letter, supra note 172. Advisers apply the Regulation S definition
of ``U.S. person'' also for other purposes. See infra note 259.
    \218\ In connection with adopting rule 203(b)(3)-2 under the
Advisers Act, we previously noted that commenters had suggested that
we incorporate the definition of U.S. person from Regulation S.
Pending our reconsideration of the use of the Regulation S
definition, we indicated at the time that we would not object if
advisers identified U.S. persons by looking: ``(i) In the case of
individuals to their residence, (ii) in the case of corporations and
other business entities to their principal office and place of
business, (iii) in the case of personal trusts and estates to the
rules set out in Regulation S, and (iv) in the case of discretionary
or non-discretionary accounts managed by another investment adviser
to the location of the person for whose benefit the account is
held.'' See Hedge Fund Adviser Registration Release, supra note 17,
at n.201. We reconsidered the use of Regulation S and concluded it
is appropriate as modified in our proposed rule.
---------------------------------------------------------------------------

    Proposed rule 203(m)-1 contains a special rule for discretionary
accounts maintained outside of the United States for the benefit of
United States persons.\219\ Under the proposed rule, an adviser must
treat a discretionary or other fiduciary account as a United States
person if the account is held for the benefit of a United States person
by a non-U.S. fiduciary who is a related person of the adviser. An
adviser could not rely on the exemption if it established discretionary
accounts for the benefit of U.S. clients with an offshore affiliate
that would then delegate the actual management of the account back to
the adviser.\220\ We request comment on this special rule. Does our
proposed rule adequately

address the concern that an adviser could avoid the limitation of the
exemption through non-U.S. discretionary accounts?
---------------------------------------------------------------------------

    \219\ Proposed rule 203(m)-1(e)(8).
    \220\ Under Regulation S, a discretionary account maintained by
a non-U.S. fiduciary (such as an investment adviser) is not a ``U.S.
person'' even if the account is owned by a U.S. person. See rule
902(k)(1)(vii); rule 902(k)(2)(i).
---------------------------------------------------------------------------

5. Transition Rule
    We propose to include in proposed rule 203(m)-1 a provision giving
an adviser one calendar quarter (three months) to register with the
Commission after becoming ineligible to rely on the exemption due to an
increase in the value of its private fund assets.\221\ Because
qualification for the exemption depends on remaining below the $150
million threshold on a quarterly basis, an adviser could exceed the
limit based on market fluctuations without any new investments from
existing or new investors. This three month period would enable the
adviser to take steps to register and otherwise come into compliance
with the requirements of the Advisers Act applicable to registered
investment advisers, including the adoption and implementation of
compliance policies and procedures.\222\ It would be available only to
an adviser that has complied with all applicable Commission reporting
requirements.\223\ We are not required to provide the safe harbor, and
we do not believe it would be appropriate for an adviser to rely on it
if the adviser has failed to comply with its reporting requirements. We
request comment on this transition period. Is the calendar quarter
period sufficient? Should the transition period be longer, such as two
calendar quarters, or shorter, such as 30 days? If the adviser
determines to expand its advisory business to manage assets other than
private funds (e.g., separate accounts), should the transition period
also be available? Should a transition period be available at all?
---------------------------------------------------------------------------

    \221\ Proposed rule 203(m)-1(d). In effect, an adviser would
register by the end of the calendar quarter following the quarter-
end date at which private fund assets equaled or exceeded $150
million. If, however, on the succeeding calendar quarter end date,
private fund assets have declined below $150 million, then
registration would not be required.
    \222\ See rule 206(4)-7.
    \223\ See proposed rule 203(m)-1(d); see also, e.g., proposed
rule 204-4 under the Advisers Act (discussed in the Implementing
Release, supra note 25, at section II.B).
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C. Foreign Private Advisers

    Section 403 of the Dodd-Frank Act replaces the current private
adviser exemption from registration under the Advisers Act with a new
exemption for a ``foreign private adviser,'' as defined in new section
202(a)(30).\224\ The new exemption is codified as amended section
203(b)(3).
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    \224\ Section 402 of the Dodd-Frank Act (providing a definition
of ``foreign private adviser,'' to be codified at section 202(a)(30)
of the Advisers Act). See supra note 23 and accompanying text.
---------------------------------------------------------------------------

    Under section 202(a)(30), a foreign private adviser is any
investment adviser that: (i) Has no place of business in the United
States; (ii) has, in total, fewer than 15 clients in the United States
and investors in the United States in private funds advised by the
investment adviser; (iii) has aggregate assets under management
attributable to clients in the United States and investors in the
United States in private funds advised by the investment adviser of
less than $25 million; \225\ and (iv) does not hold itself out
generally to the public in the United States as an investment
adviser.\226\ Section 202(a)(30) provides the Commission with authority
to increase the $25 million threshold ``in accordance with the purposes
of this title.'' \227\
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    \225\ Subparagraph (B) of section 202(a)(30) refers to the
number of ``clients and investors in the United States in private
funds,'' while subparagraph (C) refers to assets of ``clients in the
United States and investors in the United States in private funds''
(emphasis added). We interpret these provisions consistently so that
only clients in the United States and investors in the United States
should be counted for purposes of subparagraph (B).
    \226\ In addition, the exemption is not available to an adviser
that ``acts as (I) an investment adviser to any investment company
registered under the [Investment Company Act]; or (II) a company
that has elected to be a business development company pursuant to
section 54 of [that Act] and has not withdrawn its election.''
Section 202(a)(30)(D)(ii). We interpret subparagraph (II) to prevent
an adviser that advises a business development company from relying
on the exemption.
    \227\ Section 202(a)(30)(C).
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    We are proposing a new rule, 202(a)(30)-1, which would define
certain terms in section 202(a)(30) for use by advisers seeking to
avail themselves of the foreign private adviser exemption. Because
eligibility for the new foreign private adviser exemption, like the
current private adviser exemption, is determined, in part, by the
number of clients an adviser has, we propose to include in rule
202(a)(30)-1 the safe harbor rules and many of the client counting
rules that appear in rule 203(b)(3)-1, as currently in effect.\228\ In
addition, we propose to define other terms used in the definition of
``foreign private adviser'' in section 202(a)(30), including: (i)
``investor;'' (ii) ''in the United States;'' (iii) ``place of
business;'' and (iv) ``assets under management.'' \229\
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    \228\ Rule 203(b)(3)-1, as currently in effect, provides a safe
harbor for determining who may be deemed a single client for
purposes of the private adviser exemption. We would not, however,
carry over from rule 203(b)(3)-1 a provision that distinguishes
between advisers whose principal places of business are inside or
outside of the United States. Under the definition of ``foreign
private adviser,'' an adviser may not have any place of business in
the United States. See section 402 of the Dodd-Frank Act (defining
``foreign private adviser''); rule 203(b)(3)-1(b)(5). We would also
not include rule 203(b)(3)-1(b)(7), which specifies that a client
who is an owner of a private fund is a resident where the client
resides at the time of the client's investment in the fund. The
provision was vacated by Goldstein. See supra note 18. As discussed
below, we are proposing to include another, similar, provision in
rule 202(a)(30)-1, which would apply to both clients and investors
for purposes of the foreign private adviser exemption. See infra
note 257 and accompanying text.
    \229\ Proposed rule 202(a)(30)-1(c).
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1. Clients
    For purposes of the definition of ``foreign private adviser,''
proposed rule 202(a)(30)-1 would include the safe harbor for counting
clients currently in rule 203(b)(3)-1, as modified to account for its
use in the foreign private adviser context and to eliminate a provision
allowing advisers not to count those clients from which they receive no
compensation. We note, however, that the foreign private adviser
exemption provides a much more limited exemption in this regard than
our current rule 203(b)(3)-1 because section 202(a)(30) requires an
adviser to also count the number of ``investors'' of an issuer that is
a ``private fund'' (a term that is defined in section 202(a)(29))
managed by the adviser.\230\
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    \230\ See supra note 9.
---------------------------------------------------------------------------

    Specifically, proposed rule 202(a)(30)-1, like current rule
203(b)(3)-1, would allow an adviser to treat as a single client a
natural person and: (i) That person's minor children (whether or not
they share the natural person's principal residence); (ii) any
relative, spouse, or relative of the spouse of the natural person who
has the same principal residence; (iii) all accounts of which the
natural person and/or the person's minor child or relative, spouse, or
relative of the spouse who has the same principal residence are the
only primary beneficiaries; and (iv) all trusts of which the natural
person and/or the person's minor child or relative, spouse, or relative
of the spouse who has the same principal residence are the only primary
beneficiaries.\231\ Proposed rule 202(a)(30)-1 would also retain other
provisions of rule 203(b)(3)-1 that permit an adviser to treat as a
single ``client'' (i) a corporation, general partnership, limited
partnership, limited liability company, trust, or other legal
organization to which the adviser provides investment advice based on
the organization's investment objectives, and (ii) two or more legal
organizations

that have identical shareholders, partners, limited partners, members,
or beneficiaries.\232\
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    \231\ Proposed rule 202(a)(30)-1(a)(1). If a client relationship
involving multiple persons does not fall within the rule, the
question of whether the relationship may appropriately be treated as
a single ``client'' must be determined on the basis of the facts and
circumstances involved.
    \232\ Proposed rule 202(a)(30)-1(a)(2). In addition, proposed
rule 202(a)(30)-1(b)(1) through (3) would retain the following
related ``special rules'': (1) An adviser must count a shareholder,
partner, limited partner, member, or beneficiary (each, an
``owner'') of a corporation, general partnership, limited
partnership, limited liability company, trust, or other legal
organization, as a client if the adviser provides investment
advisory services to the owner separate and apart from the legal
organization; (2) an adviser is not required to count an owner as a
client solely because the adviser, on behalf of the legal
organization, offers, promotes, or sells interests in the legal
organization to the owner, or reports periodically to the owners as
a group solely with respect to the performance of or plans for the
legal organization's assets or similar matters; and (3) any general
partner, managing member or other person acting as an investment
adviser to a limited partnership or limited liability company must
treat the partnership or limited liability company as a client.
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    We would not include the ``special rule'' providing advisers with
the option of not counting as a client any person for whom the adviser
provides investment advisory services without compensation.\233\ As
noted above, we propose to require advisers to include the assets of
such clients in their ``regulatory assets under management,'' \234\ and
we propose the same approach with respect to counting clients.\235\
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    \233\ See rule 203(b)(3)-1(b)(4).
    \234\ In the Implementing Release, we are proposing to adopt a
uniform method for calculating assets under management for purposes
of registration pursuant to which an adviser would count assets that
are managed without compensation. In this Release, we propose to
apply the proposed method of calculation to the foreign private
adviser exemption and the private fund adviser exemption. See infra
section II.C.5 of this Release; Implementing Release, supra note 25,
at section II.A.3.
    \235\ As discussed in the Implementing Release, our proposed
changes to the method of calculating assets under management would
remove the option of excluding certain assets from an adviser's
calculation in order to avoid registration with the Commission and
regulatory requirements associated with registration. See
Implementing Release, supra note 25, nn.44-50 and accompanying and
following text. Allowing an adviser not to count as clients persons
in the United States that do not compensate the adviser would
similarly allow certain advisers to avoid registration through
reliance on the foreign private adviser exemption despite the fact
that the adviser provides advisory services to such persons.
---------------------------------------------------------------------------

    Finally, we propose to add a provision that would avoid double-
counting private funds and their investors by advisers.\236\ This
provision would specify that an adviser need not count a private fund
as a client if the adviser counted any investor, as defined in the
rule, in that private fund as an investor in that private fund for
purposes of determining the availability of the exemption.\237\
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    \236\ See proposed rule 202(a)(30)-1(b)(4).
    \237\ See proposed rule 202(a)(30)-1(b)(4); 202(a)(30)-1(c)(1).
See also infra section II.C.2 of this Release (discussing the
definition of investor).
---------------------------------------------------------------------------

    We are proposing to include the current rule 203(b)(3)-1 safe
harbor for counting clients in proposed rule 202(a)(30)-1 because we
believe that application of this provision (as we propose to modify it)
will operate to effect the purposes of the foreign private adviser
exemption. Congress replaced the private adviser exemption with the
foreign private adviser exemption, both of which require advisers to
count clients. As Congress was aware of rule 203(b)(3)-1's counting
guidelines when it incorporated a limitation on the number of
``clients'' in the definition of ``foreign private adviser,'' we
believe it would be consistent with Congress's amendment to preserve
generally the method for counting clients, together with the
requirement to count clients.
    We request comment generally on our approach to counting
``clients'' in proposed rule 202(a)(30)-1 and on each of the specific
proposed provisions. Is it appropriate to derive the definition of
``client'' in proposed rule 202(a)(30)-1 from rule 203(b)(3)-1's
definition? Are there alternative approaches we should consider
instead? Is including the ``special rules'' in proposed rule 202(a)
(30)-1 appropriate? Are there any that are not appropriate in this
context and should not be included in the proposed rule? In particular,
should we have maintained the special rule allowing an adviser not to
count as a client any person for whom the adviser provides investment
advisory services without compensation, even though such person may be
treated as a client for other purposes (e.g., reporting on Form ADV)?
Should we modify the proposed rule that allows an adviser not to count
a private fund as a client if it counts any investor in that private
fund by also providing that an adviser may avoid counting as a client
any person it counts as an investor? Finally, are there any further
modifications to the definition that we should make?
2. Private Fund Investor
    Section 202(a)(30) provides that a ``foreign private adviser''
eligible for the new registration exemption cannot have more than 14
clients ``or investors in the United States in private funds'' advised
by the adviser. We propose to define ``investor'' in a private fund in
rule 202(a)(30)-1 as any person who would be included in determining
the number of beneficial owners of the outstanding securities of a
private fund under section 3(c)(1) of the Investment Company Act, or
whether the outstanding securities of a private fund are owned
exclusively by qualified purchasers under section 3(c)(7) of that
Act.\238\ In order to avoid double-counting, an adviser would be able
to treat as a single investor any person who is an investor in two or
more private funds advised by the investment adviser.\239\
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    \238\ See proposed rule 202(a)(30)-1(c)(1); supra notes 8-13 and
accompanying text. Under the proposed rule, knowledgeable employees
with respect to the private fund (and certain persons related to
them) and beneficial owners of short-term paper issued by the
private fund would also count as investors. See infra note 246 and
accompanying text.
    \239\ See proposed rule 202(a)(30)-1(c)(1), at note to paragraph
(c)(1).
---------------------------------------------------------------------------

    The term ``investor'' is not currently defined under the Advisers
Act or the rules under the Advisers Act. Defining the term as proposed
would ensure consistent application of the statutory provision and
prevent, for example, non-U.S. advisers from circumventing the
limitations in section 203(b)(3) by using nominee accounts that would
aggregate investors into a single nominal investor for purposes of the
counting requirement of section 202(a)(30). Under section 203(b)(3), an
adviser relying on the foreign private adviser exemption may only have
advisory relationships with private funds with a limited number of U.S.
investors. Advisers should not be able to avoid this limitation by
setting up intermediate accounts through which investors may access a
private fund and not be counted for purposes of the exemption.
    Defining investors by reference to sections 3(c)(1) and 3(c)(7) of
the Investment Company Act may best achieve these purposes. Funds and
their advisers must determine who is a beneficial owner for purposes of
section 3(c)(1) or whether an owner is a qualified purchaser for
purposes of section 3(c)(7).\240\ Typically, a prospective investor in
a private fund must complete a subscription agreement that includes
representations or confirmations that it is qualified to invest in the
fund and whether it is a U.S. person. This information is designed to
allow the adviser (on behalf of the fund) to make the above
determination. Therefore, an adviser seeking to rely on the foreign
private adviser exemption will have ready access to this information.
---------------------------------------------------------------------------

    \240\ See supra notes 11 and 13.
---------------------------------------------------------------------------

    More important, defining the term ``investor'' by reference to
sections 3(c)(1) and 3(c)(7) appears to appropriately limit the ability
of a non-U.S. adviser to avoid application of the registration
provisions of the Advisers Act. For example, under the proposed rule,
holders of both equity and debt securities would be counted as

investors.\241\ Advisers, moreover, would have to ``look though''
nominee and similar arrangements to the underlying holders of private
fund-issued securities to determine whether they have fewer than 15
clients and private fund investors in the United States.\242\
---------------------------------------------------------------------------

    \241\ Sections 3(c)(1) and 3(c)(7) of the Investment Company Act
refer to beneficial owners and owners, respectively, of
``securities'' (which is broadly defined in section 2(a)(36) of that
Act to include debt and equity).
    \242\ Proposed rule 202(a)(30)-1(c)(1). See generally sections
3(c)(1) and 3(c)(7) of the Investment Company Act.
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    Under the proposed rule, an adviser would determine the number of
investors in a private fund based on facts and circumstances and in
light of the applicable prohibition not to do indirectly, or through or
by any other person, what is unlawful to do directly.\243\ In the
following circumstances, for example, an adviser relying on the
exemption would have to count as an investor a person who is not the
nominal owner of a private fund's securities. First, the adviser to a
master fund in a master-feeder arrangement would have to treat as
investors the holders of the securities of any feeder fund formed or
operated for the purpose of investing in the master fund rather than
the feeder funds, which act as conduits.\244\ Second, an adviser would
need to count as an investor any holder of an instrument, such as a
total return swap, that effectively transfers the risk of investing in
the private fund from the record owner of the private fund's
securities. The record owner of private fund securities could enter
into a total return swap transaction to transfer to a third party any
profits or losses that the record owner could incur as a result of its
investment in the private fund. Thus, even though the record owner
would remain the nominal owner of private fund securities, the
associated risks of an investment in the securities would have been
transferred to the third party who has made the determination to invest
in the private fund indirectly through the record owner. In such a
case, the third party would be counted as a beneficial owner under
section 3(c)(1), or be required to be a qualified purchaser under
section 3(c)(7).\245\ Accordingly, the third party would be counted as
an investor in the private fund for purposes of the foreign private
adviser exemption.
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    \243\ See section 208(d) of the Advisers Act.
    \244\ A ``master-feeder fund'' is an arrangement in which one or
more funds with identical investment objectives (``feeder funds'')
invest all of their assets in a single fund (``master fund'') with
the same investment objective and strategies. We have taken the same
approach within our rules that expressly require a private fund to
``look-through'' any investor that is formed for the specific
purpose of investing in a private fund. See rule 2a51-3(a) under the
Investment Company Act (17 CFR 270.2a51-3(a)) (a company is not a
qualified purchaser if it is ``formed for the specific purpose of
acquiring the securities'' of an investment company that is relying
on section 3(c)(7) of the Investment Company Act, unless each of the
company's beneficial owners is also a qualified purchaser). See also
Privately Offered Investment Companies, Investment Company Act
Release No. 22597 (Apr. 3, 1997) [62 FR 17512 (Apr. 9, 1997)]
(``NSMIA Release'') (explaining that rule 2a51-3(a) would limit the
possibility that ``a company will be able to do indirectly what it
is prohibited from doing directly [by organizing] * * * a `qualified
purchaser' entity for the purpose of making an investment in a
particular Section 3(c)(7) Fund available to investors that
themselves did not meet the definition of `qualified purchaser.'
'').
    \245\ As noted above, we have recognized that in certain
circumstances it is appropriate to ``look through'' an investor
(i.e., attribute ownership of a private fund to another person who
is the ultimate owner). See, e.g., NSMIA Release, supra note 244
(``The Commission understands that there are other forms of holding
investments that may raise interpretative issues concerning whether
a Prospective Qualified Purchaser `owns' an investment. For
instance, when an entity that holds investments is the `alter ego'
of a Prospective Qualified Purchaser (as in the case of an entity
that is wholly owned by a Prospective Qualified Purchaser who makes
all the decisions with respect to such investments), it would be
appropriate to attribute the investments held by such entity to the
Prospective Qualified Purchaser.'').
---------------------------------------------------------------------------

    We are also proposing to treat as investors beneficial owners (i)
who are ``knowledgeable employees'' with respect to the private fund,
and certain other persons related to such employees (we refer to these,
collectively, as ``knowledgeable employees''); \246\ and (ii) of
``short-term paper'' \247\ issued by the private fund,\248\ even though
these persons are not counted as beneficial owners for purposes of
section 3(c)(1), and knowledgeable employees are not required to be
qualified purchasers under section 3(c)(7).\249\ We are proposing to
count knowledgeable employees as investors under the same approach we
take with our proposal that advisers count in their calculation of
assets under management assets they manage without being compensated,
which often include assets of knowledgeable employees.\250\ Under our
proposed rule, holders of short-term paper, like other debt holders,
would also be counted as investors because a private fund's losses
directly affect these holders' interest in the fund just as they affect
the interest of other debt holders in the fund.\251\
---------------------------------------------------------------------------

    \246\ See proposed rule 202(a)(30)-1(c)(1)(A) (referencing rule
3c-5 under the Investment Company Act (17 CFR 270.3c-5(b)), which
excludes from the determinations under sections 3(c)(1) and 3(c)(7)
of that Act any securities beneficially owned by knowledgeable
employees of a private fund; a company owned exclusively by
knowledgeable employees; and any person who acquires securities
originally acquired by a knowledgeable employee through certain
transfers of interests, such as a gift or a bequest).
    \247\ See proposed rule 202(a)(30)-1(c)(1)(B) (referencing the
definition of ``short-term paper'' contained in section 2(a)(38) of
the Investment Company Act, which defines ``short-term paper'' to
mean ``any note, draft, bill of exchange, or banker's acceptance
payable on demand or having a maturity at the time of issuance of
not exceeding nine months, exclusive of days of grace, or any
renewal thereof payable on demand or having a maturity likewise
limited; and such other classes of securities, of a commercial
rather than an investment character, as the Commission may designate
by rules and regulations.'')
    \248\ See proposed rule 202(a)(30)-1(c)(1).
    \249\ See section 3(c)(1) of the Investment Company Act; rule
3c-5(b) under the Investment Company Act.
    \250\ See supra note 190. As discussed above, our proposed
changes to the method of calculating assets under management would
preclude some advisers from excluding certain assets from their
calculation in order to avoid registration with the Commission and
regulatory requirements associated with registration. Allowing an
adviser not to count as investors persons that do not compensate the
adviser, such as knowledgeable employees, would similarly allow
certain advisers to avoid registration by relying on the foreign
private adviser exemption.
    \251\ Various types of investment vehicles make significant use
of short-term paper for financing purposes so holders of this type
of security are, in practice, exposed to the investment results of
the security's issuer. See Money Market Fund Reform Release, supra
note 134, at nn. 37-39 and preceding and accompanying text
(discussing how money market funds were exposed to substantial
losses during 2007 as a result of exposure to debt securities issued
by structured investment vehicles).
---------------------------------------------------------------------------

    We request comment on our definition of ``investor.'' Does the term
require further definition? Does our definition of ``investor''
appropriately reflect Congress's intent in providing an exemption for
foreign private advisers? Under our proposal, advisers would not be
able to consolidate investors for counting purposes in the same manner
they would be able to consolidate clients under certain circumstances.
Should we consider extending to investors the ``special rules'' for
counting clients under proposed rule 202(a)(30)-1? Would this lead to
either under-counting or over-counting of investors? Is it appropriate
to count as a single investor a person that invests in two or more
private funds advised by the adviser? Is it appropriate to treat as
investors beneficial owners who are ``knowledgeable employees'' with
respect to the private fund, and of short-term paper issued by the
fund?
3. In the United States
    Section 202(a)(30)'s definition of ``foreign private adviser''
employs the term ``in the United States'' in several contexts
including: (i) Limiting the number of--and assets under management
attributable to--an adviser's ``clients'' ``in the United States'' and
``investors'' ``in the United States'' in private funds advised by the
adviser; (ii) exempting only those advisers without

a place of business ``in the United States''; and (iii) exempting only
those advisers that do not hold themselves out to the public ``in the
United States'' as an investment adviser.\252\ We are proposing to
define ``in the United States'' to provide clarification of the term
for all of the above purposes as well as provide specific instruction
as to the relevant time for making the related determination.
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    \252\ See section 402 of the Dodd-Frank Act.
---------------------------------------------------------------------------

    Proposed rule 202(a)(30)-1 defines ``in the United States''
generally by incorporating the definition of a ``U.S. person'' and
``United States'' under Regulation S.\253\ In particular, we would
define ``in the United States'' in proposed rule 202(a)(30)-1(c)(2) to
mean: (i) With respect to any place of business located in the ``United
States,'' as that term is defined in Regulation S; \254\ (ii) with
respect to any client or private fund investor in the United States,
any person that is a ``U.S. person'' as defined in Regulation S,\255\
except that any discretionary account or similar account that is held
for the benefit of a person ``in the United States'' by a non-U.S.
dealer or other professional fiduciary is deemed ``in the United
States'' if the dealer or professional fiduciary is a related person of
the investment adviser relying on the exemption; and (iii) with respect
to the public in the ``United States,'' as that term is defined in
Regulation S.\256\ In addition, we are proposing to add a note to
paragraph (c)(2)(i) specifying that for purposes of that definition, a
person that is ``in the United States'' may be treated as not being
``in the United States'' if such person was not ``in the United
States'' at the time of becoming a client or, in the case of an
investor in a private fund, at the time the investor acquires the
securities issued by the fund.\257\ We believe that without this note
this rule might be burdensome because an adviser would have to monitor
the location of clients and investors on an ongoing basis, and might
have to choose between registering with us or terminating the
relationship with any client that moved to the United States, or
redeeming the interest in the private fund of any investor that moved
to the United States.
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    \253\ Proposed rule 202(a)(30)-1(c)(2). As discussed above, we
are also proposing to reference Regulation S's definition of a
``U.S. person'' for purposes of the definition of ``United States
person'' in rule 203(m)-1. See sections II.B.3 and II.B.4 of this
Release (discussing proposed rules 203(m)-1(e)(7) through (8)).
    \254\ See 17 CFR 230.902(l).
    \255\ See 17 CFR 230.902(k).
    \256\ See 17 CFR 230.902(l).
    \257\ Proposed rule 202(a)(30)-1, at note to paragraph (c)(2)(i)
(``A person that is in the United States may be treated as not being
in the United States if such person was not in the United States at
the time of becoming a client or, in the case of an investor in a
private fund, at the time the investor acquires the securities
issued by the fund.'').
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    We believe that the use of Regulation S is appropriate for purposes
of the foreign private adviser exemption because Regulation S provides
more specific rules when applied to various types of legal
structures.\258\ Advisers, moreover, already apply the Regulation S
definition of U.S. person with respect to both clients and investors
for other purposes and therefore are familiar with the definition.\259\
The proposed references to Regulation S with respect to a place of
business ``in the United States'' and the public in the ``United
States'' would also allow us to maintain consistency across our rules.
---------------------------------------------------------------------------

    \258\ See supra notes 214-216 and accompanying text. See also
Letter of Paul, Hastings, Janofsky & Walker LLP (Oct. 29, 2010)
(``Paul Hastings Letter'') (addressing the foreign private adviser
exemption in response to our request for public views, and
recommending that we rely on a modified Regulation S definition of
``U.S. person'' for purposes of defining ``in the United States''
with respect to clients and investors). See generally supra note 24.
    \259\ Many non-U.S. advisers identify whether a client is a
``U.S. person'' under Regulation S in order to determine whether
such client may invest in certain private funds and certain private
placement offerings exempt from registration under the Securities
Act. With respect to ``investors,'' our staff has generally taken
the interpretive position that an investor that does not meet that
definition is not a U.S. person when determining whether a non-U.S.
private fund meets the section 3(c)(1) and 3(c)(7) counting or
qualification requirements. See supra note 217. Many non-U.S.
advisers, moreover, currently determine whether a private fund
investor is a ``U.S. person'' under Regulation S for purposes of the
safe harbor for offshore offers and sales.
---------------------------------------------------------------------------

    Similar to our approach in proposed rule 203(m)-1(e)(8),\260\ we
treat as persons ``in the United States'' for purposes of the foreign
private adviser, certain persons that would not be considered ``U.S.
persons'' under Regulation S. We are proposing to treat as a U.S.
person discretionary accounts owned by a U.S. person and managed by a
non-U.S. affiliate of the adviser in order to discourage non-U.S.
advisers from creating such discretionary accounts with the goal of
circumventing the exemption's limitation with respect to persons in the
United States.\261\
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    \260\ See supra discussion in section II.B.4 of this Release
regarding the definition of United States persons and the treatment
of discretionary accounts.
    \261\ See supra notes 219-220 and accompanying paragraph.
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    We request comment on the definition of ``in the United States'' in
proposed rule 202(a)(30)-1(c)(2). Is our definition appropriate as it
relates to a ``place of business?'' Is it appropriate as it relates to
``clients'' and ``investors in a private fund?'' Is it appropriate as
it relates to the ``public?'' Is it necessary to define ``in the United
States'' for purposes of the definition of ``foreign private adviser''
in new section 202(a)(30)? Is our understanding of non-U.S. advisers'
application of the Regulation S definition correct? Since private funds
already rely on the Regulation S definition of U.S. person to determine
which investors must qualify to invest in the fund, would adopting a
different definition increase regulatory burdens associated with
determining eligibility for the proposed exemption? \262\ Are there
alternatives that would better reflect the intent of Congress in
creating a new category of ``foreign private advisers'' and providing
them with an exemption from registration? Is our proposed note
regarding the relevant time for determining whether a person is ``in
the United States'' appropriate? If not, how should we modify it?
---------------------------------------------------------------------------

    \262\ See supra note 217 and accompanying and following text.
---------------------------------------------------------------------------

4. Place of Business
    Proposed rule 203(a)(30)-1, by reference to proposed rule 222-
1,\263\ defines ``place of business'' to mean any office where the
investment adviser regularly provides advisory services, solicits,
meets with, or otherwise communicates with clients, and any location
held out to the public as a place where the adviser conducts any such
activities.\264\ We believe this definition appropriately identifies a
location where an adviser is doing business for purposes of section
202(a)(30) of the Advisers Act and thus provides a basis for an adviser
to determine whether it can rely on the exemption in section 203(b)(3)
of the Advisers Act for foreign private advisers. Because both the
Commission and the state securities authorities use this definition to
identify an unregistered foreign adviser's place of business for
purposes of determining regulatory jurisdiction,\265\ it appears to be
logical as well as efficient to use the rule 222-1(a) definition of
``place of

business'' for purposes of the foreign private adviser exemption.
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    \263\ Rule 222-1(a) (defining ``place of business'' of an
investment adviser as: ``(1) An office at which the investment
adviser regularly provides investment advisory services, solicits,
meets with, or otherwise communicates with clients; and (2) Any
other location that is held out to the general public as a location
at which the investment adviser provides investment advisory
services, solicits, meets with, or otherwise communicates with
clients.'').
    \264\ Proposed rule 202(a)(30)-1(c)(3).
    \265\ Under section 222(d) of the Advisers Act, a state may not
require an adviser to register if the adviser does not have a
``place of business'' within, and has fewer than six clients
resident in, the state.
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    We request comment on our definition of ``place of business'' as it
relates to the definition of ``foreign private adviser.'' Is this
definition of ``place of business'' appropriate in this context? Do
commenters recommend any alternative definitions?
5. Assets Under Management
    For purposes of rule 202(a)(30)-1 we propose to define ``assets
under management'' by reference to the calculation of ``regulatory
assets under management'' for Item 5 of Form ADV.\266\ As discussed
above, in Item 5 of Form ADV we are proposing to implement a uniform
method of calculating assets under management that can be used for
several purposes under the Advisers Act, including the foreign private
adviser exemption.\267\ Because the foreign private adviser exemption
is also based on assets under management, we believe that all advisers
should use the same method for calculating assets under management to
determine if they are required to register or may be eligible for the
exemption. We believe that uniformity in the method for calculating
assets under management would result in more consistent asset
calculations and reporting across the industry and, therefore, in a
more coherent application of the Advisers Act's regulatory requirements
and of our staff's risk assessment program.\268\
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    \266\ See proposed rule 202(a)(30)-1(c)(4); instructions to Item
5.F of Form ADV, Part 1A. As discussed above, we are proposing to
take the same approach under proposed rule 203(m)-1. See supra
section II.B.2 of this Release.
    \267\ See supra note 190 and accompanying text.
    \268\ Id. See also Letter of Shearman and Sterling LLP (Nov. 3,
2010) (``Shearman & Sterling Letter'') (in response to our request
for public views, arguing that ``[w]hile each [exemption related
asset threshold established by the Dodd-Frank Act] serves a
different purpose, it appears to us that any steps that might be
taken in the way of harmonization will facilitate both compliance
with the requirements by the industry and their administration by
the Commission and its Staff,'' and suggesting that as an example,
we raise the assets under management threshold under the foreign
private adviser exemption to $150 million in line with the assets
threshold under the private fund adviser exemption). See generally
supra note 24.
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    We request comment on our definition of ``assets under management''
as it relates to the definition of ``foreign private adviser.'' Is this
definition of ``assets under management'' appropriate in this context?
Are there any special considerations relevant to foreign private
advisers? Do commenters recommend any alternative definitions? Should
assets under management be calculated at a particular point of time?
Should we, as proposed, require foreign private advisers to calculate
assets under management consistent with the proposed ``regulatory
assets under management'' calculation for Form ADV? Or should we
require a different calculation? For example, should foreign private
advisers be permitted to exclude proprietary assets or assets they
manage without compensation?

D. Subadvisory Relationships and Advisory Affiliates

    We generally interpret advisers as including subadvisers,\269\ and
therefore believe it is appropriate to permit subadvisers to rely on
each of the new exemptions, provided that subadvisers satisfy all terms
and conditions of the applicable proposed rules. We are aware that in
many subadvisory relationships a subadviser has contractual privity
with a private fund's primary adviser rather than the private fund
itself. Although both the private fund and the fund's primary adviser
may be viewed as clients of the subadviser, we would consider a
subadviser eligible to rely on section 203(m) if the subadviser's
services to the primary adviser relate solely to private funds and the
other conditions of the exemptions are met. Similarly, a subadviser may
be eligible to rely on section 203(l) if the subadviser's services to
the primary adviser relate solely to venture capital funds and the
other conditions of the rule are met.
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    \269\ See, e.g., Pay to Play Release, supra note 10, at n.391-94
and accompanying and following text; Hedge Fund Adviser Registration
Release, supra note 17, at n.243.
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    We anticipate that an adviser with advisory affiliates will
encounter interpretative issues as to whether it may rely on any of the
exemptions discussed in this Release without taking into account the
activities of its affiliates. The adviser, for example, might have
advisory affiliates that are registered or that provide advisory
services that are inconsistent with an exemption on which the adviser
may seek to rely.\270\ We request comment on whether any proposed rule
should provide that an adviser must take into account the activities of
its advisory affiliates when determining eligibility for an exemption.
For example, should the rule specify that the exemption is not
available to an affiliate of a registered investment adviser? \271\
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    \270\ Generally, a separately formed advisory entity that
operates independently of an affiliate may be eligible for an
exemption if it meets all of the criteria set forth in the relevant
rule. However, the existence of separate legal entities may not by
itself be sufficient to avoid integration of the affiliated
entities. The determination of whether the advisory businesses of
two separately formed affiliates may be required to be integrated is
based on the facts and circumstances. Our staff has taken this
position in Richard Ellis, Inc., SEC Staff No-Action Letter (Sept.
17, 1981) (discussing the staff's views of factors relevant to the
determination of whether a separately formed advisory entity
operates independently of an affiliate).
    \271\ We have received a number of letters requesting
interpretative guidance on whether and to what extent certain prior
staff positions would apply to the new exemptions provided by the
Dodd-Frank Act. See, e.g., Letter of Katten Muchin Rosenman LLP
(Sept. 14, 2010); Letter of TA Jones (Sept. 25, 2010); Letter of
Ropes & Gray LLP (Nov. 1, 2010) in response to our solicitation for
public views. See generally supra note 24. We acknowledge that such
determinations will depend on the particular facts and circumstances
of non-U.S. advisers. Advisers should consider whether they may
avail themselves of either the foreign private adviser exemption or
the private fund adviser exemption as proposed in this Release, and
are encouraged to submit comment letters addressing with
particularity and specificity interpretative issues that may not be
addressed in our proposed rules.
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III. Request for Comment

    The Commission requests comment on the proposed rules in this
Release. We also request suggestions for additional changes to existing
rules, and comments on other matters that might have an effect on the
proposals contained in this Release. Commenters are requested to
provide empirical data to support their views.

IV. Paperwork Reduction Act Analysis

    The proposed rules do not contain a ``collection of information''
requirement within the meaning of the Paperwork Reduction Act of
1995.\272\ Accordingly, the Paperwork Reduction Act is not applicable.
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    \272\ 44 U.S.C. 3501.
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V. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by
its rules. We have identified certain costs and benefits of the
proposed rules, and we request comment on all aspects of this cost-
benefit analysis, including identification and assessment of any costs
and benefits not discussed in this analysis. We seek comment and data
on the value of the benefits identified. We also welcome comments on
the accuracy of the cost estimates in this analysis, and request that
commenters provide data that may be relevant to these cost estimates.
In addition, we seek estimates and views regarding these benefits and
costs for advisers solely to venture capital funds, private fund
advisers with less than $150 million in aggregate assets under
management and foreign private advisers as well as any other costs or
benefits that may result from the adoption of the proposed rules. Where
possible, we request commenters

provide empirical data to support any positions advanced.
    As discussed above, we are proposing rules 203(l)-1, 203(m)-1 and
202(a)(30)-1 to implement certain provisions of the Dodd-Frank Act. As
a result of the Dodd-Frank Act's repeal of the private adviser
exemption, some advisers that previously were eligible to rely on that
exemption will be required to register under the Advisers Act unless
these advisers are eligible for a new exemption. Thus, the benefits and
costs associated with registration are attributable to the Dodd-Frank
Act. The Commission has discretion, however, to adopt rules to define
the terms used in the Advisers Act, and we undertake below to discuss
the benefits and costs of the defined terms that we are proposing.

A. Definition of Venture Capital Fund

    Our proposed rule is designed to: (i) implement the directive from
Congress to define the term venture capital fund in a manner that
reflects Congress' understanding of what venture capital funds are, and
as distinguished from other private equity funds and hedge funds; and
(ii) facilitate the transition to the new exemption. Our proposal would
define the term venture capital fund consistently with what we believe
Congress understood venture capital funds to be, and in light of other
provisions of the federal securities laws that seek to achieve similar
objectives.\273\
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    \273\ See supra notes 38-43 and accompanying and following text.
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    Using these characteristics as our model, we propose to define a
venture capital fund as a private fund that: (i) Invests in equity
securities of private companies in order to provide operating and
business expansion capital (i.e., ``qualifying portfolio companies'')
and at least 80 percent of each company's equity securities owned by
the fund were acquired directly from the qualifying portfolio company;
(ii) directly, or through its investment advisers, offers or provides
significant managerial assistance to, or controls, the qualifying
portfolio company; (iii) does not borrow or otherwise incur leverage
(other than limited short-term borrowing); (iv) does not offer its
investors redemption or other similar liquidity rights except in
extraordinary circumstances; (v) represents itself as a venture capital
fund to investors; and (vi) is not registered under the Investment
Company Act and has not elected to be treated as a BDC.\274\
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    \274\ Proposed rule 203(l)-1(a).
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    We propose to define a ``qualifying portfolio company'' as any
company that: (i) Is not publicly traded; (ii) does not incur leverage
in connection with the investment by the private fund; (iii) uses the
capital provided by the fund for operating or business expansion
purposes rather than to buy out other investors; and (iv) is not itself
a fund (i.e., is an operating company).\275\
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    \275\ Proposed rule 203(l)-1(c)(4).
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    We also propose to grandfather existing funds by including in the
definition of ``venture capital fund'' any private fund that: (i)
Represented to investors and potential investors at the time the fund
offered its securities that it is a venture capital fund; (ii) prior to
December 31, 2010, has sold securities to one or more investors that
are not related persons of any investment adviser of the venture
capital fund; and (iii) does not sell any securities to, including
accepting any additional capital commitments from, any person after
July 21, 2011 (the ``grandfathering provision'').\276\ An adviser
seeking to rely on the exemption under section 203(l) of the Advisers
Act would be eligible for the venture capital exemption only if it
exclusively advised venture capital funds that met all of the elements
of the proposed definition or grandfathering provision.
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    \276\ Proposed rule 203(l)-1(b).
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1. Benefits
    Based on the testimony presented to Congress and our research, we
believe that venture capital funds today would meet most, if not all,
of the elements of our proposed definition of venture capital fund. Our
proposed definition includes one specific element, however, that may
not be characteristic of some existing venture capital funds. The
proposed rule defines a venture capital fund as one that does not issue
debt or provide guarantees except on a short-term basis (and
correspondingly defines a qualifying portfolio company as one that does
not borrow or otherwise incur leverage in connection with the venture
capital fund investment). We propose this element of the qualifying
portfolio company definition because of the focus on leverage in the
Dodd-Frank Act as a potential contributor to systemic risk as discussed
by the Senate Committee report,\277\ and the testimony before Congress
that stressed the lack of leverage in venture capital investing.\278\
Our research suggests that on occasion, however, some venture capital
funds may provide financing on a short-term basis to portfolio
companies as a ``bridge'' between funding rounds.\279\ It is possible
that certain types of bridge financing currently used by venture
capital funds may not satisfy the definition of equity security under
our proposed rule.
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    \277\ See supra note 99. See also S. Rep. No. 111-176, supra
note 7, at 73-74 (stating that advisers of venture capital funds are
not required to register with the SEC because they do not present
the same risks as advisers to other private funds that are required
to register, and specifying that the Commission shall require
advisers of private funds to report systemic risk data including,
among other things, information on the ``use of leverage,
counterparty credit risk exposure, trading and investment
positions''). See also supra notes 136-137 and accompanying text.
    \278\ See supra note 100.
    \279\ See, e.g., supra note 83 and accompanying text.
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    Although the limitation on acquiring debt securities from portfolio
companies may not be characteristic of some existing venture capital
funds, the failure of existing venture capital funds to meet the
proposed definition would not preclude advisers to those funds from
relying on the exemption in section 203(l) of the Advisers Act under
our proposed rule. An adviser of existing venture capital funds could
avail itself of the exemption under the proposed grandfathering
provision provided that each fund (i) Has represented to investors that
it is a venture capital fund, (ii) has initially sold interests by
December 31, 2010, and (iii) does not sell any additional interests
after July 21, 2011.\280\ We expect that all advisers to existing
venture capital funds that currently rely on the private adviser
exemption would be exempt from registration in reliance on the proposed
grandfathering provision. As a result of this provision, we expect that
advisers to existing venture capital funds that do not meet our
proposed definition would benefit because those advisers could continue
to manage existing funds without having to (i) Weigh the relative costs
and benefits of registration and modification of fund operations to
conform existing funds with our proposed definition and (ii) incur the
costs associated with registration with the Commission or modification
of existing funds. Advisers to venture capital funds that are in
formation that would be able to launch by December 31, 2010 and meet
the July 21, 2011 deadline for sales of all securities also would
benefit from the grandfathering provision because they would not have
to incur these costs.
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    \280\ Proposed rule 203(l)-1(b).
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    Going forward, we recognize that some advisers to existing venture
capital funds that seek to rely on the exemption in section 203(l) of
the Advisers Act might have to structure new funds

differently to meet the proposed limitation on qualified portfolio
company leverage. To the extent that advisers choose not to change how
they structure or manage new funds they launch, those advisers would
have to register with the Commission,\281\ which offers many benefits
to the investing public and facilitates our mandate to protect
investors. Registered investment advisers are subject to periodic
examinations by our staff and are also subject to our rules including
rules on recordkeeping, custody of client funds and compliance
programs. We believe that in general Congress considered registration
to be beneficial to investors because of, among other things, the added
protections offered by registration. Accordingly, Congress limited the
section 203(l) exemption to advisers to venture capital funds. As noted
above, we proposed certain elements in the portfolio company definition
because of the focus on leverage in the Dodd-Frank Act as a potential
contributor to systemic risk as discussed by the Senate Committee
report,\282\ and the testimony before Congress that stressed the lack
of leverage in venture capital investing.\283\ We expect that
distinguishing between venture capital funds and other private funds
that pursue investment strategies involving financial leverage that
Congress highlighted for concern would benefit financial regulators
mandated by the Dodd-Frank Act (such as the Financial Stability
Oversight Council) with monitoring and assessing potential systemic
risks. Because advisers that manage funds with these characteristics
would be required to register, we expect that financial regulators
could more easily obtain information and data regarding these financial
market participants, which should benefit those regulators to the
extent it helps to reduce the overall cost of systemic risk monitoring
and assessment.\284\
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    \281\ See infra text following note 294; notes 299-303 and
accompanying text for a discussion of potential costs for advisers
that would have to choose between registering or restructuring
venture capital funds formed in the future.
    \282\ See supra note 99.
    \283\ See supra note 100.
    \284\ See S. Rep. No. 111-176, supra note 7, at 39 (explaining
the requirement that private funds disclose information regarding
their investment positions and strategies, including information on
fund size, use of leverage, counterparty credit risk exposure,
trading and investment positions and any other information that the
Commission in consultation with the Financial Stability Oversight
Council determines is necessary and appropriate to protect investors
or assess systemic risk).
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    In addition to the benefits discussed above, we expect that
investment advisers that seek to rely on the exemption would benefit
from the flexibility in the proposed definition of venture capital fund
than a more rigid or narrow definition, which should allow them more
easily to structure and operate funds that meet the definition. This
flexibility should facilitate compliance with the proposed rule and
transition to the new exemption. For example, we propose to define
equity securities broadly to cover many types of equity securities in
which venture capital funds typically invest, rather than limit the
definition solely to common stock.\285\ To meet the proposed
definition, at least 80 percent (not 100 percent) of the equity
securities of a portfolio company in which a venture capital fund
invests must be acquired directly from the issuing portfolio company
(including securities that have been converted into equity securities),
but there is no limit as to how the remaining 20 percent could be
acquired.\286\ Furthermore, under the proposed definition, the venture
capital fund may offer or provide managerial assistance to or
alternatively control the qualified portfolio company directly, or may