\191\ See Barrett et al., supra note 189. See also Fenn et al.,
supra note 150, at 23 (companies that have been taken private in an
LBO transaction generally ``spend less on research and development,
relative to assets, and have a greater proportion of fixed assets;
their debt-to-assets ratios are high, above 60%, and are two to four
times those of venture-backed firms.'' Moreover, compared to venture
capital backed companies, LBO-private equity backed companies that
are taken public typically use proceeds from an IPO to reduce debt
whereas new venture capital backed firms tend to use proceeds to
fund growth.).
---------------------------------------------------------------------------

    Some commenters agreed that distinguishing between venture capital
and other private funds with reference to a portfolio company's
leverage and indirect buyouts is important.\192\ Many commenters,
however, urged a more narrowly drawn restriction on a portfolio
company's ability to borrow (or issue debt) or to effect indirect
buyouts.\193\ Some argued that the manner in which proceeds from
indebtedness are used by a portfolio company (e.g., distributed by the
company to the venture capital fund) better distinguishes venture
capital funds from leveraged buyout private equity funds.\194\
Nevertheless, the majority of commenters who addressed this criterion
supported a leverage criterion that would be more specific, or

limited, in scope,\195\ focusing on the use of proceeds derived from
portfolio company leverage.\196\ Commenters suggested that the rule
define leverage as leverage incurred for the purpose of buying out
shareholders at the demand of the venture capital fund \197\ or for
returning capital to the fund,\198\ and not, for example, define
leverage to include indebtedness incurred to pay for a qualifying
portfolio company's operating expenses.\199\
---------------------------------------------------------------------------

    \192\ See, e.g., AFL-CIO Letter; Sen. Levin Letter; Pine Brook
Letter.
    \193\ See, e.g., ATV Letter; Charles River Letter; NVCA Letter;
Oak Investment Letter; Pine Brook Letter.
    \194\ See, e.g., NVCA Letter; Pine Brook Letter; SV Life
Sciences Letter; Vedanta Letter.
    \195\ See, e.g., ATV Letter; Charles River Letter (supports
modifying the rule so that up to 20% of fund capital commitments may
be invested in portfolio companies that do not adhere to the
leverage condition provided that the venture capital fund is not the
party providing the leverage to the company); NVCA Letter; Comment
Letter of the Securities Regulation Committee of the Business Law
Section of the New York State Bar Association, Apr. 1, 2011 (``NYSBA
Letter''); SVB Letter.
    \196\ Although two commenters supported the leverage limitation
as proposed (see AFL-CIO Letter (also supporting a specific
prohibition on borrowing by a portfolio company to pay dividends or
fees to the venture capital fund); Sen. Levin Letter (together with
the equity investment requirement, the definition appropriately
excludes leveraged buyout funds)), two other commenters opposed it,
arguing that qualifying portfolio company leverage should not be
restricted at all (see ESP Letter (limits on leverage would prevent
portfolio companies from receiving lending from venture debt funds
and state governments and lenders rather than regulators should
determine the appropriate level of portfolio company debt); Merkl
Letter (young negative EBITDA companies would not be able to obtain
significant amounts of debt and hence no leverage prohibition is
required)). See also NASBIC/SBIA Letter (portfolio companies should
not be precluded from accessing leverage); Sevin Rosen Letter, Pine
Brook Letter (each expressed support for a use of proceeds
approach).
    \197\ See, e.g., Gunderson Dettmer Letter; McDonald Letter; NVCA
Letter; SVB Letter.
    \198\ See, e.g., McDonald Letter; NVCA Letter.
    \199\ Gunderson Dettmer Letter; Pine Brook Letter; Trident
Letter; Vedanta Letter. One commenter suggested that a use of
proceeds test would be difficult to enforce because such a test
would need to be extremely detailed in order to prevent
circumvention. See Merkl Letter.
---------------------------------------------------------------------------

    Some commenters argued that the proposed ``in connection with''
element would be difficult to apply, arguing that the standard was too
vague or raised too many interpretative issues.\200\ In response to our
request for comment, many commenters sought confirmation that the
limitation on portfolio company leverage would be triggered only in the
instances of leverage provided to the portfolio company by the venture
capital fund or if portfolio company borrowing were effected in
satisfaction of a contractual obligation with the venture capital
fund.\201\
---------------------------------------------------------------------------

    \200\ See, e.g., Merkl Letter; Sevin Rosen Letter; SVB Letter.
    \201\ See, e.g., ABA Letter; ATV Letter; Bessemer Letter;
Mesirow Letter; NVCA Letter; SV Life Sciences Letter. See also
Proposing Release, supra note 26, discussion at section II.A.1.c.
---------------------------------------------------------------------------

    After careful consideration of the intended purpose of the leverage
limitation of the proposed rule and the concerns raised by commenters,
we are modifying the qualifying portfolio company leverage criterion to
define a qualifying portfolio company as any company that does not both
borrow (or issue debt) in connection with a venture capital fund
investment and distribute the proceeds of such borrowing or issuance to
the venture capital fund in exchange for the fund's investment. In
contrast to the proposed rule, the final rule more specifically
delineates the types of leveraged transactions involving a qualifying
fund (i.e., a company's distribution of proceeds received in a debt
offering to the qualifying fund) that would result in the company being
excluded from the definition of a qualifying portfolio company. We
believe that these modifications more closely achieve our goal of
distinguishing advisers to venture capital funds from other types of
private funds for which Congress did not provide an exemption because
it looks to the substance, not just the form, of a transaction or
series of transactions.
    This definition of qualifying portfolio company would only exclude
companies that borrow in connection with a venture capital fund's
investment and distribute such borrowing proceeds to the venture
capital fund in exchange for the investment, but would not exclude
companies that borrow in the ordinary course of their business (e.g.,
to finance inventory or capital equipment, manage cash flows, meet
payroll, etc.). Under the rule, a venture capital fund could provide
financing or loans to a portfolio company, provided that the financing
meets the definition of equity security or is made subject to the 20
percent limit for non-qualifying investments. Although we would
generally view any financing to a portfolio company that was provided
by, or was a condition of a contractual obligation with, a fund or its
adviser as part of the fund's investments in the company as being a
type of financing that is ``in connection with'' the fund's investment,
the definition's limitation would only apply if the proceeds of such
financing were distributed to the venture capital fund in exchange for
its investment. Moreover, subsequent distributions to the venture
capital fund solely because it is an existing investor would not be
inconsistent with this criterion. We believe that this modification to
the rule adequately distinguishes between venture capital funds and
leveraged buyout funds and provides a simpler and clearer approach to
determining whether or not a qualifying portfolio company satisfies the
definition.
c. Operating Company
    Rule 203(l)-1 defines the term qualifying portfolio company for the
purposes of the exemption to exclude any private fund or other pooled
investment vehicle.\202\ Under the rule, a qualifying portfolio company
could not be another private fund, a commodity pool or other
``investment companies.'' \203\ We are adopting this criterion because
Congress did not express an intent to include venture capital funds of
funds within the definition.\204\ In the Senate Report, Congress
characterized venture capital as a subset of private equity
``specializing in long-term equity investment in small or start-up
businesses'' \205\ and did not refer to funds investing in other funds.
Moreover, testimony to Congress described venture capital investments
in operating companies rather than other private funds.\206\
---------------------------------------------------------------------------

    \202\ Rule 203(l)-1(c)(4)(iii). For this purpose, pooled
investment vehicles include investment companies, issuers relying on
rule 3a-7 under the Investment Company Act and commodity pools. 17
CFR 270.3a-7.
    \203\ Under the ``holding out'' criterion (discussed in Section
II.A.7. below), a fund that represents itself as pursuing a venture
capital strategy to investors implies that the fund invests
primarily in operating companies and not for example in entities
that hold oil and gas leases.
    \204\ One commenter agreed that ``there is no indication that
Congress intended the venture capital exemption to apply to `funds
of funds,''' but argued that the qualifying portfolio company
definition was ``unduly restrictive'' because it would exclude such
funds of funds and discourage use of special purpose vehicles. ABA
Letter.
    \205\ S. Rep. No. 111-176, supra note 6, at 74.
    \206\ See generally Loy Testimony, supra note 151, and McGuire
Testimony, supra note 151.
---------------------------------------------------------------------------

    Moreover, without this definitional criterion, a qualifying fund
could circumvent the intended scope of the rule by investing in other
pooled investment vehicles that are not themselves subject to the
definitional criteria under our rule.\207\ For example, without this
criterion, a venture capital fund could circumvent the intent of the
rule by incurring off-balance sheet leverage or indirectly investing in
reporting companies in excess of the 20 percent limit for non-
qualifying

investments.\208\ Our exclusion is similar to the approach of other
definitions of ``venture capital'' discussed in the Proposing Release,
which limit investments to operating companies and thus would exclude
investments in other private funds or securitized asset vehicles.\209\
---------------------------------------------------------------------------

    \207\ One commenter indicated that it was ``sympathetic'' to the
Commission's concerns about the use of fund of funds structures to
circumvent the intended purpose of the exemption, and agreed that
such ``investments would unacceptably heighten the possibility for
abuse.'' See NVCA Letter (suggesting that the Commission address
this concern by applying the venture capital fund leverage limit on
a full ``look-through'' basis to the underlying funds).
    \208\ Similarly, a qualifying fund could not, for example,
invest in an investment management entity (e.g., a general partner
entity) that in turn invests in another pooled vehicle, except as an
investment under the non-qualifying basket.
    \209\ See Proposing Release, supra note 26, at nn.70-72
(discussing the California venture capital exemption and the VCOC
definition under ERISA, 29 CFR 2510.3-101(d)).
---------------------------------------------------------------------------

    Many commenters opposed the operating company criterion and
recommended that the rule include fund of venture capital fund
structures.\210\ Some commenters supported no limits on investments in
other pooled investment vehicles,\211\ while others supported
broadening the definition to include funds that invest in other funds
if either (i) the underlying funds qualify as venture capital funds
(i.e., comply with rule 203(l)-1) \212\ or (ii) investment in
underlying funds does not exceed a specified threshold (such as a
percentage of fund capital).\213\ Commenters argued that broadening the
definition of qualifying portfolio company was necessary in order to
accommodate current business practices,\214\ or was appropriate because
funds of funds (including secondary funds) provide investors with
liquidity or do not pose systemic risk.\215\ Other commenters advocated
a definition that would permit investments in qualifying portfolio
companies held through an intermediate holding company structure formed
solely for tax, legal or regulatory reasons.\216\
---------------------------------------------------------------------------

    \210\ See, e.g., NVCA Letter; Sevin Rosen Letter; Comment Letter
of VCFA Group (Jan. 21, 2011).
    \211\ See, e.g., Cook Children's Letter; Leland Fikes Letter;
Merkl Letter.
    \212\ See, e.g., ATV Letter, Charles River Letter, NVCA Letter,
Sevin Rosen Letter (specifically in the context of funds of ``seed''
funds); SVB Letter, Vedanta Letter (85% cap for investments in rule
203(l)-1 compliant, unleveraged funds). See also Dechert General
Letter (suggested that funds investing solely in venture capital
funds should be permitted or, in the alternative, investments of up
to 20% of committed capital should be permitted in ``incubator''
funds).
    \213\ First Round Letter (supported investments in underlying
funds representing no more than 10% of a fund's called capital,
measured at the end of the fund's term); ATV Letter and Charles
River Letter (supported investments in underlying funds representing
no more than 20% of a fund's committed capital subject to other
conditions); PEI Funds Letter (supports ``substantial'' investment
in venture capital investments rather than a specific numerical
threshold); Comment Letter of Private Equity Investors, Inc. and
Willowbridge Partners, Inc. (Jan. 7, 2011) (``PEI/Willowbridge
Letter'') (supported investments in other qualifying funds
representing at least 50% of the qualifying fund's assets or
committed capital) and Comment Letter of Venture Investment
Associates (Jan. 24, 2011) (``VIA Letter'') (supported investments
in underlying funds representing at least 50% of a qualifying fund's
capital commitments).
    \214\ See, e.g., ATV Letter, Charles River Letter, Cook
Children's Letter, Leland Fikes Letter (each of which cited the use
of technology incubators).
    \215\ See, e.g., PEI/Willowbridge Letter and VIA Letter.
    \216\ See, e.g., ABA Letter; Davis Polk Letter; NVCA Letter.
---------------------------------------------------------------------------

    For purposes of the definition of a qualifying portfolio company,
we agree that a fund may disregard a wholly owned intermediate holding
company formed solely for tax, legal or regulatory reasons to hold the
fund's investment in a qualifying portfolio company. Such structures
are used to address the particular needs of venture capital funds or
their investors and are not intended to circumvent the rule's general
limitation on investing in other investment vehicles.\217\
---------------------------------------------------------------------------

    \217\ See, e.g., Davis Polk Letter for a discussion of these
considerations.
---------------------------------------------------------------------------

    We do not agree, however, that Congress viewed funds of venture
capital funds as being consistent with the exemption, and continue to
believe that this criterion remains an important tool to prevent
circumvention of the intended scope of the venture capital exemption. A
fund strategy of selecting a venture capital or other private fund in
which to invest is different from a strategy of selecting qualifying
portfolio companies. Nevertheless, we are persuaded that a venture
capital fund's limited ability to invest a limited portion of its
assets in other pooled investment vehicles would not be inconsistent
with the intent of the rule if the fund primarily invests directly in
qualifying portfolio companies. As a result, for purposes of the
exemption, investments in other private funds or venture capital funds
could be made using the non-qualifying basket.
4. Management Involvement
    We are not adopting a managerial assistance element of the rule, as
originally proposed. We proposed that advisers seeking to rely on the
rule have a significant level of involvement in developing a fund's
portfolio companies.\218\ We modeled our proposed approach to
managerial assistance in part on existing provisions under the Advisers
Act and the Investment Company Act dealing with BDCs. These provisions
were added over the years to ease the regulatory burden on venture
capital and other private equity investments.\219\ Congress did not use
the existing BDC definitions when determining the scope of the venture
capital exemption, and the primary policy considerations that led to
the adoption of the BDC exemptions differed from those under the Dodd-
Frank Act.\220\
---------------------------------------------------------------------------

    \218\ See Proposing Release, supra note 26, section II.A.2.
    \219\ See id., at n.123.
    \220\ See id., at section II.A.2.
---------------------------------------------------------------------------

    Commenters presented several problems with the application of the
managerial assistance criterion and its intended scope under the
proposed rule. Some objected to the managerial assistance criterion as
proposed, arguing that such assistance to (or control of) a portfolio
company is not a key or distinguishing characteristic of venture
capital investing; \221\ that relationships between qualifying funds
and qualifying portfolio companies may be less formal and may not
constitute management or control of a portfolio company under the
proposed rule; \222\ or that the discretion to determine the extent of
involvement with a portfolio company should not affect a qualifying
fund's ability to satisfy the definitional criterion.\223\
---------------------------------------------------------------------------

    \221\ Merkl Letter; SVB Letter (managerial assistance criterion
is unnecessary because it does not distinguish venture capital funds
from other types of funds providing managerial assistance).
    \222\ ESP Letter.
    \223\ Sevin Rosen Letter.
---------------------------------------------------------------------------

    Most commenters sought guidance on determining what activities
would constitute managerial assistance or ``control.'' \224\ Other
commenters specifically requested confirmation that a management rights
letter for purposes of ``venture capital operating company'' status
under ERISA would be sufficient.\225\ Finally, some commenters
recommended that the rule address syndicated transactions,\226\ and
provide that the managerial assistance criterion would be satisfied if
one fund within the syndicate provided the requisite assistance or
control.\227\
---------------------------------------------------------------------------

    \224\ BCLBE Letter; Gunderson Dettmer Letter; McGuireWoods
Letter; Shearman Letter. Shearman sought confirmation on whether
control included both direct and indirect control, and BCLBE sought
confirmation that board representation would be sufficient for
control purposes. Other commenters, however, acknowledged that the
``offer-only'' element of the proposed rule would provide sufficient
flexibility for a venture capital fund to alter its relationship
with a portfolio company over time. See, e.g., First Round Letter;
NVCA Letter. The NVCA and one other commenter did not support
imposing specific requirements as to what constituted managerial
assistance. See NVCA Letter (definitive requirements are not
appropriate); Sevin Rosen Letter (opposed requiring board seat or
observer rights).
    \225\ ATV Letter; Charles River Letter; NVCA Letter; Oak
Investment Letter; Sant[eacute] Ventures Letter; Sevin Rosen Letter;
Village Ventures Letter.
    \226\ ABA Letter; ESP Letter; McGuireWoods Letter.
    \227\ ABA Letter (asserted that most deals are syndicated
deals). See also Dechert General Letter; ESP Letter (indicating that
in syndicated transactions, there may be varying degrees of
managerial involvement by funds participating in the transactions;
one fund may take an active role, with the other funds taking a more
passive role with respect to portfolio companies).

---------------------------------------------------------------------------

    We appreciate the difficulties of applying the managerial
assistance criterion under the proposed definition and in particular
the issues associated with a qualifying fund proving compliance when it
participates in a syndicated transaction involving multiple funds. We
are persuaded that to modify the rule to specify which activities
constitute ``managerial assistance'' would introduce additional
complexity and require us to insert our judgment for that of a venture
capital fund's adviser regarding the minimum level of portfolio company
involvement that would be appropriate for the fund, rather than
enabling investors to select venture capital funds based in part on
their level of involvement.\228\ We also appreciate that the offer of
managerial assistance may not distinguish venture capital funds from
other types of funds.
---------------------------------------------------------------------------

    \228\ For example, one commenter indicated that although it may
seek to offer assistance to portfolio companies, not all of the
companies have accepted. Charles River Letter. Similarly, a number
of venture capital advisers stated that their funds may invest in a
significant but non-controlling stake in underlying portfolio
companies. See, e.g., ATV Letter; First Round Letter.
---------------------------------------------------------------------------

    While many venture capital fund advisers do provide managerial
assistance, we believe that the managerial assistance criterion, as
proposed, does not distinguish these advisers from other advisers,
would be difficult to apply and could be unnecessarily prescriptive
without creating benefits for investors. As a consequence of our
modification to the proposed rule, a qualifying fund is not required to
offer (or provide) managerial assistance to, or control any, qualifying
portfolio company in order to satisfy the definition.
5. Limitation on Leverage
    Under rule 203(l)-1, a venture capital fund is a private fund that
does not borrow, issue debt obligations, provide guarantees or
otherwise incur leverage, in excess of 15 percent of the fund's capital
contributions and uncalled committed capital, and any such borrowing,
indebtedness, guarantee or leverage is for a non-renewable term of no
longer than 120 calendar days.\229\ For purposes of this leverage
criterion, any guarantee by the private fund of a qualifying portfolio
company's obligations up to the value of the private fund's investment
in the qualifying portfolio company is not subject to the 120 calendar
day limit.\230\
---------------------------------------------------------------------------

    \229\ Rule 203(l)-1(a)(3).
    \230\ Id.
---------------------------------------------------------------------------

    The 15 percent threshold is determined based on the venture capital
fund's aggregate capital commitments. In practice, this means that a
qualifying fund could leverage an investment transaction up to 100
percent when acquiring equity securities of a particular portfolio
company as long as the leverage amount does not exceed 15 percent of
the fund's total capital commitments.
    Although a minority of commenters generally supported the leverage
criterion as proposed,\231\ many commenters sought to broaden it in
several ways. Two commenters that generally supported the leveraged
criterion also recommended that the criterion exclude uncalled capital
commitments so that a qualifying fund could not incur excessive
leverage.\232\ Although determining the leverage criterion as a
percentage of total fund capital commitments may enable a qualifying
fund to incur a degree of leverage that represents a disproportionate
percentage of the fund's assets early in the life of the fund, the
leverage criterion is also constrained by the 120 calendar day limit.
Therefore, we do not believe it is necessary to exclude uncalled
capital commitments from the leverage criterion.
---------------------------------------------------------------------------

    \231\ See Sen. Levin Letter; NVCA Letter. See also AFL-CIO
Letter, AFR Letter (generally supported the leverage limit but also
supported excluding uncalled capital commitments); Oak Investment
Letter (generally supported the leverage limit, but did not agree
that the 120-day limit should apply to guarantees of portfolio
company obligations by venture capital funds).
    \232\ AFR Letter; AFL-CIO Letter.
---------------------------------------------------------------------------

    Other commenters proposed to exclude from the 15 percent leverage
limitation capital call lines of credit (i.e., venture capital fund
borrowings repaid with proceeds of capital calls from fund
investors),\233\ or borrowings by a venture capital fund in order to
meet fee and expense obligations.\234\ One commenter sought to increase
the leverage threshold from 15 percent to 20 percent.\235\ One
commenter, on behalf of many venture capital advisers, however, agreed
with the proposed leverage criterion, arguing that venture capital fund
financing would generally not exceed 15 percent of fund capital
commitments or remain outstanding for longer than 120 days.\236\
---------------------------------------------------------------------------

    \233\ Cook Children's Letter; Leland Fikes Letter; SVB Letter.
We would view a line of credit used to advance anticipated committed
capital that remains available for longer than 120 days to be
consistent with the criterion, if each drawdown is repaid within 120
days and subsequent drawdowns relate to subsequent capital calls.
    \234\ Dechert General Letter.
    \235\ See Charles River Letter (argued that a qualifying fund
should be able to borrow, without limit on duration, up to 20% of
capital commitments with the consent of its investors).
    \236\ NVCA Letter. See also Merkl Letter.
---------------------------------------------------------------------------

    We decline to increase the leverage threshold for a qualifying fund
under the rule or exclude other certain types of borrowings as
requested by some commenters. Our 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,\237\ which commenters
have confirmed.\238\ We believe that imposing a maximum at the upper
range of borrowings typically used by venture capital funds will
accommodate existing practices of the vast majority of industry
participants.
---------------------------------------------------------------------------

    \237\ See Loy Testimony, supra note 151, 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.'').
    \238\ NVCA Letter. See also Merkl Letter; Oak Investments
Letter.
---------------------------------------------------------------------------

    Our rule specifies that the 15 percent calculation must be
determined based on the fund's aggregate capital contributions and
uncalled capital commitments.\239\ Unlike most registered investment
companies or hedge funds, venture capital funds rely on investors
funding their capital commitments from time to time in order to acquire
portfolio companies.\240\ A capital commitment is a contractual
obligation to acquire an interest in, or provide the total commitment
amount over time to, a fund, when called by the fund. Accordingly, an
adviser to venture capital funds manages the fund in anticipation of
all investors fully funding their commitments when due and typically
has the right to penalize investors for failure to do so.\241\ Venture

capital funds are subject to investment restrictions, and, during the
initial years of a fund, calculate fees payable to an adviser as a
percentage of the total capital commitments of investors, regardless of
whether or not the capital commitment is ultimately fully funded by an
investor.\242\ Venture capital fund advisers typically report and
market themselves to investors on the basis of aggregate capital
commitment amounts raised for prior or existing funds.\243\ These
factors would lead to the conclusion that, in contrast to other types
of private funds, such as hedge funds, which trade on a more frequent
basis, a venture capital fund would view the fund's total capital
commitments as the primary metric for managing the fund's assets and
for determining compliance with investment guidelines. Hence, we
believe that calculating the leverage threshold to include uncalled
capital commitments is appropriate, given that capital commitments are
already used by venture capital funds themselves to measure investment
guideline compliance.
---------------------------------------------------------------------------

    \239\ Rule 203(l)-1(a)(3).
    \240\ Schell, supra note 185, 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.'').
    \241\ See Loy Testimony, supra note 151, 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'').
    \242\ See, e.g., Breslow & Schwartz, supra note 241, at Sec.
2:5.7 (noting that a cap of 10% to 25% of remaining capital
commitments is a common limitation for follow-on investments). See
also Schell, supra note 185, 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.
    \243\ See, e.g., NVCA Yearbook 2010, supra note 150, at 16; John
Jannarone, Private Equity's Cash Problem, Wall St. J., June 23,
2010, http://online.wsj.com/article/SB10001424052748704853404575323073059041024.html#printMode.
---------------------------------------------------------------------------

    Thus, we are retaining the 15 percent leverage threshold, as
proposed, so that a qualifying fund could only incur debt (or provide
guarantees of portfolio company obligations) subject to this threshold.
However, we are modifying the leverage criterion to exclude from the
120-calendar day limit any guarantee of qualifying portfolio company
obligations by the qualifying fund, up to the value of the fund's
investment in the qualifying portfolio company.\244\ Commenters
generally argued in favor of extending the period during which a
qualifying fund's leverage could remain outstanding. Some recommended
extending the 120-day limit with respect to leverage to 180 days with
one 180-day renewal in the case of non-convertible bridge loans
extended by the venture capital fund to a portfolio company.\245\
Others seeking to accommodate business practices and provide maximum
flexibility for venture capital fund debt investments in portfolio
companies recommended excluding guarantees of portfolio company debt by
a venture capital fund from the 120-day limit.\246\ Other commenters
argued that guarantees of portfolio company obligations would not
result in qualifying funds incurring extensive leverage.\247\
---------------------------------------------------------------------------

    \244\ Rule 203(l)-1)(a)(3).
    \245\ See, e.g., NVCA Letter; Davis Polk Letter; Bessemer
Letter.
    \246\ Cook Children's Letter; Leland Fikes Letter; Gunderson
Dettmer Letter; Oak Investment Letter; SVB Letter. See also ABA
Letter.
    \247\ See, e.g., SVB Letter.
---------------------------------------------------------------------------

    We understand that guarantees of portfolio company leverage by a
venture capital fund are typically limited to the value of the fund's
investment in the company (often through a pledge of the fund's
interest in the company).\248\ Such guarantees by a qualifying fund may
help a qualifying portfolio company obtain credit for working capital
purposes, rather than be used by the fund to leverage its investment in
the company.\249\ We are persuaded that such guarantees of portfolio
company indebtedness do not present the same types of risks identified
by Congress. Congress cited the implementation of trading strategies
that use financial leverage by certain private funds as creating a
potential for systemic risk.\250\ In testimony before Congress, the
venture capital industry identified the lack of financial leverage in
venture capital funds as a basis for exempting advisers to venture
capital funds \251\ in contrast with other types of private funds such
as hedge funds, which may engage in trading strategies that may
contribute to systemic risk and affect the public securities
markets.\252\ For this reason, our proposed rule was designed to
address concerns that financial leverage may contribute to systemic
risk by excluding funds that incur more than a limited amount of
leverage from the definition of venture capital fund.\253\ We believe
that the alternative approach to fund leverage we have adopted in the
final rule better reflects industry practice while still addressing
Congress' concern that the use of financial leverage may create the
potential for systemic risk.
---------------------------------------------------------------------------

    \248\ See also NVCA Letter.
    \249\ See, e.g., Oak Investments Letter; SVB Letter.
    \250\ See Proposing Release, supra note 26, at n. 136 and
accompanying text.
    \251\ See McGuire Testimony, supra note 151, at 7 (``Venture
capital firms do not use long term leverage, rely on short term
funding, or create third party or counterparty risk * * *. [F]rom
previous testimony submitted by the buy-out industry, the typical
capital structure of the companies acquired by a buyout fund is
approximately 60% debt and 40% equity. In contrast, borrowing at the
venture capital fund level, if done at all, typically is only used
for short-term capital needs (pending drawdown of capital from its
partners) and does not exceed 90 days. Not only are our partnerships
run without debt but our portfolio companies are usually run without
debt as well.''); Loy Testimony, supra note 151, at 2 (``Although
venture capital funds may occasionally borrow on a short-term basis
immediately preceding the time when the cash installments are due,
they do not use debt to make investments in excess of the partner's
capital commitments or `lever up' the fund in a manner that would
expose the fund to losses in excess of the committed capital or that
would result in losses to counter parties requiring a rescue
infusion from the government.'').
    \252\ See S. Rep. No. 111-176, supra note 6, at 74-75.
    \253\ In proposing an exemption for advisers to private equity
funds, which would have required the Commission to define the term
``private equity fund,'' the Senate Banking Committee noted the
difficulties in distinguishing some private equity funds from hedge
funds and expected the Commission to exclude from the exemption
private equity funds that raise significant potential systemic risk
concerns. S. Rep. No. 111-176, supra note 6, at 75. See also G20
Working Group 1, Enhancing Sound Regulation and Strengthening
Transparency, at 7 (March 25, 2009) (noting that unregulated
entities such as hedge funds may contribute to systemic risks
through their trading activities).
---------------------------------------------------------------------------

6. No Redemption Rights
    We are adopting as proposed the definitional element under which a
venture capital fund is a private fund that issues securities that do
not provide investors redemption rights except in ``extraordinary
circumstances'' but that entitle investors generally to receive pro
rata distributions.\254\ Unlike hedge funds, a venture capital fund
does not typically permit investors to redeem their interests during
the life of the fund,\255\ but rather distributes assets generally as
investments mature.\256\
---------------------------------------------------------------------------

    \254\ Rule 203(l)-1(a)(4).
    \255\ See Schell, supra note 185, 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 241, at Sec.  2:14.2 (``the right to withdraw from the fund is
typically provided only as a last resort'').
    \256\ Loy Testimony, supra note 151, 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 242, at 60 (noting that an investor in a private equity or
venture capital fund typically does not have the right to transfer
its interest). See generally Proposing Release, supra note 26,
section II.A.4.

---------------------------------------------------------------------------

    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 to be excluded from
particular investments due to regulatory or other legal
requirements.\257\ These events may be ``foreseeable'' because they are
circumstances that are known to occur (e.g., changes in law, corporate
events such as mergers, etc.) but are unexpected in their timing or
scope. Thus, withdrawal, exclusion or similar ``opt-out'' rights would
be deemed ``extraordinary circumstances'' if they are triggered by a
material 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.\258\
The trigger events for these rights are typically beyond the control of
the adviser and fund investor (e.g., tax and regulatory changes).
---------------------------------------------------------------------------

    \257\ See Hedge Fund Adviser Registration Release, supra note
14, 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 241, 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.'').
    \258\ See, e.g., Breslow & Schwartz, supra note 241, 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 185, 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 * * *'').
---------------------------------------------------------------------------

    Most commenters addressing the redeemability criterion did not
oppose it, but rather sought clarification or guidance on the scope of
its application.\259\ For example, commenters specifically requested
confirmation that the lack of redeemability criterion would not
preclude a qualifying fund from (i) making distributions of carried
interest to a general partner,\260\ (ii) specifying redemption rights
for certain categories of investors under certain circumstances \261\
or (iii) specifying opt-out rights for investors.\262\ Several
commenters, however, indicated that the term ``extraordinary
circumstances'' is sufficiently clear,\263\ suggesting that the
proposal did not require further clarification.
---------------------------------------------------------------------------

    \259\ A number of commenters agreed with the redeemability
criterion. See, e.g., ATV Letter; Charles River Letter; Gunderson
Dettmer Letter. However, one commenter argued that a fund's
redeemability is not necessarily characteristic of venture capital
funds. Comment Letter of Cooley LLP (Jan. 21, 2011).
    \260\ See, e.g., NVCA Letter. The rule specifies that a
qualifying fund is a private fund that ``issues securities the terms
of which do not provide a holder with any right, except in
extraordinary circumstances, to withdraw * * *'' If a general
partner interest is not a ``security,'' then the redeemability
criterion of the rule would not be implicated. Whether or not a
general partner interest is a ``security'' depends on the particular
facts and circumstances. See generally Williamson v. Tucker, 645
F.2d 404 (5th Cir. 1981), cert. denied, 454 U.S. 897 (1981).
    \261\ ABA Letter (sought guidance on whether granting redemption
rights to certain types of investors such as ERISA funds and state
plans, in the event of certain ERISA, tax or regulatory changes
would be considered extraordinary).
    \262\ McGuireWoods Letter.
    \263\ See Gunderson Dettmer Letter; Merkl Letter; SVB Letter.
---------------------------------------------------------------------------

    We believe that the term ``extraordinary circumstances'' is
sufficiently clear. Whether or not specific redemption or ``opt out''
rights for certain categories of investors under certain circumstances
should be treated as ``extraordinary'' will depend on the particular
facts and circumstances.
    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. We believe, and several commenters confirmed, that the
phrase ``extraordinary circumstances'' is sufficiently clear to
distinguish the terms for investor liquidity of venture capital funds,
as they operate today, from hedge funds.\264\ 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.\265\ Although a fund
prohibiting redemptions would satisfy the redeemability criterion of
the venture capital fund definition, the rule does not specify a
minimum period of time for an investor to remain in the fund.
---------------------------------------------------------------------------

    \264\ See, e.g., id.
    \265\ See supra notes 255-256 and accompanying text.
---------------------------------------------------------------------------

    In the Proposing Release, we expressed the general concern that a
venture capital fund might seek to circumvent the intended scope of
this criterion by providing investors with nominally ``extraordinary''
rights to redeem that effectively result in de facto redemption rights
in the ordinary course.\266\ One commenter expressly disagreed with
this view, asserting that in the case of transfers effected with the
consent of a general partner, such transactions are intended to
accommodate an investor's internal corporate restructurings,
bankruptcies or portfolio allocations rather than to provide investors
with liquidity from the fund.\267\ While consents to transfer do not
raise the same level of concern as de facto redemption rights, we do
not believe that an adviser or its related persons could, while relying
on the venture capital exemption, create de facto periodic redemption
or transfer rights by, for example, regularly identifying potential
investors on behalf of fund investors seeking to transfer or redeem
fund interests.\268\
---------------------------------------------------------------------------

    \266\ For example, in the Proposing Release, we stated that a
private fund's governing documents might 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 their otherwise non-redeemable 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.'' Rule 203(l)-1(a)(4). See
Proposing Release, supra note 26, at n.154.
    \267\ See NVCA Letter (disagreeing with statements in the
Proposing Release regarding the de facto creation of redemption
rights but generally agreeing with the general prohibition on
redemptions except in extraordinary circumstances).
    \268\ Section 208(d) of the Advisers Act.
---------------------------------------------------------------------------

    We are not modifying the rule to include additional conditions for
fund redemptions, such as specifying a minimum holding or investment
period by investors or a maximum amount that may be redeemed at any
time. Commenters generally did not support

the imposition of such conditions,\269\ and we agree that imposing such
conditions would not appear to be necessary to achieve the purposes of
the rule.
---------------------------------------------------------------------------

    \269\ See, e.g., SVB Letter (expressing opposition to a rule
that would limit redemptions following a minimum investment period
or limit redemptions to a specified maximum threshold).
---------------------------------------------------------------------------

7. Represents Itself as Pursuing a Venture Capital Strategy
    Under the rule, a qualifying fund must represent itself as pursuing
a venture capital strategy to its investors and potential
investors.\270\ 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
rule (because for example it only invests in short-term holdings, does
not borrow, does not offer investors redemption rights, and is not a
registered investment company).\271\ We believe that only funds that do
not significantly differ from the common understanding of what a
venture capital fund is,\272\ and that are actually offered to
investors as funds that pursue a venture capital strategy, should
qualify for the exemption. Thus, for example, an adviser to a venture
capital fund that is otherwise relying on the exemption could not (i)
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 (ii)
include the fund in a hedge fund database or hedge fund index.
---------------------------------------------------------------------------

    \270\ Rule 203(1)-1(a)(1).
    \271\ 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.
    \272\ See Proposing Release, supra note 26, at n.157.
---------------------------------------------------------------------------

    As proposed, rule 203(l)-1 defined a venture capital fund as a
private fund that ``represents itself as being a venture capital fund
to its investors and potential investors.'' \273\ Although several
commenters generally supported the ``holding out'' criterion as
proposed,\274\ many sought confirmation that the use of specific self-
identifying terminology by a fund in its name (e.g., ``private equity''
fund, ``multi-strategy'' fund or ``growth capital'' fund) would not
automatically disqualify the fund under the definition.\275\ Several
commenters argued that historically, some funds have avoided referring
to themselves as ``venture capital funds.'' \276\ One commenter argued
that the proposed condition was too restrictive because it focuses on
the fund's name rather than its investment strategy and suggested that
the definition instead exclude any fund that markets itself as a hedge
fund, multi-strategy fund, buyout fund or fund of funds.\277\
---------------------------------------------------------------------------

    \273\ Proposed Rule 203(l)-1(a)(1).
    \274\ See Gunderson Dettmer Letter; Sen. Levin Letter; Merkl
Letter.
    \275\ See, e.g., IVP Letter; Comment Letter of MissionPoint
Capital Partners, Jan. 24, 2011; PEI Funds Letter.
    \276\ See, e.g., NVCA Letter; Pine Brook Letter. See also IVP
Letter; PEI Funds Letter.
    \277\ See Pine Brook Letter.
---------------------------------------------------------------------------

    We believe that the ``holding out'' criterion remains an important
distinction between funds that are eligible to rely on the definition
and funds that are not, because an investor's understanding of the fund
and its investment strategy must be consistent with an adviser's
reliance on the exemption. However, we also recognize that it is not
necessary (nor indeed sufficient) for a qualifying fund to name itself
as a ``venture capital fund'' in order for its adviser to rely on the
venture capital exemption. Hence, we are modifying the proposed
definition to refer to the way a qualifying fund describes its
investment strategy to investors and prospective investors.
    A qualifying fund name that does not use the words ``venture
capital'' and is not inconsistent with pursuing a venture capital
strategy would not preclude a qualifying fund from satisfying the
definition.\278\ Whether or not a fund represents itself as pursuing a
venture capital strategy, however, will depend on the particular facts
and circumstances. Statements made by a fund to its investors and
prospective investors, not just what the fund calls itself, are
important to an investor's understanding of the fund and its investment
strategy.\279\ The appropriate framework for analyzing whether a
qualifying fund has satisfied the holding out criterion depends on all
of the statements (and omissions) made by the fund to its investors and
prospective investors. While this includes the fund name, it is only
part of the analysis.
---------------------------------------------------------------------------

    \278\ Similarly, misleadingly including the words ``venture
capital'' in the name of a fund pursuing a different strategy would
not satisfy the definition.
    \279\ One commenter requested confirmation and examples of what
constituted appropriate representations to investors given that
``many'' venture capital funds do not use private placement
memoranda or other offering materials during fundraising. See
Gunderson Dettmer Letter (expressed the view that the following
would be sufficient: (i) Checking the ``venture capital'' box on
Form D or (ii) stating on the adviser's Web site that all of the
funds advised by the adviser are venture capital funds). As we noted
above, whether or not a venture capital fund satisfies the ``holding
out'' criterion will depend on the particular facts and
circumstances surrounding all of the statements and omissions made
by the fund in light of the circumstances under which they were
made. Moreover, a venture capital fund that seeks to rely on the
safe harbor for non-public offerings under rule 506 of Regulation D
is subject to all of the conditions of such rule, including the
prohibition on general solicitation and general advertising
applicable to statements attributable to the fund on a publicly
available Web site. See 17 CFR 230.502(c).
---------------------------------------------------------------------------

    This approach is similar to our general approach to antifraud
provisions under the Federal securities laws, including Advisers Act
rule 206(4)-8 regarding pooled investment vehicles.\280\ The general
antifraud rule under rule 206(4)-8 looks to the private fund's
statements and omissions in light of the circumstances under which such
statements or omissions are made.\281\ Similarly, the holding out
criterion under our venture capital fund definition looks to all of the
relevant statements made by the qualifying fund regarding its
investment strategy.
---------------------------------------------------------------------------

    \280\ 17 CFR 275.206(4)-8.
    \281\ See Pooled Vehicles Release, supra note 122, at n.27 (``A
fact is material if there is a substantial likelihood that a
reasonable investor in making an investment decision would consider
it as having significantly altered the total mix of information
available,'' citing Basic, Inc. v. Levinson, 485 U.S. 224, 231-32
(1988)).
---------------------------------------------------------------------------

8. Is a Private Fund
    We define a venture capital fund for purposes of the exemption as a
private fund, which is defined in the Advisers Act, and exclude from
the definition funds that are registered investment companies (e.g.,
mutual funds) or have elected to be regulated as BDCs.\282\ We are
adopting this provision as proposed.
---------------------------------------------------------------------------

    \282\ Rule 203(l)-1(a) and (a)(5). See also discussion infra
note 319.
---------------------------------------------------------------------------

    There is no indication that Congress intended the venture capital
exemption to apply to advisers to these publicly available funds,\283\
referring to venture capital funds as a ``subset of private investment
funds.'' \284\ The comment letters that addressed this proposed
criterion generally supported it.\285\
---------------------------------------------------------------------------

    \283\ 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
151, at 3 (noting that venture capital funds are not directly
accessible by individual investors); Loy Testimony, supra note 151,
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 section
202(a)(29) of the Advisers Act (definition of ``private fund'').
    \284\ See S. Rep. No. 111-176, supra note 6, at 74 (describing
venture capital funds as a subset of ``private investment funds'').
    \285\ Gunderson Dettmer Letter; Merkl Letter; NYSBA Letter; Sen.
Levin Letter.
---------------------------------------------------------------------------

9. Application to Non-U.S. Advisers
    The final rule does not define a venture capital fund as a fund
advised by a U.S. adviser (i.e., an adviser with a principal office and
place of business

the United States). Thus, a non-U.S. adviser, as well as a U.S.
adviser, may rely on the venture capital exemption provided that such
adviser solely advises venture capital funds that satisfy all of the
elements of the rule or satisfy the grandfathering provision (discussed
in greater detail below). 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.
    Neither the statutory text of section 203(l) nor the legislative
reports provide 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.\286\ 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.\287\ 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.
---------------------------------------------------------------------------

    \286\ See section 203(l) of the Advisers Act; H. Rep. No. 111-
517, supra note 6, at 867; S. Rep. No. 111-176, supra note 6, at 74-
75.
    \287\ See Loy Testimony, supra note 151, at 4-5; McGuire
Testimony, supra note 151, at 5-6.
---------------------------------------------------------------------------

    Commenters generally did not support defining venture capital fund
or qualifying portfolio company by reference to the jurisdiction of
formation of the fund or portfolio company.\288\ Several commenters,
however, supported modifying the rule to apply the venture capital
exemption in the same manner as the proposed private fund adviser
exemption, with the result that a non-U.S. adviser could disregard its
non-U.S. activities when assessing eligibility for the venture capital
exemption.\289\ Under this approach, only U.S.-domiciled private funds
would be required to satisfy our definition of a venture capital fund
in order for the adviser to rely on the venture capital exemption.\290\
One commenter suggested that the same policy rationale underlying the
private fund adviser exemption justified this approach to the venture
capital exemption.\291\ Two other commenters supported this approach
arguing that non-U.S. funds may operate in a manner that does not
resemble venture capital fund investing in the United States or by U.S.
venture capital fund advisers.\292\
---------------------------------------------------------------------------

    \288\ See, e.g., Bessemer Letter; EVCA Letter; McDonald Letter;
Merkl Letter; NVCA Letter; SV Life Sciences Letter.
    \289\ See McGuireWoods Letter; Shearman Letter. See also EFAMA
Letter (also noting that as a practical matter, the rule should
account for non-U.S. specific practices so that non-U.S. advisers
could rely on the exemption); Gunderson Dettmer Letter (exemption
should be available to non-U.S. advisers even if non-U.S. funds do
not satisfy definitional elements); Dechert General Letter (non-U.S.
advisers that manage funds that are not venture capital funds
outside of the U.S. should be able to rely on rule 203(l) for funds
that are managed in the U.S. or that are marketed to U.S.
investors).
    \290\ See EFAMA Letter (certain conditions of the proposed rule,
such as the limitation on cash investments to U.S. Treasuries, are
inconsistent with practices outside the United States). We believe
that these concerns are adequately addressed by the non-qualifying
basket.
    \291\ See Shearman Letter.
    \292\ See EFAMA Letter; McGuireWoods Letter.
---------------------------------------------------------------------------

    We do not agree that the private fund adviser exemption is the
appropriate framework for the venture capital exemption in the case of
non-U.S. advisers. Section 203(l) provides an exemption for an
investment adviser based on the strategy of the funds that the adviser
manages (i.e., venture capital funds). This exemption thus specifies
the activities in which an adviser's clients may engage, and does not
refer to activities in the United States.\293\ By contrast, section
203(m) is based upon the location where the advisory activity is
conducted. Accordingly, we do not believe it would be appropriate for
an adviser relying on section 203(l) to disregard its non-U.S.
activities. Moreover, a non-U.S. adviser could circumvent the intended
scope of the exemption by merely sponsoring and advising solely non-
U.S. domiciled funds that are not venture capital funds.
---------------------------------------------------------------------------

    \293\ See also infra note 322 and accompanying and following
text.
---------------------------------------------------------------------------

    Under our rule, only a private fund may qualify as a venture
capital fund. As we noted in the Proposing Release, a non-U.S. fund
that uses U.S. jurisdictional means in the offering of the securities
it issues and that relies on section 3(c)(1) or 3(c)(7) of the
Investment Company Act would be a private fund.\294\ A non-U.S. fund
that does not use U.S. jurisdictional means to conduct an offering
would not be a private fund and therefore could not qualify as a
venture capital fund, even if it operated as a venture capital fund in
a manner that would otherwise meet the criteria under our
definition.\295\ As a result, under the proposed rule, if a non-U.S.
fund did not qualify as a venture capital fund, then the fund's adviser
would not be able to rely on the exemption.\296\
---------------------------------------------------------------------------

    \294\ 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 section 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 in the United States 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 14,
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)] (``Canadian Tax-Deferred
Retirement Savings Accounts Release''), 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 No-Action Letter''); Touche Remnant & Co., SEC Staff No-
Action Letter (Aug. 27, 1984) (``Touche Remnant No-Action Letter'');
Proposing Release, supra note 26, at n.175 and accompanying text.
    \295\ See Proposing Release, supra note 26, at nn.175 and 188
and accompanying text.
    \296\ Under the Advisers Act, an adviser relying on the venture
capital exemption must ``solely'' advise venture capital funds and
under our rule all of the funds advised by the adviser must be
private funds.
---------------------------------------------------------------------------

    In light of this result, we asked in the Proposing Release whether
we should adopt a broader interpretation of the term ``private fund.''
\297\ In response, commenters supported making the venture capital
exemption available to non-U.S. advisers even if they advise venture
capital funds that are not offered through the use of U.S.
jurisdictional means.\298\ We agree. Accordingly, as adopted, rule
203(l)-1 contains a note indicating that an adviser may treat as a
``private fund''--and thus a venture capital fund, if it meets the
rule's other criteria--any non-U.S. fund that is not offered through
the use of U.S. jurisdictional means but that would be a private fund
if the issuer were to conduct a private offering in the United
States.\299\ Moreover, a non-U.S. fund that is treated as a private
fund under these circumstances by an adviser relying on the venture
capital

exemption would also be treated as a private fund under the Advisers
Act for all purposes. This element is designed to ensure that an
adviser relying on the venture capital exemption by operation of the
note is subject to the same Advisers Act requirements as other advisers
relying on the venture capital exemption without use of the note.
---------------------------------------------------------------------------

    \297\ See Proposing Release, supra note 26, at section II.A.8
(``[S]hould 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)?'').
    \298\ See, e.g., Dechert General Letter; EFAMA Letter; Gunderson
Dettmer Letter; McGuireWoods Letter; Shearman Letter.
    \299\ As discussed below, this issue also is relevant to the
exemption provided by rule 203(m)-1. See also infra note 319.
---------------------------------------------------------------------------

10. Grandfathering Provision
    Under the rule, the definition of ``venture capital fund'' includes
any private fund that: (i) Represented to investors and potential
investors at the time the fund offered its securities that it pursues a
venture capital strategy; (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 capital commitments from, any
person after July 21, 2011 (the ``grandfathering provision'').\300\ A
grandfathered fund would thus include any fund that has accepted all
capital commitments by July 21, 2011 (including capital commitments
from existing and new investors) even if none of the capital
commitments has been called by such date.\301\ The calling of capital
after July 21, 2011 would be consistent with the grandfathering
provision, as long as the investor became obligated by July 21, 2011 to
make a future capital contribution. As a result, any investment adviser
that solely advises private funds that meet the definition in either
rule 203(l)-1(a) or (b) would be exempt from registration.
---------------------------------------------------------------------------

    \300\ Rule 203(l)-1(b).
    \301\ 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'').
---------------------------------------------------------------------------

    Although several commenters expressed support for the proposed
rule,\302\ two commenters indicated that the proposed grandfathering
provision was too restrictive because of the holding out
criterion.\303\ In contrast, the North American Securities
Administrators Association, Inc. expressed its view that the proposed
grandfathering provision was too expansive and urged that the rule
impose additional substantive requirements similar to those included
among the definitional elements in rule 203(l)-1(a).\304\
---------------------------------------------------------------------------

    \302\ Comment Letter of AustinVentures (Jan. 21, 2011) (``AV
Letter''); Norwest Letter; NYSBA Letter. See also NVCA Letter.
    \303\ DLA Piper VC Letter; Pine Brook Letter.
    \304\ Comment Letter of North American Securities Administrators
Association, Inc., Feb. 10, 2011 (``NASAA Letter'').
---------------------------------------------------------------------------

    As in the case of the holding out criterion discussed above, this
element of the grandfathering provision elicited the most comments.
Generally, commenters either (i) did not support a grandfathering
provision that defined a venture capital fund as a fund that identified
itself (or called itself) ``venture capital,'' \305\ or (ii) sought
clarification or an expansive interpretation of the holding out element
so that existing funds would not be excluded from the definition merely
because they have identified themselves as ``growth capital,'' ``multi-
strategy'' or ``private equity,'' \306\ which commenters asserted is
typical of some older funds. No commenter addressed the dates proposed
in the grandfathering provision.\307\
---------------------------------------------------------------------------

    \305\ Davis Polk Letter; DLA Piper VC Letter; Pine Brook Letter.
    \306\ Davis Polk Letter; Gunderson Dettmer Letter; IVP Letter;
Norwest Letter; NVCA Letter.
    \307\ The NVCA specifically stated that other than clarification
on the names that venture capital funds may use to identify
themselves, no ``further changes to the grandfathering proposal are
necessary or appropriate and [we] do not believe that this
criterion, as it exists for new funds, presents problems to the
industry.'' See NVCA Letter.
---------------------------------------------------------------------------

    As discussed above, we believe that the ``holding out'' requirement
is an important prophylactic tool to prevent circumvention of the
intended scope of the venture capital exemption. Thus, we are adopting
the grandfathering provision as proposed, with the modifications to the
holding out criterion discussed above.\308\ As noted above in the
definition of a venture capital fund generally, the holding out
criterion in the grandfathering provision has also been changed to
refer to the strategy pursued by the private fund. A fund that seeks to
qualify under our rule should examine all of the statements and
representations made to investors and prospective investors to
determine whether the fund has satisfied the ``holding out'' criterion
as it is incorporated into the grandfathering provision.\309\
---------------------------------------------------------------------------

    \308\ See supra discussion at Section II.A.7.
    \309\ Id.
---------------------------------------------------------------------------

    Thus, under the rule, 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 fund).
Accordingly, we believe that advisers have not had an incentive to mis-
characterize the investment strategies pursued by existing venture
capital funds that have already been marketed to investors. As we note
above, a fund that ``represents'' itself to investors as pursuing a
venture capital strategy is typically one that discloses it pursues a
venture capital strategy and identifies itself as such.\310\ We do not
expect existing funds identifying themselves as pursuing a ``private
equity'' or ``hedge'' fund strategy would be able to rely on this
element of the grandfathering provision.
---------------------------------------------------------------------------

    \310\ See id.
---------------------------------------------------------------------------

    We believe that most funds previously sold as venture capital funds
likely would satisfy all or most of the conditions in the
grandfathering provision. Nevertheless, we recognize that investment
advisers that sponsored new funds before the adoption of rule 203(l)-1
faced uncertainty regarding the precise terms of the definition and
hence uncertainty regarding their eligibility for the new exemption.
Thus, as proposed, the grandfathering provision specifies that a
qualifying fund must have commenced its offering (i.e., initially sold
securities) by December 2010 and must have concluded its offering by
the effective date of Title IV (i.e., July 21, 2011). This provision is
designed to prevent circumvention of 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 definition of a venture capital fund would likely be
impossible in many cases and yield unintended consequences for the
funds and their investors.\311\
---------------------------------------------------------------------------

    \311\ One commenter agreed that it may be difficult for a
qualifying fund seeking to rely on the grandfathering provision to
change fund terms and liquidate its positions to the possible
detriment of the fund and its investors. AV Letter.
---------------------------------------------------------------------------

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 under the Advisers Act any investment adviser solely
to private funds that has less than $150 million in assets under
management in the United States.\312\ Rule 203(m)-1, which we are

adopting today, provides the exemption and, in addition, addresses
several interpretive questions raised by section 203(m). As noted
above, we refer to this exemption as the ``private fund adviser
exemption.''
---------------------------------------------------------------------------

    \312\ Section 408 of the Dodd-Frank Act, which is codified in
section 203(m) of the Advisers Act. See supra note 19.
---------------------------------------------------------------------------

1. Advises Solely Private Funds
    Rule 203(m)-1, like section 203(m), limits an adviser relying on
the exemption to those advising ``private funds'' as that term is
defined in the Advisers Act.\313\ An adviser that has one or more
clients that are not private funds is not eligible for the exemption
and must register under the Advisers Act unless another exemption is
available. An adviser may advise an unlimited number of private funds,
provided the aggregate value of the assets of the private funds is less
than $150 million.\314\
---------------------------------------------------------------------------

    \313\ See rule 203(m)-1(a) and (b). Section 202(a)(29) of the
Advisers Act defines the term ``private fund'' as ``an issuer that
would be an investment company, as defined in section 3 of the
Investment Company Act of 1940 (15 U.S.C. 80a-3), but for section
3(c)(1) or 3(c)(7) of that Act.'' A ``private fund'' includes a
private fund that invests in other private funds. See also supra
note 294; Proposing Release, supra note 26, at n.175 and
accompanying text.
    \314\ We note, however, that depending on the facts and
circumstances, we may view two or more separately formed advisory
entities that each has less than $150 million in private fund assets
under management as a single adviser for purposes of assessing the
availability of exemptions from registration. See infra note 506.
See also section 208(d), which prohibits a person from doing,
indirectly or through or by another person, any act or thing which
it would be unlawful for such person to do directly.
---------------------------------------------------------------------------

    In the case of an adviser with a principal office and place of
business outside of the United States (a ``non-U.S. adviser''), the
exemption is available as long as all of the adviser's clients that are
United States persons are qualifying private funds.\315\ As a
consequence, a non-U.S. adviser may enter the U.S. market and take
advantage of the exemption without regard to the type or number of its
non-U.S. clients or the amount of assets it manages outside of the
United States. Under the rule, a non-U.S. adviser would not lose the
private fund adviser exemption as a result of the size or nature of its
advisory or other business activities outside of the United States. The
rule reflects our long-held view that non-U.S. activities of non-U.S.
advisers are less likely to implicate U.S. regulatory interests and
that this territorial approach is in keeping with general principles of
international comity.\316\ Commenters supported the proposed rule's
treatment of non-U.S. advisers.\317\
---------------------------------------------------------------------------

    \315\ Rule 203(m)-1(b)(1). As discussed below, we also are
adding a note to rule 203(m)-1 that clarifies that a client will not
be considered a United States person if the client was not a United
States person at the time of becoming a client. See infra note 403.
    \316\ These considerations have, for example, been incorporated
in our rules permitting a non-U.S. adviser relying on the private
adviser exemption to count only clients that are U.S. persons when
determining whether it has 14 or fewer clients. 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 392. The Dodd-Frank Act repeals the
private adviser exemption as of July 21, 2011, and we are rescinding
rule 203(b)(3)-1 in the Implementing Adopting Release. See
Implementing Adopting Release, supra note 32, at section II.D.2.a.
    \317\ See, e.g., ABA Letter; Comment Letter of Debevoise &
Plimpton LLP (Jan. 24, 2011) (``Debevoise Letter''); Comment Letter
of Dechert LLP (on behalf of Foreign Adviser) (Jan. 24, 2011)
(``Dechert Foreign Adviser Letter''); Gunderson Dettmer Letter;
Merkl Letter; Comment Letter of Katten Muchin Rosenman LLP (on
behalf of Certain Non-U.S. Advisers) (Jan. 24, 2011) (``Katten
Foreign Advisers Letter''); Comment Letter of MAp Airports Limited
(Jan. 24, 2011) (``MAp Airports Letter''); Comment Letter of
Wellington Financial LP (Jan. 24, 2011) (``Wellington Letter'').
---------------------------------------------------------------------------

    Some commenters urged that the rule should also permit U.S.
advisers relying on the exemption to advise other types of
clients.\318\ Section 203(m) directs us to provide an exemption to
advisers that act solely as advisers to private funds.\319\ Our
treatment of non-U.S. advisers with respect to their non-U.S. clients,
as we note above, establishes certain appropriate limits on the
extraterritorial application of the Advisers Act.\320\ In contrast,
permitting U.S. advisers with additional types of clients to rely on
the exemption would appear to directly conflict with section 203(m),
and we therefore are not revising the rule as the commenters proposed.
---------------------------------------------------------------------------

    \318\ See, e.g., Letter of Sadis & Goldberg (Jan. 11, 2011)
(submitted in connection with the Implementing Proposing Release,
avail. at http://www.sec.gov/comments/s7-36-10/s73610.shtml)
(``Sadis & Goldberg Implementing Release Letter'') (exemption should
be available to advisers who, in addition to advising private funds,
also have five or fewer clients that are separately managed
accounts); Comment Letter of Seward & Kissel LLP (Jan. 31, 2011)
(``Seward Letter'') (advisers should be permitted to rely on
multiple exemptions and advisers relying on the private fund adviser
exemption should be permitted to engage in ``some activities that do
not involve advising clients and have no effect on assets under
management,'' such as providing research to institutional
investors).
    \319\ One commenter argued that a U.S. adviser should be
permitted to treat as a private fund for purposes of rule 203(m)-1 a
non-U.S. fund that has not made an offering to U.S. persons. See
Comment Letter of Fox Horan & Camerini LLP (Dec. 22, 2010). See also
supra notes 294 and 313. We agree.
    \320\ In contrast to the foreign private adviser exemption
discussed in Section II.C, a non-U.S. adviser relying on the private
fund adviser exemption may have a U.S. place of business, but a non-
U.S. adviser need not have a U.S. place of business to rely on the
private fund adviser exemption.
---------------------------------------------------------------------------

    Some commenters suggested that the rule permit advisers to combine
other exemptions with rule 203(m)-1 so that, for example, an adviser
could advise venture capital funds with assets under management in
excess of $150 million in addition to other types of private funds with
less than $150 million in assets under management.\321\ We believe that
the commenters' proposed interpretation runs contrary to the language
of section 203(m), which limits advisers relying on the exemption to
advising solely private funds with assets under management in the
United States of less than $150 million or solely venture capital funds
in the case of section 203(l).\322\
---------------------------------------------------------------------------

    \321\ NASBIC/SBIA Letter; Seward Letter.
    \322\ The same analysis also would apply to non-U.S. advisers,
which may not for example combine the private fund adviser exemption
and the foreign private adviser exemption (e.g., a non-U.S. adviser
could not advise private funds that are United States persons with
assets in excess of $25 million in reliance on the private fund
adviser exemption and also advise other clients in the United States
that are not private funds in reliance on the foreign private
adviser exemption). We also note that depending on the facts and
circumstances, we may view two or more separately formed advisory
entities, each of which purports to rely on a separate exemption
from registration, as a single adviser for purposes of assessing the
availability of exemptions from registration. See infra note 506.
See also section 208(d), which prohibits a person from doing,
indirectly or through or by another person, any act or thing which
it would be unlawful for such person to do directly.
---------------------------------------------------------------------------

    A few commenters also asked us to address whether a fund with a
single investor could be a ``private fund'' for purposes of the
exemption.\323\ Whether a single-investor fund could be a private fund
for purposes of the exemption depends on the facts and circumstances.
We are concerned that an adviser simply could convert client accounts
to single-investor funds in order to avoid registering under the
Advisers Act. These ``funds'' would be tantamount to separately managed
accounts. Section 208(d) of the Advisers Act anticipates these and
other artifices and thus prohibits a person from doing, indirectly or
through or by another person, any act or thing which it would be
unlawful for such person to do directly.\324\ We recognize, however,
that

there are circumstances in which it may be appropriate for an adviser
to treat a single-investor fund as a private fund for purposes of rule
203(m)-1.\325\
---------------------------------------------------------------------------

    \323\ See ABA Letter (single-investor funds formed at the
request of institutional investors should be considered private
funds if they are managed in a manner similar to the adviser's
related multi-investor private funds, have audited financial
statements, and are treated as private funds for purposes of the
custody rule); Comment Letter of Alternative Investment Management
Association (Jan. 24, 2011) (``AIMA Letter'') (sought guidance
concerning single-investor funds and managed accounts structured as
funds); Commenter Letter of Managed Funds Association (Jan. 24,
2011) (``MFA Letter'') (asserted that single-investor funds are
``private funds'').
    \324\ We would view a structure with no purpose other than
circumvention of the Advisers Act as inconsistent with section
208(d). See, e.g., Custody of Funds or Securities of Clients by
Investment Advisers, Investment Advisers Act Release No. 2968 (Dec.
30, 2009) [75 FR 1456 (Jan. 11, 2010)] at n.132 (the use of a
special purpose vehicle in certain circumstances could constitute a
violation of section 208(d) of the Advisers Act). Thus, for example,
an adviser would not be eligible for the exemption if it advises
what is nominally a ``private fund'' but that in fact operates as a
means for providing individualized investment advice directly to the
investors in the ``private fund.'' In this case, the investors would
also be clients of the adviser. Cf. Advisers Act rule 202(a)(30)-
1(b)(1) (an adviser ``must count an owner [of a legal organization]
as a client if [it] provide[s] investment advisory services to the
owner separate and apart from the investment advisory services [it]
provide[s] to the legal organization'').
    \325\ For example, a fund that seeks to raise capital from
multiple investors but has only a single, initial investor for a
period of time could be a private fund, as could a fund in which all
but one of the investors have redeemed their interests.
---------------------------------------------------------------------------

    One commenter argued that advisers should be permitted to treat as
a private fund for purposes of rule 203(m)-1 a fund that also qualifies
for another exclusion from the definition of ``investment company'' in
the Investment Company Act in addition to section 3(c)(1) or 3(c)(7),
such as section 3(c)(5)(C), which excludes certain real estate
funds.\326\ These funds would not be private funds, because a ``private
fund'' is a fund that would be an investment company as defined in
section 3 of the Investment Company Act but for section 3(c)(1) or
3(c)(7) of that Act.\327\
---------------------------------------------------------------------------

    \326\ Dechert General Letter. See also Comment Letter of Baker
McKenzie LLP (Jan. 26, 2011) (submitted in connection with the
Implementing Proposing Release, avail. at http://www.sec.gov/comments/s7-36-10/s73610.shtml) (recommended that the Commission
revise the calculation of assets under management on Form ADV to
exclude assets in certain funds relying on section 3(c)(5)(C) of the
Investment Company Act); Comment Letter of DLA Piper LLP (US)
(submitted by John H. Heuberger and Hal M. Brown) (similarly sought
to exempt advisers to certain funds relying on section 3(c)(5)(C)).
    \327\ Section 202(a)(29) of the Advisers Act (defining the term
``private fund'').
---------------------------------------------------------------------------

    The commenter argued, and we agree, that an adviser should
nonetheless be permitted to advise such a fund and still rely on the
exemption. Otherwise, for example, an adviser to a section 3(c)(1) or
3(c)(7) fund would lose the exemption if the fund also qualified for
another exclusion, even though the adviser may be unaware of the fund
so qualifying and the fund does not purport to rely on the other
exclusion. We do not believe that Congress intended that an adviser
would lose the exemption in these circumstances. Accordingly, the
definition of a ``qualifying private fund'' in rule 203(m)-1 permits an
adviser to treat as a private fund for purposes of the exemption a fund
that qualifies for an exclusion from the definition of investment
company as defined in section 3 of the Investment Company Act in
addition to the exclusions provided by section 3(c)(1) or 3(c)(7).\328\
---------------------------------------------------------------------------

    \328\ Rule 203(m)-1(d)(5). This provision may also apply to non-
U.S. funds that seek to comply with section 7(d) of the Investment
Company Act and exclusions in addition to those provided by section
3(c)(1) or 3(c)(7) of that Act.
---------------------------------------------------------------------------

    An adviser relying on this provision must treat the fund as a
private fund under the Advisers Act and the rules thereunder for all
purposes.\329\ This is to ensure that an adviser relying on the
exemption as a result of our modification of the definition of a
``qualifying private fund'' is subject to the same Advisers Act
requirements as other advisers relying on the exemption. Therefore, an
adviser to a fund that also qualifies for another exclusion in addition
to section 3(c)(1) or 3(c)(7) may treat the fund as a private fund and
rely on rule 203(m)-1 if the adviser meets the rule's other conditions,
provided that the adviser treats the fund as a private fund under the
Advisers Act and the rules thereunder for all purposes including, for
example, reporting on Form ADV, which requires advisers to report
certain information about the private funds they manage.\330\
---------------------------------------------------------------------------

    \329\ Rule 203(m)-1(d)(5).
    \330\ See Item 7.B of Form ADV, Part 1A.
---------------------------------------------------------------------------

2. Private Fund Assets
a. Method of Calculation
    Under rule 203(m)-1, an adviser must aggregate the value of all
assets of private funds it manages to determine if the adviser is below
the $150 million threshold.\331\ Rule 203(m)-1 requires advisers to
calculate the value of private fund assets pursuant to instructions in
Form ADV, which provide a uniform method of calculating assets under
management for regulatory purposes under the Advisers Act.\332\
---------------------------------------------------------------------------

    \331\ Rule 203(m)-1(d)(4).
    \332\ See rules 203(m)-1(a)(2); 203(m)-1(b)(2); 203(m)-1(d)(1)
(defining ``assets under management'' to mean ``regulatory assets
under management'' in item 5.F of Form ADV, Part 1A); 203(m)-1(d)(4)
(defining ``private fund assets'' to mean the ``assets under
management'' attributable to a ``qualifying private fund''). In the
case of a subadviser, an adviser must count only that portion of the
private fund assets for which it has responsibility. See Form ADV:
Instructions for Part 1A, instr. 5.b.(2) (explaining that, if an
adviser provides continuous and regular supervisory or management
services for only a portion of a securities portfolio, it should
include only that portion of the securities portfolio for which it
provides such services, and that an adviser should exclude, for
example, the portion of an account under management by another
person).
---------------------------------------------------------------------------

    In the Implementing Adopting Release, we are revising the
instructions to Form ADV to provide a uniform method to calculate
assets under management for regulatory purposes, including determining
eligibility for Commission, rather than state, registration; reporting
assets under management for regulatory purposes on Form ADV; and
determining eligibility for two of the new exemptions from registration
under the Advisers Act discussed in this Release.\333\ Under the
revised Form ADV instructions, as relevant here, advisers must include
in their calculations proprietary assets and assets managed without
compensation as well as uncalled capital commitments.\334\ In addition,
an adviser must determine the amount of its private fund assets based
on the market value of those assets, or the fair value of those assets
where market value is unavailable,\335\ and must calculate the assets
on a gross basis, i.e., without deducting liabilities, such as accrued
fees and expenses or the amount of any borrowing.\336\
---------------------------------------------------------------------------

    \333\ See Implementing Adopting Release, supra note 32,
discussion at section II.A.3 (discussing the rationale underlying
the new instructions for calculating assets under management for
regulatory purposes).
    \334\ See Form ADV: Instructions for Part 1A, instr. 5.b.(1),
(4). Advisers also must include in their ``regulatory assets under
management'' assets of non-U.S. clients. See Implementing Adopting
Release, supra note 32, at n.76 (explaining that a domestic adviser
dealing exclusively with non-U.S. clients must register with the
Commission if it uses any U.S. jurisdictional means in connection
with its advisory business unless the adviser qualifies for an
exemption from registration or is prohibited from registering with
the Commission). See also infra note 415.
    \335\ This valuation requirement is described in terms similar
to the definition of ``value'' in the Investment Company Act, which
looks to market value when quotations are readily available and, if
not, then to fair value. See Investment Company Act section
2(a)(41). See also Implementing Adopting Release, supra note 32, at
n.91 and accompanying text. Other standards also may be expressed as
requiring that a determination of fair value be based on market
quotations where they are readily available. Id.
    \336\ See Form ADV: Instructions for Part 1A, instr. 5.b.(2),
(4). See also Implementing Adopting Release, supra note 32,
discussion at section II.A.3.
---------------------------------------------------------------------------

    Use of this uniform method will, we believe, 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 assessment of risk.\337\ In addition, the
uniform method of calculation is designed to ensure that, to the extent
possible, advisers with similar amounts of assets under management will
be treated similarly for regulatory purposes, including their ability
to rely

on the private fund adviser exemption and the foreign private adviser
exemption, both of which refer to an adviser's assets under
management.\338\
---------------------------------------------------------------------------

    \337\ See Proposing Release, supra note 26, discussion at
section II.B.2. See also Implementing Adopting Release, supra note
32, discussion at section II.A.3.
    \338\ See Proposing Release, supra note 26, discussion at
section V.B.1 (explaining that, because the instructions to Form ADV
previously permitted advisers to exclude certain types of managed
assets, ``it is not possible to conclude that two advisers reporting
the same amount of assets under management are necessarily
comparable because either adviser may elect to exclude all or some
portion of certain specified assets that it manages'').
---------------------------------------------------------------------------

    Many commenters expressed general support for a uniform method of
calculating assets under management in order to maintain consistency
for registration and risk assessment purposes.\339\ The proposals to
use fair value of private fund assets and to include uncalled capital
commitments in private fund assets also received support.\340\ As
discussed below, however, a number of commenters disagreed with or
sought changes to one or more of the elements of the proposed method of
calculating assets under management for regulatory purposes set forth
in Form ADV.\341\ None of the commenters, however, suggested
alternative approaches that could accommodate the specific changes they
sought and achieve our goals of consistent asset calculations and
reporting discussed above, and we are not aware of such an alternative
approach.
---------------------------------------------------------------------------

    \339\ See, e.g., AFL-CIO Letter (``We support the SEC's proposal
to require funds to use a uniform standard to calculate their assets
under management and agree that it is important that the calculation
account for asset appreciation.''); AFR Letter (``AFR supports the
SEC's proposal to require funds to use a uniform standard to
calculate their assets under management, and to account for asset
appreciation in those calculations''); AIMA Letter (``We agree that
a clear and unified approach for calculation of AUM is necessary and
we believe that using as a standard the assets for which an adviser
has `responsibility' is appropriate.''); Dechert General Letter
(commented on particular aspects of the proposed uniform method but
stated ``[w]e generally agree with the Commission's initiative in
creating a single uniform method of calculating an adviser's assets
under management (`AUM') for purposes of determining an adviser's
registration status (`Regulatory AUM')''). See also Implementing
Adopting Release, supra note 32, at n.68 and accompanying text.
    \340\ See ABA Letter (supported use of fair value); AIMA Letter
(supported including uncalled capital commitments, provided that the
adviser has full contractual rights to call that capital and would
be given responsibility for management of those assets).
    \341\ See also Implementing Adopting Release, supra note 32,
discussion at section II.A.3.
---------------------------------------------------------------------------

    For example, some commenters sought to exclude from the calculation
proprietary assets and assets managed without compensation because such
a requirement would be inconsistent with the statutory definition of
``investment adviser.'' \342\ Although a person is not an ``investment
adviser'' for purposes of the Advisers Act unless it receives
compensation for providing advice to others, once a person meets that
definition (by receiving compensation from any client to which it
provides advice), the person is an adviser, and the Advisers Act
applies to the relationship between the adviser and any of its clients
(whether or not the adviser receives compensation from them).\343\ Both
the private fund adviser exemption and the foreign private adviser
exemption are conditioned upon an adviser not exceeding specified
amounts of ``assets under management.'' \344\ Neither statutory
exemption limits the types of assets that should be included in this
term, and we do not believe that such limits would be appropriate.\345\
In our view, the source of the assets managed should not affect the
availability of the exemptions.
---------------------------------------------------------------------------

    \342\ See, e.g., Dechert General Letter; Seward Letter. See also
ABA Letter; AIMA Letter (suggested a 12-month exclusion for seed
capital consistent with the Volcker rule); Dechert Foreign Adviser
Letter; EFAMA Letter; Katten Foreign Advisers Letter; MFA Letter.
Under section 202(a)(11) of the Advisers Act, the definition of
``investment adviser'' includes, among others, ``any person who, for
compensation, engages in the business of advising others * * * as to
the value of securities or as to the advisability of investing in,
purchasing, or selling securities * * *.'' One commenter argued that
including proprietary assets would deter non-U.S. advisers that
manage large amounts of proprietary assets from establishing U.S.
operations. Katten Foreign Advisers Letter. Such an adviser,
however, would not be ineligible for the private fund adviser
exemption merely because it established U.S. operations. As
discussed below, a non-U.S. adviser may rely on the private fund
adviser exemption while also having one or more U.S. places of
business, provided it complies with the exemption's conditions. See
infra Section II.B.3.
    \343\ See Implementing Adopting Release, supra note 32, at n.74
and accompanying text. Several commenters also asserted that
including proprietary assets as proposed would in effect require a
wholly owned control affiliate to register as an investment adviser.
See, e.g., Comment Letter of American Insurance Association (Jan.
24, 2011) (``AIA Letter''); Comment Letter of Katten Muchin Rosenman
LLP (on behalf of APG Asset Management US Inc.) (Jan. 21, 2011);
Comment Letter of Katten Muchin Rosenman LLP (Jan. 24, 2011) (on
behalf of Certain Non-U.S. Insurance Companies) (``Katten Foreign
Insurance Letter''). Whether a control affiliate is deemed to be an
``investment adviser'' under the Advisers Act because, among other
things, it ``engages in the business of advising others'' will
depend on the particular facts and circumstances. The calculation of
regulatory assets under management, including the mandatory or
optional inclusion of specified assets in that calculation, is
applicable after the entity is determined to be an investment
adviser.
    \344\ See sections 203(m) and 202(a)(30) of the Advisers Act.
    \345\ See also Implementing Adopting Release, supra note 32, at
n.75 and accompanying text (explaining that ``the management of
`proprietary' assets or assets for which the adviser may not be
compensated, when combined with other client assets, may suggest
that the adviser's activities are of national concern or have
implications regarding the reporting for the assessment of systemic
risk'').
---------------------------------------------------------------------------

    We also do not expect that advisers' principals (or other
employees) generally will cease to invest alongside the advisers'
clients as a result of the inclusion of proprietary assets, as some
commenters suggested.\346\ If private fund investors value their
advisers' co-investments as suggested by these commenters, we expect
that the investors will demand them and their advisers will structure
their businesses accordingly.\347\
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    \346\ See, e.g., ABA Letter; Katten Foreign Advisers Letter;
Seward Letter.
    \347\ Moreover, we note that an adviser seeking to rely on rule
203(m)-1 may have only private fund clients and must include the
assets of all of its private fund clients when determining if it
remains under the rule's $150 million threshold.
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    Other commenters objected to calculating regulatory assets under
management on the basis of gross, rather than net, assets.\348\ They
argued, among other things, that gross asset measurements would be
confusing,\349\ complex,\350\ and inconsistent with industry
practice.\351\ However, nothing in the current instructions suggests
that liabilities should be deducted from the calculation of an
adviser's assets under management. Indeed, since 1997, the instructions
have stated that an adviser should not deduct securities purchased on
margin when calculating its assets

under management.\352\ Whether a client has borrowed to purchase a
portion of the assets managed does not seem to us a relevant
consideration in determining the amount an adviser has to manage, the
scope of the adviser's business, or the availability of the
exemptions.\353\
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    \348\ ABA Letter; Dechert General Letter; Merkl Letter; MFA
Letter; Seward Letter; Shearman Letter.
    \349\ Dechert General Letter. See also Implementing Adopting
Release, supra note 32, at n.80 and accompanying text.
    \350\ MFA Letter.
    \351\ See, e.g., Merkl Letter; Shearman Letter. One commenter
asserted that the ``inclusion of borrowed assets may create an
incentive for an adviser to reduce client borrowings to qualify for
an exemption from registration even though reducing leverage may not
be in the best interest of its clients,'' and that it ``could
encourage advisers to use methods other than borrowing to obtain
financial leverage for their clients (e.g., through swaps or other
derivative products, which could be disadvantageous to clients due
to the counterparty risks and increased costs that they entail).''
Seward Letter. See also Gunderson Dettmer Letter. We note that
advisers, as fiduciaries, may not subordinate clients' interests to
their own such as by altering their investing behavior in a way that
is not in the client's best interest in an attempt to remain under
the exemption's $150 million threshold. Another commenter argued
that a gross assets calculation would make calculations of
regulatory assets under management more volatile. See Dechert
General Letter. As discussed in more detail below, we are permitting
advisers relying on rule 203(m)-1 to calculate their private fund
assets annually, rather than quarterly as proposed, and are
extending the period during which certain advisers may file their
registration applications if their private fund assets exceed the
exemption's $150 million threshold. See infra Section II.B.2.b. We
believe these measures will substantially mitigate or eliminate any
volatility that may be caused by using a gross assets measurement,
as well as potential volatility in currency exchange rates
identified by some commenters. See CompliGlobe Letter; EVCA Letter;
O'Melveny Letter.
    \352\ See Form ADV: Instructions for Part 1A, instr. 5.b.(2), as
in effect before it was amended by the Implementing Adopting Release
(``Do not deduct securities purchased on margin.''). Instruction
5.b.(2), as amended in the Implementing Adopting Release, provides
``Do not deduct any outstanding indebtedness or other accrued but
unpaid liabilities.'' See Implementing Adopting Release, supra note
32, discussion at section II.A.3.
    \353\ See id.
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    Moreover, we are concerned that the use of net assets could permit
advisers to highly leveraged funds to avoid registration under the
Advisers Act even though the activities of such advisers may be
significant and the funds they advise may be appropriate for systemic
risk reporting.\354\ One commenter argued, in contrast, that it would
be ``extremely unlikely that a net asset limit of $150,000,000 in
private funds could be leveraged into total investments that would pose
any systemic risk.'' \355\ But a comprehensive view of systemic risk
requires information about certain funds that may not present systemic
risk concerns when viewed in isolation, but nonetheless are relevant to
an assessment of systemic risk across the economy. Moreover, because
private funds are not subject to the leverage restrictions in section
18 of the Investment Company Act, a private fund with less than $150
million in net assets could hold assets far in excess of that amount as
a result of its extensive use of leverage. In addition, under a net
assets test such a fund would be treated similarly for regulatory
purposes as a fundamentally different fund, such as one that did not
make extensive use of leverage and had $140 million in net assets.
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    \354\ See id., at n.82 and preceding and accompanying text.
    \355\ ABA Letter.
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    The use of gross assets also need not cause any investor confusion,
as some commenters suggested.\356\ Although an adviser will be required
to use gross (rather than net) assets for purposes of determining
whether it is eligible for the private fund adviser or the foreign
private adviser exemptions (among other purposes), we would not
preclude an adviser from holding itself out to its clients as managing
a net amount of assets as may be its custom.\357\
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    \356\ See, e.g., Dechert General Letter. See also Implementing
Adopting Release, supra note 32, at n.80 and accompanying text.
    \357\ In addition, in response to commenters seeking
clarification of the application of the gross assets calculation to
mutual funds, short positions and leverage, we expect that advisers
will continue to calculate their gross assets as they do today, even
if they currently only calculate gross assets as an intermediate
step to compute their net assets. See Implementing Adopting Release,
supra note 32, at n.83. In the case of pooled investment vehicles
with a balance sheet, for instance, an adviser could include in the
calculation the total assets of the entity as reported on the
balance sheet. Id.
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    One commenter opposed the requirement that advisers include in the
calculation of private fund assets uncalled capital commitments,
asserting that the uncalled capital remains under the management of the
fund investor.\358\ As we noted in the Proposing Release, in the early
years of a private fund's life, its adviser typically earns fees based
on the total amount of capital commitments, which we presume reflects
compensation for efforts expended on behalf of the fund in preparation
for the investments.\359\
---------------------------------------------------------------------------

    \358\ See Merkl Letter.
    \359\ Proposing Release, supra note 26, discussion at section
II.B.2. See also Implementing Adopting Release, supra note 32, at
n.90 and accompanying text.
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    A number of commenters objected to the requirement to determine
private fund assets based on fair value, generally arguing that the
requirement would cause those advisers that did not use fair value
methods to incur additional costs, especially if the private funds'
assets that they manage are illiquid and therefore difficult to fair
value.\360\ We noted in the Proposing Release that we understood that
many private funds already value assets in accordance with U.S.
generally accepted accounting principles (``GAAP'') or other
international accounting standards that require the use of fair value,
citing letters we had received in connection with other rulemaking
initiatives.\361\ We are sensitive to the costs this new requirement
will impose. We believe, however, that this approach is warranted in
light of the unique regulatory purposes of the calculation under the
Advisers Act. We estimated these costs in the Proposing Release \362\
and we have taken several steps to mitigate them.\363\
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    \360\ See, e.g., Gunderson Dettmer Letter; Merkl Letter;
O'Melveny Letter; Seward Letter; Wellington Letter.
    \361\ See Proposing Release, supra note 26, at n.196 and
accompanying text.
    \362\ See id., at n.326 and accompanying text.
    \363\ We recognize that although these steps will provide
advisers greater flexibility in calculating the value of their
private fund assets, they also will result in valuations that are
not as comparable as they could be if we specified a fair value
standard (e.g., as specified in GAAP).
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    While many advisers will calculate fair value in accordance with
GAAP or another international accounting standard,\364\ other advisers
acting consistently and in good faith may utilize another fair
valuation standard.\365\ While these other standards may not provide
the quality of information in financial reporting (for example, of
private fund returns), we expect these calculations will provide
sufficient consistency for the purposes that regulatory assets under
management serve in our rules, including rule 203(m)-1.\366\
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    \364\ Several commenters asked that we not require advisers to
fair value private fund assets in accordance with GAAP for purposes
of calculating regulatory assets under management because many
funds, particularly offshore ones, do not use GAAP and such a
requirement would be unduly burdensome. See, e.g., EFAMA Letter;
Katten Foreign Advisers Letter. We did not propose such a
requirement, nor are we adopting one. See Implementing Adopting
Release, supra note 32, at n.98.
    \365\ See id., at n.99 and accompanying text. Consistent with
this good faith requirement, we would expect that an adviser that
calculates fair value in accordance with GAAP or another basis of
accounting for financial reporting purposes will also use that same
basis for purposes of determining the fair value of its regulatory
assets under management. Id.
    \366\ See id., at n.100 and accompanying text. In addition, the
fair valuation process need not be the result of a particular
mandated procedure and the procedure need not involve the use of a
third-party pricing service, appraiser or similar outside expert. An
adviser could rely on the procedure for calculating fair value that
is specified in a private fund's governing documents. The fund's
governing documents may provide, for example, that the fund's
general partner determines the fair value of the fund's assets.
Advisers are not, however, required to fair value real estate assets
only in those limited circumstances where real estate assets are not
required to be fair valued for financial reporting purposes under
accounting principles that otherwise require fair value for assets
of private funds. For example, in those cases, an adviser may
instead value the real estate assets as the private fund does for
financial reporting purposes. We note that the Financial Accounting
Standards Board (``FASB'') has a current project related to
investment property entities that may require real estate assets
subject to that accounting standard to be measured by the adviser at
fair value. See FASB Project on Investment Properties. We also note
that certain international accounting standards currently permit,
but do not require, fair valuation of certain real estate assets.
See International Accounting Standard 40, Investment Property. To
the extent that an adviser follows GAAP or another accounting
standard that requires or in the future requires real estate assets
to be fair valued, this limited exception to the use of fair value
measurement for real estate assets would not be available.
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    Commenters also suggested alternative approaches to valuation,
including the use of local accounting principles; \367\ the methodology
used to report to the private fund's investors; \368\ the methodologies
described in a client's governing documents or offering materials;
\369\ historical cost; \370\ and aggregate capital raised by a private

fund.\371\ Use of these approaches would limit our ability to compare
data from different advisers and thus would be inconsistent with our
goal of achieving more consistent asset calculations and reporting
across the industry, as discussed above, and also could result in
advisers managing comparable amounts of assets under management being
subject to different registration requirements. Moreover, these
alternative approaches could permit advisers to circumvent the Advisers
Act's registration requirements. Permitting the use of any valuation
standard set forth in the governing documents of the private fund other
than fair value could effectively yield to the adviser the choice of
the most favorable standard for determining its registration obligation
as well as the application of other regulatory requirements.
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    \367\ Dechert Foreign Adviser Letter; EFAMA Letter.
    \368\ Merkl Letter; Wellington Letter.
    \369\ AIMA Letter; MFA Letter; Seward Letter.
    \370\ O'Melveny Letter.
    \371\ Gunderson Dettmer Letter.
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    For these reasons and as we proposed, rule 203(m)-1 requires
advisers to calculate the value of private fund assets pursuant to the
instructions in Form ADV.
b. Frequency of Calculation and Transition Period
    An adviser relying on the exemption provided by rule 203(m)-1 must
annually calculate the amount of the private fund assets it manages and
report the amount in its annual updating amendments to its Form
ADV.\372\ If an adviser reports in its annual updating amendment that
it has $150 million or more of private fund assets under management,
the adviser is no longer eligible for the private fund adviser
exemption.\373\ Advisers thus may be required to register under the
Advisers Act as a result of increases in their private fund assets that
occur from year to year, but changes in the amount of an adviser's
private fund assets between annual updating amendments will not affect
the availability of the exemption.
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    \372\ An adviser relying on rule 203(m)-1 must file an annual
updating amendment to its Form ADV within 90 days after the end of
its fiscal year, and must calculate its private fund assets in the
manner described in the instructions to Form ADV within 90 days
prior to the date it makes the filing. See rule 203(m)-1(c); rule
204-4(a); General Instruction 4 to Form ADV; Form ADV: Instructions
for Part 1A, instr. 5.b. The adviser must report its private fund
assets on Section 2.B of Schedule D to Form ADV. Advisers also must
report their private fund assets when they file their initial
reports as exempt reporting advisers. See Implementing Adopting
Release, supra note 32, discussion at section II.B.
    \373\ Under Item 2.B of Part 1A of Form ADV, an adviser relying
on rule 203(m)-1 must complete Section 2.B of Schedule D, which
requires the adviser to provide the amount of the ``private fund
assets'' it manages. A note to Section 2.B of Schedule D provides
that ``private fund assets'' has the same meaning as under rule
203(m)-1, and that non-U.S. advisers should only include private
fund assets that they manage at a place of business in the United
States. See also infra notes 377-378 and accompanying text.
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    We proposed to require advisers relying on the exemption to
calculate their private fund assets each quarter to determine if they
remain eligible for the exemption. Commenters persuaded us, however,
that requiring advisers to calculate their private fund assets annually
in connection with their annual updating amendments to Form ADV would
be more appropriate because it would likely result in the same advisers
becoming registered each year while reducing the costs and burdens
associated with quarterly calculations.\374\ In addition, annual
calculations provide a range of dates on which an adviser may calculate
its private fund assets, addressing concerns raised by commenters about
shorter-term fluctuations in assets under management.\375\ The rule as
adopted also is consistent with the timeframes for valuing assets under
management and registering with the Commission applicable to state-
registered advisers switching from state to Commission
registration.\376\
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    \374\ A number of commenters argued, among other things, that
calculating private fund assets quarterly would: (i) Impose
unnecessary costs and burdens on advisers, some of whom might not
otherwise perform quarterly valuations; and (ii) inappropriately
permit shorter-term fluctuations in assets under management to
require advisers to register. See ABA Letter; AIMA Letter; Dechert
Foreign Adviser Letter; Dechert General Letter; EFAMA Letter; Katten
Foreign Advisers Letter; Merkl Letter; NASBIC/SBIA Letter; Seward
Letter.
    \375\ As discussed above, an adviser relying on rule 203(m)-1
must calculate its private fund assets in the manner described in
the instructions to Form ADV within 90 days prior to the date it
files its annual updating amendment to its Form ADV.
    \376\ See General Instruction 4 to Form ADV; Form ADV:
Instructions for Part 1A, instr. 5.b.; rule 203A-1(b). See also ABA
Letter (``We believe an annual measurement would be most
appropriate, especially since advisers exempt from registration
because they do not meet the $100,000,000 asset threshold will
calculate their assets for this purpose annually, and an annual test
for both purposes has a compelling consistency.'').
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    As noted above, if an adviser reports in its annual updating
amendment that it has $150 million or more of private fund assets under
management, the adviser is no longer eligible for the exemption and
must register under the Advisers Act unless it qualifies for another
exemption. An adviser that has complied with all Commission reporting
requirements applicable to an exempt reporting adviser as such,
however, may apply for registration with the Commission up to 90 days
after filing the annual updating amendment, and may continue to act as
a private fund adviser, consistent with the requirements of rule
203(m)-1, during this transition period.\377\ This 90-day transition
period is not available to advisers that have failed to comply with all
Commission reporting requirements applicable to an exempt reporting
adviser as such or that have accepted a client that is not a private
fund.\378\ These advisers therefore should plan to register before
becoming ineligible for the exemption.
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    \377\ General Instruction 15 to Form ADV. See also Implementing
Adopting Release, supra note 32, discussion at section II.B.5. We
removed what was proposed rule 203(m)-1(d), which contained the
proposed transition period, and renumbered the final rule
accordingly. The transition period as adopted is described in
General Instruction 15 to Form ADV. Rule 203(m)-1(c) refers advisers
to this instruction. This transition period is available to an
adviser that has complied with ``all [Commission] reporting
requirements applicable to an exempt reporting adviser as such,''
rather than ``all applicable Commission reporting requirements,'' as
proposed. This condition reflects the importance of the Advisers Act
reporting requirements applicable to advisers relying on the private
fund adviser exemption.
    \378\ General Instruction 15 to Form ADV. See also Implementing
Adopting Release, supra note 32, discussion at section II.B.5. An
adviser would lose the exemption immediately upon accepting a client
that is not a private fund. Accordingly, for the adviser to comply