do so through its advisers. As noted above, we have modeled this
element of the definition in part on existing provisions under the
Advisers Act and Investment Company Act dealing with BDCs.\287\ Our
proposed definition also is designed to be a simplified version of the
definition of ``making available significant managerial assistance''
under the BDC provisions, which we expect would reduce confusion and
facilitate understanding of the proposed rule.\288\ This approach would
preserve flexibility for venture capital funds that invest as a group
to determine which members of the group are best qualified, or best
able, to control the portfolio company or alternatively to offer (and/
or provide) managerial assistance to the portfolio company.
---------------------------------------------------------------------------

    \285\ See supra notes 85-87 and accompanying text.
    \286\ See supra section II.A.1.d of this Release.
    \287\ See supra notes 123-128 and accompanying text.
    \288\ See supra note 128 and accompanying and following text.
For example, unlike the BDC provision, the proposed definition does
not specifically define managerial assistance by referring to a
fund's directors, officers, employees or general partners. In
addition, like the BDC provision, the proposed definition would
require the venture capital fund to control the qualifying portfolio
company (if it does not offer or provide significant managerial
assistance), but without reference to exercising a controlling
influence because the ability to exercise a controlling influence is
inherent in the control relationship. See section 202(a)(12) of the
Advisers Act (defining control to mean the power to exercise a
controlling influence over the management or policies of a company
unless such power is solely the result of an official position with
such company). See supra note 129 for the definition of ``making
available significant managerial assistance'' by a BDC.
---------------------------------------------------------------------------

    Our proposed definition of qualifying portfolio company is
similarly broad because the definition does not restrict qualifying
companies to ``small or start-up'' companies. As we have noted above,
we believe that such definitions would be too restrictive and provide
venture capital fund advisers with too little flexibility and limited
options with respect to potential portfolio company investments.\289\
In addition, we propose to define a ``qualifying portfolio company'' as
a company that does not borrow from, or issue debt in connection with
the investment from, venture capital funds. Thus, a qualifying
portfolio company could borrow for working capital or other operating
needs from other lenders, such as banks, without jeopardizing the
venture capital fund adviser's eligibility for the exemption. These
proposed broad definitions and criteria should benefit advisers that
intend to rely on the exemption because they give the adviser
flexibility to structure transactions and investments in underlying
portfolio companies in a manner that meets their business objectives
without unduly creating systemic or other risks of the kind that
Congress suggested should require registration of the fund's adviser.
For commenters recommending more narrow elements for our definition, we
request comment on the costs to advisers of having to change their
business practices to comply with such narrower elements.
---------------------------------------------------------------------------

    \289\ See supra discussion in section II.A.1.a of this Release.
---------------------------------------------------------------------------

    We believe that the grandfathering provision would promote
efficiency because it will allow advisers to existing venture capital
funds to continue to rely on the exemption without having to
restructure funds that may not meet the proposed definition. It also
would allow advisers to funds that are currently in formation and can
meet the requirements of the grandfathering provision to rely on the
exemption without the potential costs of having to renegotiate with
potential investors and restructure those funds within the limited
period before the rule must be adopted. Advisers that seek to form new
funds should have sufficient time and notice to structure those funds
to meet the proposed definition should they seek to rely on the
exemption in section 203(l) of the Advisers Act.
    Finally, we believe that our proposed definition would include an
additional benefit for investors and regulators. Section 203(l) of the
Advisers Act provides an exemption specifically for

advisers that ``solely'' advise venture capital funds. Currently none
of our rules requires that an adviser exempt from registration specify
the basis for the exemption. We are proposing, however, to require
exempt reporting advisers to identify the exemption(s) on which they
are relying.\290\ Requiring that venture capital funds represent
themselves as such to investors should allow the Commission and the
investing public (particularly potential investors in venture capital
funds) to determine, and confirm, an adviser's rationale for remaining
unregistered with the Commission. This element is designed to deter
advisers to private funds other than venture capital funds from
claiming to rely on an exemption from registration for which they are
not eligible.
---------------------------------------------------------------------------

    \290\ See Implementing Release, supra note 25, at n.130 and
accompanying text.
---------------------------------------------------------------------------

    We request comment on the potential benefits we have identified
above. Are there benefits of the proposed definition that we have not
identified?
2. Costs
    Costs for advisers to existing venture capital funds. As discussed
above, we do not expect that the proposed rule would result in any
significant costs for unregistered advisers to venture capital funds
currently in existence and operating. We estimate that currently there
are 800 advisers to venture capital funds.\291\ We expect that all
these advisers, which we assume currently are not registered in
reliance on the private adviser exemption, would continue to be exempt
after the repeal of that exemption on July 21, 2011 in reliance on the
proposed grandfathering provision.\292\ We anticipate that such
advisers to grandfathered funds would incur minimal costs, at most, to
confirm that existing venture capital funds managed by the adviser meet
the conditions of the grandfathering provision. We estimate that these
costs would be no more than $800 to hire outside counsel to assist in
this determination.\293\
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    \291\ See NVCA Yearbook 2010, supra note 41, at figure 1.04
(providing number of ``active'' venture capital advisers who have
raised a venture capital partnership within the past eight years).
    \292\ We estimate that these advisers (and any other adviser
that seeks to remain unregistered in reliance on the exemption under
section 203(l) of the Advisers Act) would incur, on average, $2,041
per year to complete and update related reports on Form ADV,
including Schedule D information relating to private funds. See
Implementing Release, supra note 25, at section IV.B.2. This
estimate includes internal costs to the adviser of $1,764 to prepare
and submit an initial report on Form ADV and $277 to prepare and
submit annual amendments to the report. These estimates are based on
the following calculations: $1,764 = ($3,528,000 aggregate costs /
2,000 advisers); $277 = ($554,400 aggregate costs / 2,000 advisers).
Id., at nn.337, 339 and accompanying text. We estimate that one
exempt reporting adviser would file Form ADV-H per year at a cost of
$204 per filing. Id., at n.344 and accompanying text. We further
estimate that three exempt reporting advisers would file Form ADV-NR
per year at a cost of $57 per filing. Id., at nn.347, 349 and
accompanying text. We anticipate that filing fees for exempt
reporting advisers would be the same as those for registered
investment advisers. See infra note 300. These reporting costs are
attributable to the Dodd-Frank Act, which directs the Commission to
require advisers to venture capital funds to provide such annual and
other reports as we determine necessary or in the public interest or
for the protection of investors. See section 203(l) of the Advisers
Act.
    \293\ We expect that a venture capital adviser would need no
more than 2 hours of legal advice to learn the differences between
its current business practices and the conditions for reliance on
the proposed grandfathering provision. We estimate that this advice
would cost $400 per hour per firm based on our understanding of the
rates typically charged by outside consulting or law firms.
---------------------------------------------------------------------------

    We recognize, however, that advisers to funds that are currently in
the process of being formed and negotiated with investors may incur
costs to determine whether they qualify for the grandfathering
provision. For example, these advisers may need to assess the impact on
the fund of selling interests to initial third party investors by
December 31, 2010 and selling interests to all investors no later than
July 21, 2011. We do not expect that the cost of evaluating the
grandfathering provision would be significant, however, because we
believe that most funds in formation represent themselves as being
venture capital funds or funds that pursue a venture capital investing
strategy to their potential investors and the typical fundraising
period for a venture capital fund is approximately 12 months.\294\
Thus, we do not anticipate that venture capital fund advisers would
have to alter typical business practice to structure or raise capital
for venture capital funds being formed. Nevertheless, we recognize that
after the final rule goes into effect, exempt advisers of such funds in
formation may forgo the opportunity to accept investments from
investors that may seek to invest after July 21, 2011 in order to
comply with the grandfathering provision.
---------------------------------------------------------------------------

    \294\ See Breslow & Schwartz, supra note 144, at 2-22 (``Once
the first closing [of a private equity fund] has occurred,
subsequent closings are typically held over a defined period of time
[the marketing period] of approximately six to twelve months.'').
See also Dow Jones Report, supra note 145, at 22.
---------------------------------------------------------------------------

    We request comment on the potential costs of this aspect of our
proposed rule. Are there advisers to existing venture capital funds or
venture capital funds in formation that would not be covered by the
grandfathering provision? We request commenters to quantify the number
of these advisers and provide us with specific examples of why such
advisers would not be able to rely on the grandfathering provision.
    Costs for new advisers and advisers to new venture capital funds.
We expect that existing advisers that seek to form new venture capital
funds and investment advisory firms that seek to enter the venture
capital industry would incur one-time ``learning costs'' to determine
how to structure new funds they may manage to meet the elements of our
proposed definition. We estimate that on average, there are 24 new
advisers to venture capital funds each year.\295\ We expect that the
one-time learning costs would be no more than between $2,800 and $4,800
on average for an adviser if it hires an outside consulting or law firm
to assist in determining how the elements of our proposed definition
may affect intended business practices.\296\ Thus, we estimate the
aggregate cost to existing advisers of determining how the proposed
definition would affect funds they plan to launch would be from $67,200
to $115,200.\297\ We request comment on whether these estimates
accurately reflect the fees an adviser would be likely to pay to
consulting and law firms it hires. As they launch new funds and
negotiate with potential investors, these advisers would have to
determine whether it is more cost effective to register or to structure
the venture capital funds they manage to meet the proposed definition.
Such considerations of legal or other requirements, however, comprise a
typical business and operating expense of conducting new business. New
advisers that enter into the business of managing venture capital funds
also would incur such ordinary costs of doing business in a regulated
industry.\298\
---------------------------------------------------------------------------

    \295\ This is the average annual increase in the number of
venture capital advisers between 1980 and 2009. See NVCA Yearbook
2010, supra note 41, at figure 1.04.
    \296\ We expect that a venture capital adviser would need
between 7 and 12 hours of consulting or legal advice to learn the
differences between its current business practices and the proposed
definition, depending on the experience of the firm and its
familiarity with the elements of the proposed rule. We estimate that
this advice would cost $400 per hour per firm based on our
understanding of the rates typically charged by outside consulting
or law firms.
    \297\ This estimate is based on the following calculations:
$2,800 x 24 = $67,200; 24 x $4,800 = $115,200.
    \298\ For estimates of the costs of registration for those
advisers that would choose to register, see infra notes 299-304.
---------------------------------------------------------------------------

    We believe that existing advisers to venture capital funds meet
most, if not all, of the elements of the proposed

definition because it is modeled on current business practices of
venture capital funds. We thus do not anticipate that many venture
capital fund advisers would have to change significantly the structure
of new funds they launch. Under our proposed definition, an adviser
would not be able to rely on the exemption if a venture capital fund
invested in securities that were not equity securities issued by
qualifying portfolio companies. Although we believe this practice is
not common in the industry, this element of our proposed rule may
result in some venture capital funds incurring costs to structure and
acquire equity investments that possess terms and protections typically
found in debt instruments. To the extent that venture capital funds
might not be able to structure equity investments in this way, and
portfolio companies would have to forgo debt issuance, the proposal
could have an adverse effect on capital formation.
    We also recognize that some existing venture capital funds may have
characteristics that differ from the elements of the proposed
definition other than the limitation on investments in debt securities
issued by portfolio companies. To the extent that investment advisers
seek to form new venture capital funds with these characteristics,
those advisers would have to choose whether to structure new venture
capital funds to conform to the proposed definition, forgo forming new
funds, or register with the Commission. In any case, each investment
adviser would assess the costs associated with registering with the
Commission relative to the costs of remaining unregistered (and hence
structuring funds to meet our proposed definition in order to be
eligible for the exemption). We expect that this assessment would take
into account many factors, including the size, scope and nature of its
business and investor base. Such factors will vary from adviser to
adviser, but each adviser would determine whether registration,
relative to other choices, is the most cost-effective or strategic
business option for itself.
    To the extent that advisers choose to structure new venture capital
funds to conform to the proposed definition, or choose not to form new
funds in order to avoid registration, these choices could result in
fewer investment choices for investors, less competition and less
capital formation. To the extent that advisers choose to register in
order to structure new venture capital funds without regard to the
proposed definitional elements or in order to expand their business
(e.g., pursue additional investment strategies beyond venture capital
investing or expand the potential investor base to include investors
that are required to invest with registered advisers), these choices
may result in greater investment choices for investors, greater
competition and greater capital formation.
    Investment advisers to new venture capital funds that would not
meet the proposed definition would have to register and incur the costs
associated with registration (assuming the adviser could not rely on
the private fund adviser exemption). We estimate that the internal cost
to register with the Commission would be $11,526 on average for a
private fund adviser,\299\ excluding the initial filing fees and annual
filing fees to the Investment Adviser Registration Depository
(``IARD'') system operator.\300\ These registration costs include the
costs attributable to completing and periodically amending Form ADV,
preparing brochure supplements, and delivering codes of ethics to
clients.\301\ In addition to the internal costs described above, we
estimate that for an adviser choosing to use outside legal services to
complete its brochure, such costs would be $3,000 to $5,000.\302\
---------------------------------------------------------------------------

    \299\ This estimate is based upon the following calculations:
$11,526 = ($7,699,860 aggregate costs to complete Form ADV / 750
advisers) + ($1,197,000 aggregate costs to complete private fund
reporting requirements / 950 advisers). See Implementing Release,
supra note 25, at nn.355-361. This also assumes that an adviser's
registration process would be conducted by a senior compliance
examiner and a compliance manager at an estimated cost of $210 and
$294 per hour, respectively. See Implementing Release, supra note
25, at nn.354 and accompanying text.
    \300\ The initial filing fee and annual filing fee for advisers
with $25 million to $100 million of assets under management is $150
and for advisers with $100 million or more of assets under
management is $200. See Electronic Filing for Investment Advisers on
IARD: IARD Filing Fees, available at http://www.sec.gov/divisions/investment/iard/iardfee.shtml.
    \301\ Part 1 of Form ADV requires advisers to answer basic
identifying information about their business, their affiliates and
their owners, information that is readily available to advisers, and
thus should not result in significant costs to complete. Registered
advisers must also complete Part 2 of Form ADV and file it
electronically with us. Part 2 requires disclosure of certain
conflicts of interest and could be prepared based on information
already contained in materials provided to investors, which could
reduce the costs of compliance even further.
    \302\ See Implementing Release, supra note 25, at n.363, 421
(noting the cost estimate for compliance consulting services related
to initial preparation of the amended Form ADV ranges from $3,000
for smaller advisers to $5,000 for medium-sized advisers).
---------------------------------------------------------------------------

    New registrants would also face costs to bring their business
operations into compliance with the Advisers Act and the rules
thereunder. These costs would vary depending on the size, scope and
nature of the adviser's business, but in any case would be an ordinary
business and operating expense of entering into any business that is
regulated. We estimate that the one-time costs to new registrants to
establish a compliance infrastructure would range from $10,000 to
$45,000, while ongoing annual costs of compliance and examination would
range from $10,000 to $50,000.\303\
---------------------------------------------------------------------------

    \303\ We expect that most advisers that might choose to register
have already built compliance infrastructures as a matter of good
business practice. Nevertheless, we expect advisers will incur costs
for outside legal counsel to evaluate their compliance procedures
initially and on an ongoing basis. We estimate that the costs to
advisers to establish the required compliance infrastructure will
be, on average, $20,000 in professional fees and $25,000 in internal
costs including staff time. These estimates were prepared in
consultation with attorneys who, as part of their private practice,
have counseled private fund advisers establishing their
registrations with the Commission. We have included a range because
we believe there are a number of unregistered private funds whose
compliance operations are already substantially in compliance with
the Advisers Act and that would therefore experience only minimal
incremental ongoing costs as a result of registration. In connection
with previous estimates we have made regarding compliance costs for
registered advisers, we received comments from small advisers
estimating that their annual compliance costs would be $25,000 and
could be as high as $50,000. See, e.g., Comment Letter of Joseph L.
Vidich (Aug. 7, 2004). Cf. Comment Letter of Venkat Swarna (Sept.
14, 2004) (estimating costs of $20,000 to $25,000). These comment
letters were submitted in connection with Hedge Fund Adviser
Registration Release, supra note 17, and are available on the
Commission's Internet Web site at http://www.sec.gov/rules/proposed/s73004.shtml.
---------------------------------------------------------------------------

    We do not believe that the proposed definition of venture capital
fund is likely to affect whether advisers to venture capital funds
would choose to launch new funds or whether persons would choose to
enter into the business of advising venture capital funds because, as
noted above, we believe the proposed definition reflects the way most
venture capital funds currently operate. For this reason, we expect
that the proposed definition is not likely to significantly affect the
way in which investment advisers to these funds do business and thus
compete. For the same reason, we do not believe that our proposed rule
is likely to have a significant effect on overall capital formation.
    We request comment on the costs we have discussed above. Are there
costs of the proposed definition that we have not identified? How many
advisers to venture capital funds are likely to choose to register or
structure new venture capital funds differently from their existing
funds in order to meet the proposed definition? How costly would it be
for advisers to structure new venture capital funds to conform to the
proposed definition in order to qualify

for an exemption from registration? Would advisers choose not to launch
new funds or not enter the venture capital industry in order to avoid
the costs associated with structuring venture capital funds to conform
to the definition or registration? \304\
---------------------------------------------------------------------------

    \304\ Commission staff estimates that the one-time costs of
registration for a venture capital fund adviser with $150 million in
assets under management in the United States (i.e., an adviser that
would not qualify for the exemption under section 203(m) of the
Advisers Act), would be approximately 0.01% of assets, and annual
costs of compliance and examination would range from 0.007% to 0.03%
of assets under management. These figures are based on the following
calculations: ($11,526 (registration costs) + $3,000 (lower estimate
of external costs to prepare brochure)) / $150,000,000 = 0.000097;
($11,526 (registration costs) + $5,000 (higher estimate of external
costs to prepare brochure)) / $150,000,000 = 0.0001); $10,000 (lower
estimate of ongoing costs) / $150,000,000 = 0.000067; $50,000
(higher estimate of ongoing costs) / $150,000,000 = 0.000333).
---------------------------------------------------------------------------

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

    As discussed in Section II.B., proposed rule 203(m)-1 would exempt
any investment adviser solely to private funds that has less than $150
million in assets under management in the United States. Our proposed
rule is designed to implement the private fund adviser exemption, as
directed by Congress, in section 203(m) of the Advisers Act and
includes provisions for determining the amount of an adviser's private
fund assets for purposes of the exemption and when those assets are
deemed managed in the United States.\305\
---------------------------------------------------------------------------

    \305\ See supra sections II.B.2-3 of this Release.
---------------------------------------------------------------------------

1. Benefits
    As discussed above and in the Implementing Release, we are
proposing a uniform method of calculating assets under management in
the instructions to Form ADV, which would be used to determine whether
an adviser qualifies to register with the Commission rather than the
states, and to determine eligibility for the private fund adviser
exemption under section 203(m) of the Advisers Act and the foreign
private adviser exemption under section 203(b)(3) of the Advisers
Act.\306\ We anticipate that this uniform approach would benefit
regulators (both state and federal) as well as advisers, because only a
single determination of assets under management would be required for
purposes of registration and exemption from federal registration.
---------------------------------------------------------------------------

    \306\ See supra note 190 and accompanying text; Implementing
Release, supra note 25, at nn.58-59 and accompanying text. Thus,
under proposed rule 203(m)-1, to determine its assets under
management for purposes of the proposed private fund adviser
exemption, an adviser would calculate its ``regulatory assets under
management'' attributable to private funds according to the
instructions to Form ADV. Proposed rule 203(m)-1(a)(2), (b)(2)
(conditioning the exemption on an adviser managing private fund
assets of less than $150 million); proposed rule 203(m)-1(e)(1)
(defining ``assets under management'' for purposes of the proposed
rule's exemption); proposed rule 203(m)-1(e)(4) (defining ``private
fund assets'' as the investment adviser's assets under management
attributable to a qualifying private fund).
---------------------------------------------------------------------------

    The instructions to Form ADV currently permit, but do not require,
advisers to exclude certain types of managed assets.\307\ As a result,
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. By specifying that assets under
management must be calculated according to the instructions to Form
ADV, our proposed approach should benefit advisers by increasing
administrative efficiencies because advisers would have to calculate
assets under management only once for multiple purposes.\308\ We expect
this would minimize costs relating to software modifications,
recordkeeping, and training required to determine assets under
management for regulatory purposes. We also anticipate that the
consistent calculation and reporting of assets under management would
benefit investors and regulators because it would provide enhanced
transparency and comparability of data, and allow investors and
regulators to analyze on a more cost effective basis whether any
particular adviser may be required to register with the Commission or
is eligible for an exemption.
---------------------------------------------------------------------------

    \307\ See proposed Form ADV: Instructions to Part 1A, instr.
5.b(1).
    \308\ See Shearman & Sterling Letter, supra note 268.
---------------------------------------------------------------------------

    We anticipate that the valuation of private fund assets under
proposed rule 203(m)-1 would benefit private fund advisers that seek to
rely on the exemption.\309\ Under proposed rule 203(m)-1, each adviser
would determine the amount of its private fund assets based on the fair
value of the assets at the end of each quarter. We propose that
advisers use fair value of private fund assets in order to ensure that,
for purposes of this exemption, advisers value private fund assets on a
meaningful and consistent basis. We understand that many, but not all,
advisers to private funds value assets based on their fair value in
accordance with GAAP or other international accounting standards.\310\
We acknowledge that some advisers to private funds may not use fair
value methodologies, which may be more difficult to apply when the fund
holds illiquid or other types of assets that are not traded on
organized markets.
---------------------------------------------------------------------------

    \309\ See proposed rule 203(m)-1(c); Implementing Release, supra
note 25, proposed Form ADV: Instructions to Part 1A, instr. 5.b(4).
    \310\ See supra note 196.
---------------------------------------------------------------------------

    Proposed rule 203(m)-1(c) specifies that an adviser relying on the
exemption would determine the amount of its private fund assets
quarterly, which we believe would benefit advisers. We understand that
a quarterly calculation of assets under management is consistent with
business practice--many types of private funds calculate fees payable
to advisers and other service providers on at least a quarterly
basis.\311\ The quarterly calculation also would allow advisers that
rely on the exemption to maintain the exemption despite short-term
market value fluctuations that might result in the loss of the
exemption if, for example, the rule required daily valuation. We expect
that quarterly valuation would also benefit these advisers by allowing
them to avoid the cost of more frequent valuations, including costs
(such as third party quotes) associated with valuing illiquid assets,
which may be particularly difficult to value more often because of the
lack of frequency with which such assets are traded.
---------------------------------------------------------------------------

    \311\ See supra section II.B.2 of this Release; see, e.g.,
Breslow & Schwartz, supra note 144, at Sec.  2.8.2[C].
---------------------------------------------------------------------------

    Under proposed rule 203(m)-1(a), all of the private fund assets of
an adviser with a principal office and place of business in the United
States would be considered to be ``assets under management in the
United States,'' even if the adviser has offices outside of the United
States.\312\ A non-U.S. adviser would need only count private fund
assets it manages from a place of business in the U.S. toward the $150
million limit under the exemption. As discussed below, we believe that
this interpretation of ``assets under management in the United States''
would offer greater flexibility to advisers and reduce many costs
associated with compliance. These costs could include difficult
attribution determinations that would be required if assets are managed
by teams located in multiple jurisdictions or if portfolio managers
located in one jurisdiction rely heavily on research or other

advisory services performed by employees located in another
jurisdiction.
---------------------------------------------------------------------------

    \312\ As discussed above, the proposed rule looks to an
adviser's principal office and place of business as the location
where it directs, controls and coordinates its global advisory
activities. Proposed rule 203(m)-1(e)(3). See supra notes 202-203
and accompanying text.
---------------------------------------------------------------------------

    To the extent that this interpretation may increase the number of
advisers subject to registration under the Advisers Act, we anticipate
that our proposal also would benefit investors by providing more
information about those advisers (e.g., information that would become
available through Form ADV, Part I). We further anticipate that this
would enhance investor protection by increasing the number of advisers
registering pursuant to the Advisers Act and by improving the
Commission's ability to exercise its investor protection and
enforcement mandates over those newly registered advisers. As discussed
above, registration offers benefits to the investing public, including
periodic examination of the adviser and compliance with rules requiring
recordkeeping, custody of client funds and compliance programs.\313\
---------------------------------------------------------------------------

    \313\ See supra text following note 281 and preceding and
accompanying text.
---------------------------------------------------------------------------

    Under proposed rule 203(m)-1(b), a non-U.S. adviser with no U.S.
place of business could avail itself of the exemption under section
203(m) even if it advised non-U.S. clients that are not private funds,
provided that it did not advise any U.S. clients other than private
funds.\314\ We anticipate that the proposed approach to the exemption
under section 203(m) of the Advisers Act, which would look primarily to
the principal office and place of business of an adviser to determine
eligibility for the exemption, would increase the number of non-U.S.
advisers that may be eligible for the exemption. As with other
Commission rules that adopt a territorial approach, the private fund
adviser exemption would be available to a non-U.S. adviser (regardless
of its non-U.S. advisory activities) in recognition that non-U.S.
activities of non-U.S. advisers are less likely to implicate U.S.
regulatory interests and in consideration of general principles of
international comity. This approach to the exemption is designed to
encourage the participation of non-U.S. advisers in the U.S. market by
applying the U.S. securities laws in a manner that does not impose U.S.
regulatory and operational requirements on an adviser's non-U.S.
advisory business.\315\ We anticipate that our proposed interpretation
of the availability of the private fund adviser exemption for non-U.S.
advisers may benefit those advisers by facilitating their continued
participation in the U.S. market with limited disruption to their non-
U.S. advisory business practices.\316\ This approach also might benefit
U.S. investors and facilitate competition in the market for advisory
services to the extent that it would maintain or increase U.S.
investors' access to potential advisers. Furthermore, because non-U.S.
advisers that elect to avail themselves of the exemption would be
subject to certain reporting requirements,\317\ our proposed approach
would increase the availability of information publicly available to
U.S. investors who invest in the private funds advised by such exempt
but reporting non-U.S. advisers.
---------------------------------------------------------------------------

    \314\ By contrast, a U.S. adviser could ``solely advise private
funds'' as specified in the statute. Compare proposed rule 203(m)-
1(a)(1) with proposed rule 203(m)-1(b)(1).
    \315\ See supra note 208 and accompanying text.
    \316\ See supra section II.B.3 of this Release.
    \317\ See Implementing Release, supra note 25, at section II.B.
---------------------------------------------------------------------------

    We request comment on the potential benefits we have identified
above. Are there benefits of the proposed rule that we have not
identified?
2. Costs
    As noted above, under proposed rule 203(m)-1, we would look to an
adviser's principal office and place of business as the location where
the adviser directs, controls or has responsibility for, the management
of private fund assets and therefore as the place where all the
adviser's assets are managed. Thus, a U.S. adviser would include all
its private fund assets under management in determining whether it
exceeds the $150 million limit under the exemption. We also look to
where day-to-day management of private fund assets may occur for
purposes of a non-U.S. adviser, whose principal office and place of
business is outside the United States.\318\ A non-U.S. adviser
therefore would count only the private fund assets it manages from a
place of business in the United States in determining the availability
of the exemption. This approach is similar to the way we have defined
the location of the adviser for regulatory purposes under our current
rules,\319\ and thus we believe it is the way in which most advisers
would interpret the exemption without our proposed rule.\320\ We
anticipate that our proposed approach would promote efficiency because
advisers are familiar with it, and we do not anticipate that U.S.
investment advisers to private funds would likely change their business
models, the location of their private funds, or the location where they
manage assets as a result of the proposed rule. We anticipate, however
that non-U.S. advisers may incur minimal costs to determine whether
they have assets under management in the U.S. We estimate that these
costs would be no greater than $6,940 to hire U.S. counsel and perform
an internal review to assist in this determination, in particular to
assess whether a non-U.S. affiliate manages a discretionary account for
the benefit of a United States person under the proposed rule.\321\
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    \318\ See supra paragraph accompanying note 205.
    \319\ See supra note 202 and accompanying text.
    \320\ We do not believe that the statutory text refers to where
the assets themselves may be located or traded or the location of
the account where the assets are held. In today's market, using the
location of assets would raise numerous questions of where a
security with no physical existence is ``located.'' Although
physical stock certificates were once sent to investors as proof of
ownership, stock certificates are now centrally held by securities
depositories, which perform electronic ``book-entry'' changes in
their records to document ownership of securities. This arrangement
reduces transmittal costs and increases efficiencies for securities
settlements. See generally Bank for International Settlements, The
Depository Trust Company: Response to the Disclosure Framework for
Securities Settlement Systems (2002), http://www.bis.org/publ/cpss20r3.pdf. An account also has no physical location even if the
prime broker, custodian or other service that holds assets on behalf
of the customer does. Each of these approaches would be confusing
and extremely difficult to apply on a consistent basis.
    \321\ We expect that a non-U.S. adviser would need no more than
10 hours of external legal advice (at $400 per hour) and 10 hours of
internal review by a senior compliance officer (at $294 per hour) to
evaluate whether the adviser would qualify for the exemption under
section 203(l).
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    As noted above, because our rule is designed to encourage the
participation of non-U.S. advisers in the U.S. market, we anticipate
that it would have minimal regulatory and operational burdens on
foreign advisers and their U.S. clients. Non-U.S advisers would be able
to rely on proposed rule 203(m)-1 if they manage U.S. private funds
with more than $150 million in assets from a non-U.S. location as long
as the private fund assets managed from a U.S. place of business are
less than $150 million. This could affect competition with U.S.
advisers, which must register when they have $150 million in private
fund assets under management regardless of where the assets are
managed.
    To avail themselves of proposed rule 203(m)-1, some advisers might
choose to move their principal office and place of business outside the
United States and manage private funds from that location. This might
result in costs to U.S. investors in private funds that are managed by
these advisers because they would not have the investor protection and
other benefits that result from an adviser's registration under the
Advisers Act. We do not expect that many advisers would be likely to
relocate for

purposes of avoiding registration, however, because we understand that
the primary reasons for advisers to locate in a particular jurisdiction
involve tax and other business considerations. We also note that if an
adviser did relocate, it would incur the costs of regulation under the
laws of most of the foreign jurisdictions in which it may be likely to
relocate. We do not believe, in any case, that the adviser would
relocate if relocation would result in a material decrease in the
amount of assets managed because that loss would likely not justify the
benefits of avoiding registration, and thus we do not believe our
proposed rule would have an adverse effect on capital formation.
    Our proposed rule incorporates the valuation methodology in the
instructions to Form ADV. More specifically, proposed instruction
5.b(4) to Form ADV would require advisers to use fair value of private
fund assets for determining regulatory assets under management. We
acknowledge that there may be some private fund advisers that may not
use fair value methodologies.\322\ The costs incurred by these advisers
to use fair valuation methodology would vary based on factors such as
the nature of the asset, the number of positions that do not have a
market value, and whether the adviser has the ability to value such
assets internally or would rely on a third party for valuation
services.\323\ Nevertheless, we do not believe that the requirement to
use fair value methodologies would result in significant costs for
these advisers. We understand that private fund advisers, including
those that may not use fair value methodologies for reporting purposes,
perform administrative services, including valuing assets, internally
as a matter of business practice.\324\ Commission staff estimates that
such an adviser would incur $1,224 in internal costs to conform its
internal valuations to a fair value standard.\325\ In the event a fund
does not have an internal capability for valuing specific illiquid
assets, we expect that it could obtain pricing or valuation services
from an outside administrator or other service provider. In the event a
fund does not have an internal capability for valuing specific illiquid
assets, we expect that it could obtain pricing or valuation services
from an outside administrator or other service provider. Staff
estimates that the cost of such a service would range from $1,000 to
$120,000 annually, which could be borne by several funds that invest in
similar assets or have similar investment strategies.\326\ We request
comment on these estimates. Do advisers that do not use fair value
methodologies for reporting purposes have the ability to fair value
private fund assets internally? If not, what would be the costs to
retain a third party valuation service? Are there certain types of
advisers (e.g., advisers to real estate private funds) that would
experience special difficulties in performing fair value analyses? If
so, why?
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    \322\ See supra note 310 and accompanying and following text.
    \323\ See supra note 197.
    \324\ For example, a hedge fund adviser may value fund assets
for purposes of allowing new investments in the fund or redemptions
by existing investors, which may be permitted on a regular basis
after an initial lock-up period. An adviser to private equity funds
may obtain valuation of portfolio companies in which the fund
invests in connection with financing obtained by those companies.
Advisers to private funds also may value portfolio companies each
time the fund makes (or considers making) a follow-on investment in
the company. Private fund advisers could use these valuations as a
basis for complying with the fair valuation requirement we propose
with respect to private fund assets.
    \325\ This estimate is based upon the following calculation: 8
hours x $153/hour = $1,224. The hourly wage is based on data for a
fund senior accountant from SIFMA's Management and Earnings in the
Securities Industry 2009, modified by Commission staff to account
for an 1,800-hour work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead.
    \326\ These estimates are based on conversations with valuation
service providers. We understand that the cost of valuation for
illiquid fixed income securities generally ranges from $1.00 to
$5.00 per security, depending on the difficulty of valuation, and is
performed for clients on weekly or monthly basis. We understand that
appraisals of privately placed equity securities may cost from
$3,000 to $5,000 with updates to such values at much lower prices.
For purposes of this cost benefit analysis, we are estimating the
range of costs for (i) a private fund that holds 50 fixed income
securities at a cost of $5.00 to price and (ii) a private fund that
holds privately placed securities of 15 issuers that each cost
$5,000 to value initially and $1,000 thereafter. We believe that
costs for funds that hold both fixed-income and privately placed
equity securities would fall within the maximum of our estimated
range. We note that funds that have significant positions in
illiquid securities are likely to have the in-house capacity to
value those securities or already subscribe to a third party service
to value them. We note that many private funds are likely to have
many fewer fixed income illiquid securities in their portfolios,
some or all of which may cost less than $5.00 per security to value.
Finally, we note that obtaining valuation services for a small
number of fixed income positions on an annual basis may result in a
higher cost for each security or require a subscription to the
valuation service for those that do not already purchase such
services. The staff's estimate is based on the following
calculations: (50 x $5.00 x 4 = $1,000; (15 x $5,000) + (15 x $1,000
x 3) = $120,000).
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    Our earlier discussion of the proposed rule also seeks comment on
an alternative interpretation of ``assets under management in the
United States,'' which would reference the source of the assets (i.e.,
U.S. private fund investors).\327\ Under this approach, a non-U.S.
adviser would count the assets of private funds attributable to U.S.
investors towards the $150 million threshold, regardless of the
location where it manages private funds, and a U.S. adviser would
exclude assets that are not attributable to U.S. investors. As a
result, under this alternative more U.S. advisers might be able to rely
on rule 203(m)-1 than under our proposed approach. To the extent that
non-U.S. advisers have U.S. investors in funds that they manage from a
non-U.S. location, fewer non-U.S. advisers would be eligible for the
exemption under this approach than under our proposal. Thus, this
alternative could increase costs for those non-U.S. advisers who would
have to register but reduce costs for those U.S. advisers who would not
have to register. We seek comment on the number of U.S. advisers that
would be able to avail themselves of the private fund adviser exemption
under this alternative approach, but would not be able to rely on
proposed rule 203(m)-1.
---------------------------------------------------------------------------

    \327\ See supra paragraph following note 210.
---------------------------------------------------------------------------

    This alternative approach could discourage U.S. advisers that may
want to avoid registration from managing U.S. investor assets, which
could affect competition for the management of those assets. We believe
this is unlikely however, because to the extent the adviser would
manage fewer assets we do not believe the loss of managed assets would
justify the savings from avoiding registration.
    Under either the proposed approach or the alternative, each adviser
may incur costs to evaluate whether it would be able to avail itself of
the exemption. We estimate that each adviser may incur between $800 to
$4,800 in legal advice to learn whether it may rely on the
exemption.\328\ Each adviser that registers would incur registration
costs, which we estimate would be $11,526.\329\ They also would incur
estimated initial compliance costs ranging from $10,000 to $45,000 and
ongoing annual compliance costs from $10,000 to $50,000.\330\
Nevertheless, to the extent there would be an increase in registered
advisers, as we have noted above, there

are benefits to registration for both investors and the
Commission.\331\
---------------------------------------------------------------------------

    \328\ We expect that a private fund adviser would obtain between
2 and 12 hours of external legal advice (at a cost of $400 per hour)
to determine whether it would be eligible for the private fund
adviser exemption.
    \329\ This range is attributable to the amount of assets under
management, which affects the magnitude of filing fees associated
with registration, and whether the adviser chooses to retain outside
legal services to prepare its brochure. See supra notes 300-302 and
accompanying text.
    \330\ See supra note 303 and accompanying text.
    \331\ See supra text following note 281.
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    We seek comment on our analysis of the costs associated with the
approach we have proposed and the costs of the alternative on which we
seek comment. Are there costs of the proposed rule or the alternative
approach that we have not identified?

C. Foreign Private Adviser Exemption

    Section 403 of the Dodd-Frank Act replaces the current private
adviser exemption from registration under the Advisers Act with a new
exemption for a ``foreign private adviser,'' as defined in new section
202(a)(30) of the Advisers Act.\332\ We are proposing new rule
202(a)(30)-1, which would define certain terms in section 202(a)(30)
for use by advisers seeking to avail themselves of the foreign private
adviser exemption.\333\ Because eligibility for the new foreign private
adviser exemption, like the current private adviser exemption, is
determined, in part, by the number of clients an adviser has, we
propose to include in rule 202(a)(30)-1 the safe harbor and many of the
client counting rules that appear in rule 203(b)(3)-1, as currently in
effect.\334\ In addition, we propose to define other terms used in the
definition of ``foreign private adviser'' under section 202(a)(30)
including: (i) ``Investor;'' (ii) ``in the United States;'' (iii)
``place of business;'' and (iv) ``assets under management.'' \335\
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    \332\ See supra note 224 and accompanying text. The new
exemption is codified as amended section 203(b)(3).
    \333\ See supra section II.C of this Release.
    \334\ See supra section II.C.1 of this Release. Rule 203(b)(3)-
1, as currently in effect, provides a safe harbor for determining
who may be deemed a single client for purposes of the private
adviser exemption. We would not, however, carry over rules
203(b)(3)-1(b)(4), (5), or (7). See supra notes 228 and 233 and
accompanying text.
    \335\ Proposed rule 202(a)(30)-1(c). See supra section II.C.2-4
of this Release.
---------------------------------------------------------------------------

    Proposed rule 202(a)(30)-1 clarifies several provisions used in the
statutory definition of ``foreign private adviser.'' First, the
proposed rule would include the safe harbor for counting clients
currently in rule 203(b)(3)-1, as modified to account for its use in
the foreign private adviser context. Under the safe harbor, an adviser
would count certain natural persons as a single client under certain
circumstances.\336\ Proposed rule 202(a)(30)-1 would also retain
another provision of rule 203(b)(3)-1 that permits an adviser to treat
as a single ``client'' an entity that receives investment advice based
on the entity's investment objectives and two or more entities that
have identical owners.\337\ As mentioned above, we would not include
the ``special rule'' that allows advisers not to count as a client any
person for whom the adviser provides investment advisory services
without compensation.\338\ Finally, we propose to add a provision that
would permit advisers to avoid double-counting private funds and their
investors.\339\
---------------------------------------------------------------------------

    \336\ Proposed rule 202(a)(30)-1(a)(1).
    \337\ Proposed rule 202(a)(30)-1(a)(2)(i)-(ii). In addition,
proposed rule 202(a)(30)-1(b)(1) through (3) would retain the
following related ``special rules'': (1) An adviser must count a
shareholder, partner, limited partner, member, or beneficiary (each,
an ``owner'') of a corporation, general partnership, limited
partnership, limited liability company, trust, or other legal
organization, as a client if the adviser provides investment
advisory services to the owner separate and apart from the legal
organization; (2) an adviser is not required to count an owner as a
client solely because the adviser, on behalf of the legal
organization, offers, promotes, or sells interests in the legal
organization to the owner, or reports periodically to the owners as
a group solely with respect to the performance of or plans for the
legal organization's assets or similar matters; and (3) any general
partner, managing member or other person acting as an investment
adviser to a limited partnership or limited liability company must
treat the partnership or limited liability company as a client.
    \338\ See rule 203(b)(3)-1(b)(4); supra notes 233-235 and
accompanying text.
    \339\ See proposed rule 202(a)(30)-1(b)(4) (specifying that an
adviser would not be required to count a private fund as a client if
it counted any investor, as defined in the proposed rule, in that
private fund as an investor in the United States in that private
fund).
---------------------------------------------------------------------------

    Second, section 202(a)(30) provides that a ``foreign private
adviser'' eligible for the new registration exemption cannot have more
than 14 clients ``or investors.'' We propose to define ``investor'' in
a private fund in rule 202(a)(30)-1 as any person that would be
included in determining the number of beneficial owners of the
outstanding securities of a private fund under section 3(c)(1) of the
Investment Company Act, or whether the outstanding securities of a
private fund are owned exclusively by qualified purchasers under
section 3(c)(7) of that Act.\340\ We are also proposing to treat as
investors beneficial owners (i) who are ``knowledgeable employees''
with respect to the private fund; \341\ and (ii) of ``short-term
paper'' \342\ issued by the private fund, even though these persons are
not counted as beneficial owners for purposes of section 3(c)(1), and
knowledgeable employees are not required to be qualified purchasers
under section 3(c)(7).\343\
---------------------------------------------------------------------------

    \340\ See proposed rule 202(a)(30)-1(c)(1); supra section II.C.2
of this Release. In order to avoid double-counting, we would allow
an adviser to treat as a single investor any person that is an
investor in two or more private funds advised by the investment
adviser. See proposed rule 202(a)(30)-1(c)(1), at note to paragraph
(c)(1).
    \341\ See proposed rule 202(a)(30)-1(c)(1)(A); supra note 246
and accompanying text.
    \342\ See proposed rule 202(a)(30)-1(c)(1)(B); supra notes 247-
248 and accompanying text.
    \343\ See rule 3c-5(b) under the Investment Company Act; section
3(c)(1) of the Investment Company Act. See also supra note 249 and
accompanying text.
---------------------------------------------------------------------------

    Third, proposed rule 202(a)(30)-1 defines ``in the United States''
generally by incorporating the definition of a ``U.S. person'' and
``United States'' under Regulation S.\344\ In particular, we would
define ``in the United States'' in proposed rule 202(a)(30)-1 to mean:
(i) With respect to any place of business located in the ``United
States,'' as that term is defined in Regulation S; \345\ (ii) with
respect to any client or private fund investor in the United States,
any person that is a ``U.S. person'' as defined in Regulation S,\346\
except that under the proposed rule, any discretionary account or
similar account that is held for the benefit of a person ``in the
United States'' by a non-U.S. dealer or other professional fiduciary is
a person ``in the United States'' if the dealer or professional
fiduciary is a related person of the investment adviser relying on the
exemption; and (iii) with respect to the public in the ``United
States,'' as that term is defined in Regulation S.\347\ Fourth,
proposed rule 202(a)(30)-1 defines ``place of business'' to have the
same meaning as in Advisers Act rule 222-1(a).\348\ Finally, for
purposes of rule 202(a)(30)-1 we propose to define ``assets under
management'' by reference to ``regulatory assets under management'' as
determined under Item 5 of Form ADV.\349\
---------------------------------------------------------------------------

    \344\ Proposed rule 202(a)(30)-1(c)(2). See supra notes 253-261
and accompanying paragraphs.
    \345\ See 17 CFR 230.902(l).
    \346\ See 17 CFR 230.902(k). We would allow foreign advisers to
determine whether a client or investor is ``in the United States''
by reference to the time the person became a client or an investor.
See proposed rule 202(a)(30)-1's note to paragraph (c)(2)(i).
    \347\ See 17 CFR 230.902(l).
    \348\ See proposed rule 202(a)(30)-1(c)(3); proposed rule 222-
1(a) (defining ``place of business'' of an investment adviser as:
``(i) An office at which the investment adviser regularly provides
investment advisory services, solicits, meets with, or otherwise
communicates with clients; and (ii) Any other location that is held
out to the general public as a location at which the investment
adviser provides investment advisory services, solicit, meets with,
or otherwise communicates with clients.''). See supra section II.C.4
of this Release.
    \349\ See proposed rule 202(a)(30)-1(c)(4); proposed Form ADV:
Instructions to Part 1A, instr. 5.b(4). See also supra section
II.C.5 of this Release.
---------------------------------------------------------------------------

1. Benefits
    We are proposing to define certain terms included in the statutory
definition of ``foreign private adviser'' in order to clarify the
meaning of these terms and reduce the potential administrative and
regulatory burdens for advisers that seek to rely on the

foreign private adviser exemption. As discussed above, our proposed
rule references definitions set forth in other Commission rules under
the Advisers Act, the Investment Company Act and the Securities Act,
all of which are likely to be familiar to foreign advisers active in
the U.S. capital markets. We anticipate that by defining these terms,
we would benefit foreign advisers by providing clarity with respect to
the proposed terms that advisers would otherwise be required to
interpret (and which they would likely interpret with reference to the
rules we reference).\350\ The proposal would provide consistency among
these other rules and the new exemption. This would limit foreign
advisers' need to undertake additional analysis with respect to these
terms for purposes of determining the availability of the foreign
private adviser exemption.\351\ We believe that the consistency and
clarity that would result from the proposed rule would promote
efficiency for foreign advisers and the Commission.
---------------------------------------------------------------------------

    \350\ See Paul Hastings Letter, supra note 258 (in response to
our request for public views, urging us to provide guidance on the
interpretation of the terms of the statutory definition of ``foreign
private adviser''). See generally supra note 24.
    \351\ This is true for all of the proposed definitions except
for ``assets under management.'' An adviser that relies on the
foreign private adviser exemption would need to calculate its assets
under management according to the proposed instructions to Item 5 of
Form ADV only for purposes of the availability of the exemption. As
discussed, above, proposed rule 202(a)(30)-1 includes a reference to
Item 5 of Form ADV in order to ensure consistency in the calculation
of assets under management for various purposes under the Advisers
Act. See supra note 266 and accompanying text.
---------------------------------------------------------------------------

    For example, for purposes of determining eligibility for the
foreign private adviser exemption, advisers would count clients
substantially in the same manner they count clients under the current
private adviser exemption.\352\ In identifying ``investors,'' advisers
could rely on the determination made to assess whether the private fund
meets the counting or qualification requirements under sections 3(c)(1)
and 3(c)(7) of the Investment Company Act.\353\ In determining whether
a client, an investor, or a place of business is ``in the United
States,'' or whether it holds itself out as an investment adviser to
the public ``in the United States,'' an adviser would apply the same
analysis it would otherwise apply under Regulation S.\354\ In
identifying whether it has a place of business in the United States, an
adviser would use the definition of ``place of business'' under section
222 of the Advisers Act, which is used to determine whether a state may
assert regulatory jurisdiction over the adviser.\355\
---------------------------------------------------------------------------

    \352\ See supra section II.C.1 of this Release.
    \353\ See supra paragraph accompanying note 240.
    \354\ See supra notes 258-259 and accompanying paragraph.
    \355\ See supra section II.C.3 of this Release. Under section
222 of the Advisers Act a state may not require an adviser to
register if the adviser does not have a ``place of business''
within, and has fewer than 6 client residents of, the state.
---------------------------------------------------------------------------

    As noted above, the proposed definitions of ``investor'' and
``United States'' under our proposed rule would rely on existing
definitions, with slight modifications.\356\ Our proposed rule also
would incorporate the current safe harbor in rule 203(b)(3)-1 for
counting clients, except that it would no longer allow an adviser to
disregard clients for whom the adviser provides services without
compensation.\357\ We propose these modifications in order to preclude
some advisers from excluding certain assets or clients from their
calculation so as to avoid registration with the Commission and the
regulatory requirements associated with registration.\358\ We believe
that without a definition of these terms, advisers would likely rely on
the same definitions we propose to cross reference in rule 202(a)(30)-
1, but without the proposed modifications. Our proposal, therefore,
would likely have the practical effect of narrowing the scope of the
exemption, and thus would result in more advisers registering.
---------------------------------------------------------------------------

    \356\ See supra notes 238, 246-251, 253-257 and accompanying
text.
    \357\ See supra notes 336-339 and accompanying text.
    \358\ See supra notes 246-251, 253-257 and accompanying text.
See also infra notes 362-363 and accompanying text for an estimate
of the costs associated with registration.
---------------------------------------------------------------------------

    We believe that any increase in registration as compared to the
number of foreign advisers that might register if we did not propose
rule 202(a)(30)-1 would benefit investors. Investors whose assets are,
directly or indirectly, managed by the foreign advisers that would be
required to register would benefit from the increased protection
afforded by federal registration of the adviser and application to the
adviser of all of the requirements of the Advisers Act. As noted above,
registration offers benefits to the investing public, including
periodic examination of the adviser and compliance with rules requiring
recordkeeping, custody of client funds and compliance programs.\359\
---------------------------------------------------------------------------

    \359\ See supra text accompanying and following note 281.
---------------------------------------------------------------------------

    We request comment on the potential benefits we have identified
above. Are there benefits of the proposed rule that we have not
identified?
2. Costs
    We do not believe that the proposed definitions would result in
significant costs for foreign advisers. We anticipate that each foreign
adviser that seeks to avail itself of the foreign private adviser
exemption may incur costs to determine whether it is eligible for the
exemption. We expect that these advisers would consult with outside
U.S. counsel and perform an internal review of the extent to which an
advisory affiliate manages discretionary accounts owned by a U.S.
person that would be counted toward the limitation on clients and
investors in the United States. We estimate these costs would be
$6,940.\360\
---------------------------------------------------------------------------

    \360\ This estimate is based on consultation with outside
counsel (at a cost of $400 per hour) of 10 hours and an internal
review of discretionary accounts owned by U.S. persons performed by
a senior compliance officer (at a cost of $294 per hour) of 10
hours. The calculation is as follows: (10 hours x $400) + (10 hours
x $294) = $6,940.
---------------------------------------------------------------------------

    Without the proposed rule, we expect that most advisers would
interpret the new statutory provision by reference to the same rules we
propose to cross reference in rule 202(a)(30)-1. Without our proposal,
some advisers would likely incur additional costs because they would
seek guidance in interpreting the terms used in the statutory
exemption. By defining the statutory terms in a rule, we believe that
we can provide certainty for foreign advisers and limit the time,
compliance costs and legal expenses foreign advisers might incur in
seeking an interpretation, all of which costs could inhibit capital
formation or reduce efficiency. We expect that advisers also would be
less likely to seek additional assistance from us because they could
rely on relevant guidance we have previously provided with respect to
the definitions we propose to cross reference. We also believe that
foreign advisers' ability to rely on the definitions that we have
referenced in the proposed rule and the guidance provided with respect
to the referenced rules may reduce Commission resources that would be
otherwise applied to administering the private foreign adviser
exemption, which resources could be allocated to other matters.
    We anticipate that our proposed instruction allowing foreign
advisers to determine whether a client or investor is ``in the United
States'' by reference to the time the person became a client or an
investor, would also reduce advisers' costs.\361\ Advisers would make
the determination only once and would not be required to monitor
changes in the

status of each client and private fund investor. Moreover, if a client
or an investor moved to the United States, under our approach the
adviser would not be forced to choose among registering with us,
terminating the relationship with the client, or forcing the investor
out of the the private fund.
---------------------------------------------------------------------------

    \361\ See proposed rule 202(a)(30)-1, at note to paragraph
(c)(2)(i); supra notes 267-268 and accompanying text.
---------------------------------------------------------------------------

    The proposed modifications may result in some costs for foreign
advisers who might change their business practices in order to rely on
the exemption. Some foreign advisers may have to choose to limit the
scope of their contacts with the United States in order to rely on the
statutory exemption for foreign private advisers or to register with
us. As noted above, we have estimated the costs of registration to be
$11,526.\362\ In addition, registered advisers would incur initial
costs to establish a compliance infrastructure, which we estimate would
range from $10,000 to $45,000 and ongoing annual costs of compliance
and examination, which we estimate would range from $10,000 to
$50,000.\363\ In either case, foreign advisers would assess the costs
of registering with the Commission relative to relying on the
exemption. This assessment, however, would take into account many
factors, which would vary from one adviser to another, to determine
whether registration, relative to other options, is the most cost-
effective business option for the adviser to pursue. If a foreign
adviser limited its activities within the United States in order to
rely on the exemption, the modifications might have the effect of
reducing competition in the market for advisory services. Were the
foreign adviser to register, competition among registered advisers
would increase. Furthermore, to the extent that the modifications
included in the definition of ``investor'' (in particular the one
concerning knowledgeable employees) would limit a foreign adviser's
ability to attract certain private fund investors, those modifications
may have an adverse effect on capital formation.
---------------------------------------------------------------------------

    \362\ See supra note 299 and accompanying text.
    \363\ See supra note 303 and accompanying text.
---------------------------------------------------------------------------

    By referencing the method of calculating assets under management
under Form ADV, certain foreign private advisers would use the
valuation method provided in the instructions to Form ADV to verify
compliance with the $25 million asset threshold included in the foreign
private adviser exemption.\364\ More specifically, proposed instruction
5.b(4) to Form ADV would require advisers to use fair value of private
fund assets for determining regulatory assets under management. Some
foreign advisers to private funds may value assets based on their fair
value in accordance with GAAP or other international accounting
standards, while other advisers to private funds may not use fair value
methodologies.\365\ As discussed above, the costs associated with fair
valuation would vary based on factors such as the nature of the asset,
the number of positions that do not have a market value, and whether
the adviser has the ability to value such assets internally or would
rely on a third party for valuation services.\366\ Nevertheless, we do
not believe that the requirement to use fair value methodologies would
result in significant costs for these advisers to these funds.\367\
Commission staff estimates that such advisers would each incur $1,224
in internal costs to conform its internal valuations to a fair value
standard.\368\ In the event a fund does not have an internal capability
for valuing illiquid assets, we expect that it could obtain pricing or
valuation services from an outside administrator or other service
provider. Staff estimates that the annual cost of such a service would
range from $1,000 to $120,000 annually which could be borne by several
funds that invest in similar assets or have similar investment
strategies.\369\ We request comment on these estimates. Do foreign
advisers that do not use fair value methodologies for reporting
purposes have the ability to fair value private fund assets internally?
If not, what would be the costs to retain a third party valuation
service? Are there certain types of foreign advisers (e.g., advisers to
real estate private funds) that would experience special difficulties
in performing fair value analyses? If so, why?
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    \364\ See supra section II.C.5 of this Release.
    \365\ See supra note 310 and accompanying and following text.
    \366\ See supra notes 322-325 and accompanying paragraph.
    \367\ See supra note 324 and accompanying text.
    \368\ See supra note 325.
    \369\ See supra note 326 and accompanying text.
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    We request comment on the potential costs we have identified above.
Are there costs of the proposed rule that we have not identified?

D. Request for Comment

    The Commission requests comments on all aspects of the cost-benefit
analysis, including the accuracy of the potential costs and benefits
identified and assessed in this Release, as well as any other costs or
benefits that may result from the proposals. We encourage commenters to
identify, discuss, analyze, and supply relevant data regarding these or
additional costs and benefits. For purposes of the Small Business
Regulatory Enforcement Fairness Act of 1996,\370\ the Commission also
requests information regarding the potential annual effect of the
proposals on the U.S. economy. Commenters are requested to provide
empirical data to support their views.
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    \370\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
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VI. Regulatory Flexibility Act Certification

    Pursuant to section 605(b) of the Regulatory Flexibility Act,\371\
the Commission hereby certifies that proposed rules 203(l)-1 and
203(m)-1 under the Advisers Act would not, if adopted, have a
significant economic impact on a substantial number of small entities.
Under Commission rules, for the purposes of the Advisers Act and the
Regulatory Flexibility Act, an investment adviser generally is a small
entity if it: (i) Has assets under management having a total value of
less than $25 million; (ii) did not have total assets of $5 million or
more on the last day of its most recent fiscal year; and (iii) does not
control, is not controlled by, and is not under common control with
another investment adviser that has assets under management of $25
million or more, or any person (other than a natural person) that had
$5 million or more on the last day of its most recent fiscal year
(``small adviser'').\372\
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    \371\ 5 U.S.C. 605(b).
    \372\ Rule 0-7(a) (17 CFR 275.0-7(a)).
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    Investment advisers solely to venture capital funds and advisers
solely to private funds in each case with assets under management of
less than $25 million would remain generally ineligible for
registration with the Commission under section 203A of the Advisers
Act.\373\ We expect that any small adviser solely to existing venture
capital funds that would not be ineligible to register with the
Commission would be able to avail itself of the exemption from
registration under the grandfathering provision. If an adviser solely
to a new venture capital fund could not avail itself of the exemption
because, for example, the fund it advises did not meet the proposed
definition of ``venture capital fund,'' we anticipate that the adviser
could avail itself of the exemption in section 203(m) of the Advisers
Act as

implemented by proposed rule 203(m)-1. Similarly, we expect that any
small adviser solely to private funds would be able to rely on the
exemption in section 203(m) of the Advisers Act as implemented by
proposed rule 203(m)-1. We further believe that these advisers would be
able to avail themselves of the exemption for private fund advisers
regardless of whether our implementing rules required them to calculate
assets under management as proposed approach or under the alternative
method on which we request comment.\374\
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    \373\ Section 203A of the Advisers Act (prohibiting an
investment adviser that is regulated or required to be regulated as
an investment adviser in the State in which it maintains its
principal office and place of business from registering with the
Commission unless the adviser has $25 million or more in assets
under management or is an adviser to a registered investment
company).
    \374\ See supra section II.B.2 of this Release.
---------------------------------------------------------------------------

    Thus, we believe that small advisers solely to venture capital
funds and small advisers to other private funds would generally be
ineligible to register with the Commission. Those small advisers that
may not be ineligible to register with the Commission, we believe,
would be able to rely on the venture fund exemption under section
203(l) of the Advisers Act or the private fund adviser exemption under
section 203(m) of that Act as implemented by our proposed rules. For
these reasons, we are certifying that proposed rules 203(l)-1 and
203(m)-1 under the Advisers Act would not, if adopted, have a
significant economic impact on a substantial number of small entities.
    The Commission requests written comments regarding this
certification. The Commission requests that commenters describe the
nature of any impact on small businesses and provide empirical data to
support the extent of the impact.

VII. Statutory Authority

    The Commission is proposing rule 202(a)(30)-1 under the authority
set forth in sections 403 and 406 of the Dodd-Frank Act, to be codified
at sections 203(b) and 211(a) of the Advisers Act, respectively (15
U.S.C. 80b-3(b), 80b-11(a)). The Commission is proposing rule 203(l)-1
under the authority set forth in sections 406 and 407 of the Dodd-Frank
Act, to be codified at sections 211(a) and 203(l) of the Advisers Act,
respectively (15 U.S.C. 80b-11(a), 80b-3(l)). The Commission is
proposing rule 203(m)-1 under the authority set forth in sections 406
and 408 of the Dodd-Frank Act, to be codified at sections 211(a) and
203(m) of the Advisers Act, respectively (15 U.S.C. 80b-11(a), 80b-
3(m)).

List of Subjects in 17 CFR Part 275

    Reporting and recordkeeping requirements; Securities.

Text of Proposed Rules

    For reasons set out in the preamble, the Commission proposes to
amend Title 17, Chapter II of the Code of Federal Regulations as
follows:

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

    1 . The general authority citation for Part 275 is revised to read
as follows:

    Authority:  15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(11)(H), 80b-
2(a)(17), 80b-3, 80b-4, 80b-6(4), 80b-6(a), and 80b-11, unless
otherwise noted.
* * * * *
    2. Section 275.202(a)(30)-1 is added to read as follows:

Sec.  275.202(a)(30)-1  Foreign private advisers.

    (a) Client. You may deem the following to be a single client for
purposes of section 202(a)(30) of the Act (15 U.S.C. 80b-2(a)(30)):
    (1) A natural person, and:
    (i) Any minor child of the natural person;
    (ii) Any relative, spouse, or relative of the spouse of the natural
person who has the same principal residence;
    (iii) All accounts of which the natural person and/or the persons
referred to in this paragraph (a)(1) are the only primary
beneficiaries; and
    (iv) All trusts of which the natural person and/or the persons
referred to in this paragraph (a)(1) are the only primary
beneficiaries;
    (2)(i) A corporation, general partnership, limited partnership,
limited liability company, trust (other than a trust referred to in
paragraph (a)(1)(iv) of this section), or other legal organization (any
of which are referred to hereinafter as a ``legal organization'') to
which you provide investment advice based on its investment objectives
rather than the individual investment objectives of its shareholders,
partners, limited partners, members, or beneficiaries (any of which are
referred to hereinafter as an ``owner''); and
    (ii) Two or more legal organizations referred to in paragraph
(a)(2)(i) of this section that have identical owners.
    (b) Special rules regarding clients. For purposes of this section:
    (1) You must count an owner as a client if you provide investment
advisory services to the owner separate and apart from the investment
advisory services you provide to the legal organization, provided,
however, that the determination that an owner is a client will not
affect the applicability of this section with regard to any other
owner;
    (2) You are not required to count an owner as a client solely
because you, on behalf of the legal organization, offer, promote, or
sell interests in the legal organization to the owner, or report
periodically to the owners as a group solely with respect to the
performance of or plans for the legal organization's assets or similar
matters;
    (3) A limited partnership or limited liability company is a client
of any general partner, managing member or other person acting as
investment adviser to the partnership or limited liability company; and
    (4) You are not required to count a private fund as a client if you
count any investor, as that term is defined in paragraph (c)(1) of this
section, in that private fund as an investor in the United States in
that private fund.

    Note to paragraphs (a) and (b):  These paragraphs are a safe
harbor and are not intended to specify the exclusive method for
determining who may be deemed a single client for purposes of
section 202(a)(30) of the Act (15 U.S.C. 80b-2(a)(30)).

    (c) Definitions. For purposes of section 202(a)(30) of the Act (15
U.S.C. 80b-2(a)(30)),
    (1) Investor means any person that would be included in determining
the number of beneficial owners of the outstanding securities of a
private fund under section 3(c)(1) of the Investment Company Act of
1940 (15 U.S.C. 80a-3(c)(1)), or whether the outstanding securities of
a private fund are owned exclusively by qualified purchasers under
section 3(c)(7) of that Act (15 U.S.C. 80a-3(c)(7)), except that any of
the following persons is also an investor:
    (i) Any beneficial owner of the private fund that pursuant to Sec.
270.3c-5 of this title would not be included in the above
determinations under section 3(c)(1) and 3(c)(7) of the Investment
Company Act of 1940 (15 U.S.C. 80a-3(c)(1), (7)); and
    (ii) Any beneficial owner of any outstanding short-term paper, as
defined in section 2(a)(38) of the Investment Company Act of 1940 (15
U.S.C. 80a-2(a)(38)), issued by the private fund.

    Note to paragraph (c)(1): You may treat as a single investor any
person that is an investor in two or more private funds you advise.

    (2) In the United States means with respect to:
    (i) Any client or investor, any person that is a ``U.S. person'' as
defined in Sec.  230.902(k) of this title, except that any
discretionary account or similar account that is held for the benefit
of a person in the United States by a dealer or other

professional fiduciary is in the United States if the dealer or
professional fiduciary is a related person of the investment adviser
relying on this section and is not organized, incorporated, or (if an
individual) resident in the United States.

    Note to paragraph (c)(2)(i): A person that is in the United
States may be treated as not being in the United States if such
person was not in the United States at the time of becoming a client
or, in the case of an investor in a private fund, at the time the
investor acquires the securities issued by the fund.

    (ii) Any place of business, in the United States, as that term is
defined in Sec.  230.902(l) of this chapter; and
    (iii) The public, in the United States, as that term is defined in
Sec.  230.902(l) of this chapter.
    (3) Place of business has the same meaning as in Sec.  275.222-
1(a).
    (4) Assets under management means the regulatory assets under
management as determined under Item 5.F of Form ADV (Sec.  279.1 of
this chapter).
    (d) Holding out. If you are relying on this section, you shall not
be deemed to be holding yourself out generally to the public in the
United States as an investment adviser, within the meaning of section
202(a)(30) of the Act (15 U.S.C. 80b-2(a)(30)), solely because you
participate in a non-public offering in the United States of securities
issued by a private fund under the Securities Act of 1933 (15 U.S.C.
77a).
    3. Section 275.203(l)-1 is added to read as follows:

Sec.  275.203(l)-1  Venture capital fund defined.

    (a) Venture capital fund defined. For purposes of section 203(l) of
the Act (15 U.S.C. 80b-3(l)), a venture capital fund is any private
fund that:
    (1) Represents to investors and potential investors that it is a
venture capital fund;
    (2) Owns solely:
    (i) Equity securities issued by one or more qualifying portfolio
companies, and at least 80 percent of the equity securities of each
qualifying portfolio company owned by the fund was acquired directly
from the qualifying portfolio company; and
    (ii) Cash and cash equivalents, as defined in Sec.  270.2a51-
1(b)(7)(i), and U.S. Treasuries with a remaining maturity of 60 days or
less;
    (3) With respect to each qualifying portfolio company, either
directly or indirectly through each investment adviser not registered
under the Act in reliance on section 203(l) thereof:
    (i) Has an arrangement whereby the fund or the investment adviser
offers to provide, and if accepted, does so provide, significant
guidance and counsel concerning the management, operations or business
objectives and policies of the qualifying portfolio company; or
    (ii) Controls the qualifying portfolio company;
    (4) Does not borrow, issue debt obligations, provide guarantees or
otherwise incur leverage, in excess of 15 percent of the private fund's
aggregate 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;
    (5) Only issues securities the terms of which do not provide a
holder with any right, except in extraordinary circumstances, to
withdraw, redeem or require the repurchase of such securities but may
entitle holders to receive distributions made to all holders pro rata;
and
    (6) Is not registered under section 8 of the Investment Company Act
of 1940 (15 U.S.C. 80a-8), and has not elected to be treated as a
business development company pursuant to section 54 of that Act (15
U.S.C. 80a-53).
    (b) Certain pre-existing venture capital funds. For purposes of
section 203(l) of the Act (15 U.S.C. 80b-3(l)) and in addition to any
venture capital fund as set forth in paragraph (a) of this section, a
venture capital fund also includes any private fund that:
    (1) Has represented to investors and potential investors at the
time of the offering of the private fund's securities that it is a
venture capital fund;
    (2) Prior to December 31, 2010, has sold securities to one or more
investors that are not related persons, as defined in Sec.  275.204-
2(d)(7), of any investment adviser of the private fund; and
    (3) Does not sell any securities to (including accepting any
committed capital from) any person after July 21, 2011.
    (c) Definitions. For purposes of this section:
    (1) Committed capital means any commitment pursuant to which a
person is obligated to acquire an interest in, or make capital
contributions to, the private fund.
    (2) Equity securities has the same meaning as in section 3(a)(11)
of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(11)) and Sec.
240.3a11-1 of this chapter.
    (3) Publicly traded means, with respect to a company, being subject
to the reporting requirements under section 13 or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)), or having a
security listed or traded on any exchange or organized market operating
in a foreign jurisdiction.
    (4) Qualifying portfolio company means any company that:
    (i) At the time of any investment by the private fund, is not
publicly traded and does not control, is not controlled by or under
common control with another company, directly or indirectly, that is
publicly traded;
    (ii) Does not borrow or issue debt obligations, directly or
indirectly, in connection with the private fund's investment in such
company;
    (iii) Does not redeem, exchange or repurchase any securities of the
company, or distribute to pre-existing security holders cash or other
company assets, directly or indirectly, in connection with the private
fund's investment in such company; and
    (iv) Is not an investment company, a private fund, an issuer that
would be an investment company but for the exemption provided by Sec.
270.3a-7, or a commodity pool.
    4. Section 275.203(m)-1 is added to read as follows:

Sec.  275.203(m)-1  Private fund adviser exemption.

    (a) United States investment advisers. For purposes of section
203(m) of the Act (15 U.S.C. 80b-3(m)), an investment adviser with its
principal office and place of business in the United States is exempt
from the requirement to register under section 203 of the Act if the
investment adviser:
    (1) Acts solely as an investment adviser to one or more qualifying
private funds; and
    (2) Manages private fund assets of less than $150 million.
    (b) Non-United States investment advisers. For purposes of section
203(m) of the Act (15 U.S.C. 80b-3(m)), an investment adviser with its
principal office and place of business outside of the United States is
exempt from the requirement to register under section 203 of the Act
if:
    (1) The investment adviser has no client that is a United States
person except for one or more qualifying private funds; and
    (2) All assets managed by the investment adviser from a place of
business in the United States are solely attributable to private fund
assets, the total value of which is less than $150 million.
    (c) Calculations. For purposes of this section, private fund assets
are calculated as the total value of such assets as of the end of each
calendar quarter.
    (d) Transition rule. With respect to the calendar quarter period
immediately

following the calendar quarter end date that the investment adviser
ceases to be exempt from registration under section 203(m) of the Act
(15 U.S.C. 80b-3(m)) due to having $150 million or more in private fund
assets, the Commission will not assert a violation of the requirement
to register under section 203 of the Act (15 U.S.C. 80b-3) by an
investment adviser that was previously exempt in reliance on section
203(m) of the Act; provided that such investment adviser has complied
with all applicable Commission reporting requirements.
    (e) Definitions. For purposes of this section,
    (1) Assets under management means the regulatory assets under
management as determined under Item 5.F of Form ADV (Sec.  279.1 of
this chapter).
    (2) Place of business has the same meaning as in Sec.  275.222-
1(a).
    (3) Principal office and place of business of an investment adviser
means the executive office of the investment adviser from which the
officers, partners, or managers of the investment adviser direct,
control, and coordinate the activities of the investment adviser.
    (4) Private fund assets means the investment adviser's assets under
management attributable to a qualifying private fund.
    (5) Qualifying private fund means any private fund that is not
registered under section 8 of the Investment Company Act of 1940 (15
U.S.C 80a-8) and has not elected to be treated as a business
development company pursuant to section 54 of that Act (15 U.S.C. 80a-
53).
    (6) Related person has the meaning set forth in Sec.  275.204-
2(d)(7).
    (7) United States has the meaning set forth in Sec.  230.902(l) of
this chapter.
    (8) United States person means any person that is a ``U.S. person''
as defined in Sec.  230.902(k) of this chapter, except that any
discretionary account or similar account that is held for the benefit
of a United States person by a dealer or other professional fiduciary
is a United States person if the dealer or professional fiduciary is a
related person of the investment adviser relying on this section and is
not organized, incorporated, or (if an individual) resident in the
United States.

    By the Commission.

    Dated: November 19, 2010.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-29957 Filed 12-9-10; 8:45 am]
BILLING CODE P